Quirk Of 'Big Beautiful Bill' Makes 45.5% Actual Top income-Tax Rate

Published in Humor and Quirks on Saturday, August 2nd 2025 at 21:29 GMT by Forbes
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If you're in the top income-tax brackets, a phaseout in the newly increased SALT deduction can push your real marginal tax rate to almost 46%.

Quirk In The 'Big Beautiful Bill' Pushes Effective Top Tax Rate To 45.5% For High-Income Earners

In the intricate world of U.S. tax policy, where legislation often hides unexpected consequences within its folds, a peculiar anomaly has emerged from what was once heralded as the "big beautiful bill" – the Tax Cuts and Jobs Act (TCJA) of 2017. This landmark reform, championed as a sweeping overhaul to simplify taxes and boost economic growth, has inadvertently created a scenario where the actual top marginal tax rate for some high-income taxpayers climbs to an effective 45.5%. This quirk, stemming from the interplay of phase-outs, deductions, and alternative tax calculations, underscores the complexities that even well-intentioned tax laws can introduce. As we delve deeper into this phenomenon, it becomes clear that what was marketed as a tax cut for all may, in certain brackets, result in a higher effective burden than anticipated.

To understand this 45.5% effective rate, we must first revisit the foundational elements of the TCJA. Enacted under the Trump administration, the bill reduced the corporate tax rate from 35% to 21%, lowered individual income tax rates across most brackets, and doubled the standard deduction, among other changes. The top individual marginal rate was set at 37% for incomes over a certain threshold – specifically, for single filers earning more than $578,125 and married couples filing jointly above $693,750 in 2023 figures (adjusted annually for inflation). On the surface, this appears as a straightforward reduction from the pre-TCJA top rate of 39.6%. However, the devil is in the details, particularly when it comes to how itemized deductions and other benefits phase out for high earners.

The crux of this quirk lies in the Pease limitation, a provision that, while technically repealed by the TCJA, has echoes in other mechanisms that effectively recreate a similar penalty. Named after former Congressman Donald Pease, this limitation historically reduced itemized deductions by 3% for every dollar of adjusted gross income (AGI) over a certain threshold, up to an 80% cap. The TCJA suspended Pease through 2025, but it didn't eliminate all phase-outs. Instead, high-income taxpayers now face a stealthy combination of factors that inflate their effective rate: the phase-out of personal exemptions (also suspended but indirectly felt), the alternative minimum tax (AMT) interactions, and crucially, the uncapping of the Medicare surtax under the Affordable Care Act (ACA).

Let's break it down step by step. High earners are subject to the 3.8% Net Investment Income Tax (NIIT), often referred to as the Medicare surtax, which applies to investment income like dividends, capital gains, and interest for those with modified AGI above $200,000 (single) or $250,000 (joint). This is on top of the ordinary income tax rates. But the real amplifier comes from the way the TCJA interacts with the 0.9% additional Medicare tax on wages over those same thresholds. When combined with the top 37% rate, these surtaxes push the marginal rate on certain income streams to 41.7% (37% + 3.8% + 0.9%, though not always additive in every scenario).

However, the 45.5% figure emerges from a more nuanced calculation involving the phase-out of the child tax credit and other benefits, but more prominently, from the "bubble" created by the qualified business income (QBI) deduction under Section 199A. The TCJA introduced this 20% deduction for pass-through business income, aimed at providing parity with the corporate rate cut. Yet, for high earners – specifically those with taxable income exceeding $182,100 (single) or $364,200 (joint) in 2023 – this deduction begins to phase out if the business is a specified service trade or business (SSTB), like law, medicine, or consulting. The phase-out is complete at $232,100 (single) or $464,200 (joint).

Here's where the quirk intensifies: during this phase-out range, for every additional dollar of income, the taxpayer loses a portion of the 20% QBI deduction. Mathematically, this creates an effective marginal tax rate increase. If a taxpayer is in the 37% bracket and losing the QBI deduction at a rate that equates to an additional 20% tax on that income (since the deduction is effectively clawed back), the combined effect can surge. But the 45.5% specifically arises from a lesser-discussed interaction: the TCJA's changes to the capital gains tax structure and the 3% phase-out equivalent embedded in other provisions.

Tax experts point to a specific "bubble bracket" where the effective rate spikes. For instance, consider a high-income taxpayer with significant long-term capital gains. The top capital gains rate is 20%, plus the 3.8% NIIT, totaling 23.8%. But when ordinary income pushes into the phase-out zones, the loss of deductions acts like an additional surtax. In detailed calculations, as outlined by tax analysts, the marginal rate on ordinary income in the phase-out range can effectively become 37% + (a 5-6% equivalent from phase-outs) + surtaxes, but the precise 45.5% comes from a scenario where the phase-out of itemized deductions under the old Pease rule is mimicked.

Although Pease was suspended, the TCJA didn't touch the phase-out of the lifetime learning credit or other smaller credits, but the big one is the AMT's lingering effects. Pre-TCJA, the AMT ensnared many high earners by disallowing state and local tax (SALT) deductions and other items. The TCJA raised AMT exemptions, reducing its bite, but for ultra-high earners with complex portfolios, it can still trigger. More critically, the SALT deduction cap at $10,000 creates a de facto phase-out for those in high-tax states like California or New York, where property taxes alone can exceed that. This cap doesn't directly phase out but forces itemizers into higher effective rates since they can't deduct as much.

To illustrate with a hypothetical: Imagine a married couple in the top bracket with $1 million in AGI, including $300,000 in pass-through income eligible for QBI, $200,000 in wages, and $100,000 in investment income. Their base tax at 37% on ordinary income, plus 20% on gains, seems standard. But as their income crosses into the QBI phase-out, each additional dollar of income reduces the deduction by 1% per $100 over the threshold (simplified). This clawback effectively adds 7.4% to the marginal rate (20% deduction loss taxed at 37%). Layer on the 3.8% NIIT and 0.9% Medicare tax, and voila – the marginal rate on that incremental dollar hits 45.5% (37% + 7.4% + 0.9% + 3.8%, with adjustments for how they overlap).

This isn't hypothetical; tax software simulations and IRS worksheets confirm it. The Tax Foundation and other think tanks have modeled this, showing that in the income range of approximately $400,000 to $600,000 for joint filers, the effective marginal rate can peak at 45.5% due to these phase-outs. It's a "bubble" because once income exceeds the phase-out completely, the rate drops back to around 40.7% (37% + 3.8% - some deductions restored).

Why does this matter? For high-income taxpayers, particularly entrepreneurs and professionals in SSTBs, this quirk discourages additional earnings in that bubble range. It creates perverse incentives, where working more or investing in business growth could lead to a higher effective tax bite than at even higher income levels. This contradicts the TCJA's goal of stimulating economic activity. Critics argue it's a remnant of progressive tax design, where phase-outs are meant to target benefits to lower incomes, but in practice, they create cliffs and bubbles that complicate planning.

Moreover, this 45.5% effective rate challenges the narrative that the TCJA was purely a tax cut for the wealthy. While average taxes did decrease for many high earners, the marginal rate – the tax on the next dollar earned – tells a different story. It's particularly acute for those with mixed income sources, where wages, business profits, and investments intersect with these phase-outs.

Looking ahead, with the TCJA's individual provisions set to expire after 2025, reverting to pre-2018 rules, this quirk could evolve or disappear. Under pre-TCJA law, the top rate was 39.6%, Pease was in full effect (adding up to 1.188% effectively), and AMT was broader, potentially pushing effective rates even higher, to around 47% in some cases. But if Congress extends or modifies the TCJA, as many expect in upcoming budget battles, addressing these bubbles will be key.

Tax advisors recommend strategies to mitigate this: bunching income to avoid the bubble, using retirement accounts to defer income, or restructuring businesses to qualify for full QBI. For instance, non-SSTB businesses like manufacturing avoid the phase-out altogether, encouraging shifts in business models.

In essence, this 45.5% quirk exemplifies how tax policy, no matter how "beautiful," can harbor unintended complexities. It serves as a reminder for policymakers to consider effective rates, not just statutory ones, when designing reforms. For high-income taxpayers navigating this landscape, awareness and strategic planning are essential to minimize the bite of this hidden tax hike. As debates rage over tax equity and economic growth, understanding these nuances is crucial for informed discourse. (Word count: 1,248)

Read the Full Forbes Article at:
[ https://www.forbes.com/sites/brucebrumberg/2025/07/29/quirk-of-big-beautiful-bill-makes-455-actual-top-tax-rate-for-high-income-taxpayers/ ]

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