Edison is getting ready to do his taxes. He is single and lives in New York City

Question

Edison is getting ready to do his taxes. He is single and lives in New York City. Edison earned $110,000 in taxable income in 2015. He reviews the following table, which shows the IRS tax rates for a single taxpayer in 2015. On Annual Taxable Income... The Tax Rate Is... (Percent) Up to $9,225 10.0 From $9,225 to $37,450 15.0 From $37,450 to $90,750 25.0 From $90,750 to $189,300 28.0 From $189,300 to $411,500 33.0 From $411,500 to $413,200 35.0 Over $413,200 39.6 Based on the IRS table, Edison calculates that his marginal tax rate is when his annual taxable income is $110,000. Edison calculates that he owes in income taxes for 2015. Edison then calculates that his average tax rate is , based on the annual income level and the amount of taxes he owes for 2015. After figuring out what he owes in taxes in 2015, Edison decides to ask an accountant for tax advice. The accountant claims that he has found a legal way to shelter $2,000 of taxable income from the federal government. The maximum amount that Edison is willing to pay to learn this strategy and reduce his taxable income by $2,000 is . (Hint: Sheltering some income means finding a legal way to avoid being charged income tax on that income. For example, someone who has $50,000 in taxable income and shelters $10,000 pays income tax on only $40,000.)

Explanation / Answer

The income is $110,000 and hence the amount of tax to be computed is:

Tax = 9225*10% + (37450 - 9225)*15% + (90750 - 37450)*25% + (110,000 - 90750)*28% = 23,871.25

Marginal tax rate = 28%, Average tax rate = 23,871.25/110,000 = 21.70

When taxable income is reduced by 2000, new tax = 9225*10% + (37450 - 9225)*15% + (90750 - 37450)*25% + (108,000 - 90750)*28% = 23311.25

Hence The maximum amount that Edison is willing to pay to learn this strategy and reduce his taxable income by $2,000 is (23,871.25 - 23,311.25) = 560

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