Marginal Tax Rate

An adviser gathering data wants to verify what a client has said about his marginal tax bracket rather than rely on his recollection. The most useful document to request is

1. A.the most recent statement for the brokerage account the client holds elsewhere.Wrong. It reports holdings and transactions but never the taxable income figure that sets a bracket.
2. B.the most recent federal income tax return the client filed.Correct. Filing status and taxable income appear there together, which is what determines the bracket.
3. C.a credit report obtained from a consumer reporting agency.Wrong. It documents borrowing history and contains no statement of income at all.
4. D.the summary plan description for the retirement plan of his employer.Wrong. That describes the terms of the plan rather than anything about the finances of this client.

Why: Data gathering means corroborating what the client reports, and each document answers only the question it was designed to answer. A federal income tax return shows filing status, taxable income, the treatment of investment income and any carryforwards, which together establish the bracket and much else the plan depends on. A brokerage statement shows holdings and activity but not the income figure that sets the bracket, and a credit report addresses borrowing rather than earning. Where the client had a highly unusual year, the adviser would need to ask whether the return is representative before relying on it.

Tariq Santos expects a fully taxable yield of 8.20% on a $17,209 investment and assumes a 24% marginal tax rate applies to the income. Ignoring other taxes, what is the after-tax yield?

1. A.10.79%This is the taxable-equivalent transformation, which answers the opposite comparison.
2. B.6.23%This multiplies the pretax yield by the percentage retained after tax.
3. C.7.96%This subtracts a decimal tax rate from percentage points of yield, mixing units.
4. D.10.17%This increases yield for taxes instead of reducing the amount retained.

Why: After-tax yield on fully taxable income is the pretax yield multiplied by one minus the applicable tax rate. This calculation answers how much of the stated yield the investor keeps after the assumed tax.

Rosa Ito expects a fully taxable yield of 4.90% on a $93,133 investment and assumes a 16% marginal tax rate applies to the income. Ignoring other taxes, what is the after-tax yield?

1. A.4.12%This multiplies the pretax yield by the percentage retained after tax.
2. B.5.68%This increases yield for taxes instead of reducing the amount retained.
3. C.4.74%This subtracts a decimal tax rate from percentage points of yield, mixing units.
4. D.5.83%This is the taxable-equivalent transformation, which answers the opposite comparison.

Why: After-tax yield on fully taxable income is the pretax yield multiplied by one minus the applicable tax rate. This calculation answers how much of the stated yield the investor keeps after the assumed tax.

Noah Ivanov expects a fully taxable yield of 5.90% on a $13,693 investment and assumes a 40% marginal tax rate applies to the income. Ignoring other taxes, what is the after-tax yield?

1. A.9.83%This is the taxable-equivalent transformation, which answers the opposite comparison.
2. B.8.26%This increases yield for taxes instead of reducing the amount retained.
3. C.3.54%This multiplies the pretax yield by the percentage retained after tax.
4. D.5.50%This subtracts a decimal tax rate from percentage points of yield, mixing units.

Why: After-tax yield on fully taxable income is the pretax yield multiplied by one minus the applicable tax rate. This calculation answers how much of the stated yield the investor keeps after the assumed tax.