Effective Tax Rate

AAA

DEFINITION of 'Effective Tax Rate'

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 by taxable income. 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.

INVESTOPEDIA EXPLAINS '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. Income Tax

    A tax that governments impose on financial income generated by ...
  2. Internal Revenue Service - IRS

    A United States government agency that is responsible for the ...
  3. Marginal Tax Rate

    The amount of tax paid on an additional dollar of income. The ...
  4. Taxable Income

    The amount of income that is used to calculate an individual's ...
  5. Tax Bracket

    The rate at which an individual is taxed. Tax brackets are set ...
  6. Progressive Tax

    A tax that takes a larger percentage from the income of high-income ...
Related Articles
  1. How Your Tax Rate Is Determined
    Taxes

    How Your Tax Rate Is Determined

  2. How International Tax Rates Impact Your ...
    Forex Education

    How International Tax Rates Impact Your ...

  3. How does the marginal tax rate system ...
    Investing

    How does the marginal tax rate system ...

  4. How are savings bonds taxed?
    Taxes

    How are savings bonds taxed?

Hot Definitions
  1. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
  2. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
  3. Accelerated Depreciation

    Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years ...
  4. Call Risk

    The risk, faced by a holder of a callable bond, that a bond issuer will take advantage of the callable bond feature and redeem ...
  5. Parity Price

    When the price of an asset is directly linked to another price. Examples of parity price are: 1. Convertibles - the price ...
  6. Earnings Multiplier

    An adjustment made to a company's P/E ratio that takes into account current interest rates. The earnings multiplier is used ...
Trading Center