Effective tax rate

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Effective tax rate

The net rate a taxpayer pays on income that includes all forms of taxes. It is calculated by dividing the total tax paid by taxable income.

Effective Tax Rate

The tax rate one pays assuming that one pays a flat rate rather than under a progressive system. Under progressive tax systems, one pays different rates for different amounts in income. For example, one may pay 10% for the first $10,000 of income and 25% for all additional income. In practice this means that one would pay somewhere between 10% and 25%. One calculates the effective tax rate simply by taking the total tax liability, dividing by one's taxable income and multiplying by 100.

Suppose one makes $20,000 in a year and is taxed under the above system. This person pays $1000 (10%) of the first $10,000 and 2500 (25%) of the second $10,000. The total tax liability is $3500, which when divided by the $20,000 of income and multiplied 100, is found to have an effective tax rate of 17.5%.

Effective tax rate.

Your effective tax rate is the rate you actually pay on all of your taxable income. You find your annual effective rate by dividing the tax you paid in the year by your taxable income for the year.

Your effective rate will always be lower than your marginal tax rate, which is the rate you pay on the income that falls into the highest tax bracket you reach.

For example, if you file your federal tax return as a single taxpayer, had taxable income of $75,000, and paid $15,332 in federal income taxes, your federal marginal tax rate would be 28% but your effective rate would be 20.4%. That lower rate reflects the fact that you paid tax on portions of your income at the 10%, 15%, and 25% rates, as well as the final portion at 28%.

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