Effective Tax Rate


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.


Loading the player...

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.

  1. Income Tax

    A tax that governments impose on financial income generated by ...
  2. Tax Bracket

    The rate at which an individual is taxed. Tax brackets are set ...
  3. Marginal Tax Rate

    The amount of tax paid on an additional dollar of income. The ...
  4. Internal Revenue Service - IRS

    A United States government agency that is responsible for the ...
  5. Progressive Tax

    A tax that takes a larger percentage from the income of high-income ...
  6. Taxable Income

    The amount of income that is used to calculate an individual's ...
Related Articles
  1. Taxes

    What is the Effective Tax Rate?

    The effective tax rate is the average rate at which an individual or corporation is taxed per year.
  2. Taxes

    How Your Tax Rate Is Determined

    Feel like the government always has its hand in your pocket? Learn the theory behind how it decides how much to take.
  3. Forex Education

    How International Tax Rates Impact Your Investments

    International investors need to be aware of the staggering correlation between tax rates and economic performance.
  4. Taxes

    The 5 Countries Without Income Taxes

    Discover information on some of the best countries to consider relocating to that offer the financial benefit of charging no income tax.
  5. Taxes

    Tax Haven Vs. Tax Shelters: Is There a Difference?

    Learn about the difference between tax havens and tax shelters, and how both are used to reduce tax liability or avoid paying taxes altogether.
  6. Savings

    The Top Seven 529 Plans for 2015

    With so many choices and so many features (tax advantages, fees, annualized returns) to consider, it's hard to know which 529 plan to choose. Here's help.
  7. Fundamental Analysis

    7 Ways to Create a Tax-Efficient Portfolio

    Taxes may be a necessary evil, but that doesn't mean they can't be reduced. Here's a host of smart moves today's investors can make.
  8. Economics

    Explaining Fair Market Value

    Fair market value is the price at which a buyer and seller are willing to exchange a good.
  9. Taxes

    4 Reasons Why Delaware Is Considered a Tax Shelter

    Understand what a tax shelter is and how one is normally created. Learn about Delaware and the top five reasons why it's considered a tax shelter.
  10. Mutual Funds & ETFs

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  1. How does the effective tax rate for an individual differ from that of a corporation?

    There is not much difference between the method of calculating or meaning behind the effective tax rate for individuals on ... Read Full Answer >>
  2. How do I calculate my effective tax rate using Excel?

    Your effective tax rate can be calculated using Microsoft Excel through a few standard functions and an accurate breakdown ... Read Full Answer >>
  3. Which state generates the most tax revenue from marijuana sales?

    As of 2015, Colorado generates the most tax revenue from marijuana sales. The first state in the nation to legalize recreational ... Read Full Answer >>
  4. 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 Full Answer >>
  5. Why is the Cayman Islands considered a tax haven?

    The Cayman Islands is one of the most well-known tax havens in the world. Unlike most countries, the Cayman Islands does ... Read Full Answer >>
  6. Why is Luxembourg considered a tax haven?

    Luxembourg has been the tax haven of choice for many corporations and mega-rich individuals around the world since the 197 ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!