U.S. Tax Puzzle Answer

First compute the 2014 tax assuming Blonzo skipped moonlighting as a professional dust collector, in which case he has $40,000 of ordinary income. Blonzo takes the standard deduction ($6,200) and one exemption ($3950), leaving him with $38,850 of taxable income. This puts him in the 15% tax bracket according to IRS tables. The 15% tax bracket goes up to $89,350. Of his $8000 of qualified dividends, some is taxed at 0% and the rest at 15%. So Blonzo figures his effective Federal marginal tax rate is only 15%, and so he's feeling motivated to collect dust.

Had Blonzo skipped moonlighting for an extra $1000 of ordinary income, his Federal tax would have been $4,171. But come April 2015, Blonzo finds out that he owes $4,471. The extra tax is 30% of his extra $1000! What happened? Each additional dollar that he earned pushed a dollar of his qualified dividends from the 0% to the 15% rate. So he's really paying 15%+15% on his moonlighting income.

The moral: Your "tax bracket" published by the government is not necessarily your marginal tax rate. If you are using tax software, try computing your true marginal rate by checking how much your last $1000 of income increased your taxes.