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Assume that Joe, who is single, has a marginal tax rate of 37 percent and decides to make the election to include preferentially taxed capital and qualified dividends as investment income. What rate must Joe use when calculating the tax on these two items?

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To address the problem presented, let's break down the key concepts and the calculation process step-by-step.

1. Understanding Marginal Tax Rate:
Joe's marginal tax rate is 37 percent. This rate applies to the highest portion of his income. The marginal tax rate is the rate of tax applied to his last dollar of income.

2. Preferentially Taxed Capital Gains and Qualified Dividends:
Typically, long-term capital gains and qualified dividends are taxed at preferential rates that are lower than ordinary income tax rates. In the United States, these rates are generally 0%, 15%, or 20% depending on income levels.

3. Election to Include in Investment Income:
When Joe decides to make the election to include preferentially taxed capital gains and qualified dividends as investment income, he essentially chooses to have these items taxed at his marginal tax rate instead of the preferential rates.

4. Calculation of Tax Rate:
Since Joe is making this election, the rate used for taxing his capital gains and qualified dividends is then his marginal tax rate, which is 37 percent.

Summarizing the procedure, we conclude that:

- Joe's marginal tax rate is 37%.
- By making the election, he includes his capital gains and qualified dividends in his investment income.
- As a result, the rate he must use to calculate the tax on these capital gains and qualified dividends is 37 percent.

This means that, due to the election he made, Joe will not benefit from the favorable tax rates usually applied to capital gains and qualified dividends; instead, these will be taxed at his marginal tax rate.
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