Effective Tax Rate

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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.

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RELATED FAQS
  1. How does the effective tax rate for an individual differ from that of a corporation?

    Read about the effective tax rate for individuals when compared with the effective tax rate for corporations, including how ... Read Answer >>
  2. 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 >>
  3. What is the income breakdown for the effective tax rate?

    Read about the effective tax rate, how the marginal income tax brackets affect it and how the denominator in its formula ... Read Answer >>
  4. Is progressive tax the same thing as marginal tax rate?

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  5. Is the marginal tax rate a progressive tax?

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    Discover how to reduce your effective tax rate without losing income by maximizing adjustments and deductions, earning tax-free ... Read Answer >>
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