Average versus marginal tax rates average tax rate a

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Unformatted text preview: has beforetax earnings of $250,000. The tax on these earnings can be found by using the tax rate schedule in Table 1.4: Total taxes due $22,250 $22,250 $22,250 [0.39 ($250,000 $100,000)] (0.39 $150,000) $58,500 $80,750 From a financial point of view, it is important to understand the difference between average and marginal tax rates, the treatment of interest and dividend income, and the effects of tax deductibility. Average Versus Marginal Tax Rates average tax rate A firm’s taxes divided by its taxable income. marginal tax rate The rate at which additional income is taxed. The average tax rate paid on the firm’s ordinary income can be calculated by dividing its taxes by its taxable income. For firms with taxable income of $10,000,000 or less, the average tax rate ranges from 15 to 34 percent, reaching 34 percent when taxable income equals or exceeds $335,000. For firms with taxable income in excess of $10,000,000, the average tax rate ranges between 34 and 35 percent. The average tax rate paid by Webster Manufacturing, Inc., in the preceding example was 32.3 percent ($80,750 $250,000). As a corporation’s taxable income increases, its average tax rate approaches and finally reaches 34 percent. It remains at that level up to $10,000,000 of taxable income, beyond which it rises toward but never reaches 35 percent. The marginal tax rate represents the rate at which additional income is taxed. In the current corporate tax structure, the marginal tax rate on income up to $50,000 is 15 percent; from $50,000 to $75,000 it is 25 percent; and so on, as shown in Table 1.4. Webster Manufacturing’s marginal tax rate is currently 39 percent because its next dollar of taxable income (bringing its before-tax earnings to $250,001) would be taxed at that rate. To simplify calculations in the text, a fixed 40 percent tax rate is assumed to be applicable to ordinary corporate income. Given our focus on financial decision making, this rate is assumed to represent the firm’s marginal tax rate. 30 PART 1 Introduction to Managerial Finance Inter...
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