Effective Tax Rate

Loading the player...

What is the 'Effective Tax Rate'

The effective tax rate is the average rate at which an individual or corporation is taxed. The effective tax rate for individuals is the average rate at which their earned income is taxed. The effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed. An individual's effective tax rate is calculated by dividing total tax expense (line 63 on your 1040 Form) by taxable income (line 22). For corporations, the effective tax rate is computed by dividing total tax expenses by the firm's earnings before taxes. The effective tax rate is the net rate a taxpayer pays if all forms of taxes are included and divided by taxable income.

BREAKING DOWN 'Effective Tax Rate'

The effective tax rate is often a more accurate representation of a taxpayer's tax liability than its marginal tax rate. Two companies that are in the same marginal tax bracket, for example, may end up with different effective tax rates depending on their earnings. This occurs particularly with a progressive, or tiered, tax system, where different levels of income are taxed at different rates. For example, the first $100,000 of income may be taxed at 10%, and income between $100,001 and $500,000 might be taxed at a rate of 15%. The corporation's income is taxed at the various levels, and to determine the effective (or average) tax rate, the total tax is divided by the total taxable income.

RELATED TERMS
  1. Tax Rate

    The percentage at which an individual or corporation is taxed. ...
  2. Tax Base

    The assessed value of a set of assets, investments or income ...
  3. Tax Bracket

    The rate at which an individual is taxed. Tax brackets are set ...
  4. Net Of Tax

    An accounting figure that has been adjusted for the effects of ...
  5. Progressive Tax

    A tax that takes a larger percentage from the income of high-income ...
  6. Federal Tax Brackets

    Income tax groupings specified by the Internal Revenue Service ...
Related Articles
  1. Personal Finance

    Why America's Taxes Are Too Low

    The solution to America's economic woes may not be in lowering taxes further, but may, in fact, lie in increasing them.
  2. Personal Finance

    Explaining Progressive Tax

    A progressive tax is a levy in a tax system where the tax rate increases as the taxable base increases.
  3. Personal Finance

    Understanding Taxes

    Taxes are mandatory fees that individuals and corporations must pay to their governments.
  4. Financial Advisor

    Federal Tax Brackets

    Why do we have income tax brackets? What do they do for us? Read this to understand the basics and where to find your own bracket.
  5. Personal Finance

    The History Of Taxes In The U.S.

    The number of taxes that we now consider a given did not always exist. Find out how they arose.
  6. Personal Finance

    How Getting A Raise Affects Your Taxes

    Many people think they may actually make less overall because they are paying more taxes.
  7. Investing

    Calculating Net of Tax

    Net of tax is a figure that has been adjusted for taxes.
  8. Personal Finance

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  9. Personal Finance

    Highest Corporate Taxes By Sector

    The amount a U.S. company pays in tax depends upon the sector it is in.
  10. Personal Finance

    Breaking Down Taxes For Different Income Brackets

    Here is a useful rundown of how much you will pay in taxes based on your income.
RELATED FAQS
  1. What is the difference between income tax and capital gains tax?

  2. How does the marginal tax rate system work?

    The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. As the marginal tax ... Read Answer >>
  3. How are effective tax rates calculated from income statements?

    Learn how to read an income statement and how to find the information necessary to calculate a company's effective income ... Read Answer >>
  4. Is the marginal tax rate a progressive tax?

    Learn how the marginal tax rate is a progressive tax that takes a higher percentage of income tax from high-income earners ... Read Answer >>
  5. How can I lower my effective tax rate without lowering my income?

    Discover how to reduce your effective tax rate without losing income by maximizing adjustments and deductions, earning tax-free ... Read Answer >>
  6. What's the difference between the marginal tax rate system and a flat tax?

    Find out about the difference between marginal tax rates and flat taxes. Gain insights on both systems and the arguments ... Read Answer >>
Hot Definitions
  1. Glass-Steagall Act

    An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment ...
  2. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  3. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  4. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  5. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  6. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
Trading Center