Unlike the federal income tax, which has a tiered marginal rate system, there are no specific income tiers when calculating the effective tax rate. This rate changes for every individual or corporation based on their taxable income and total tax expenses. All forms of taxable income are included in the effective tax rate formula, and any income generated tax-free – such as proceeds from a home sale – are excluded.

Marginal Income Brackets and the Effective Tax Rate

The Internal Revenue Service posts the income breakdown for federal tax brackets on its website. The federal government uses a progressive tax code, whereby the percentage of income that the IRS takes increases as the amount of adjusted gross income increases. For example, the first $10,000 might be taxed at 10%, while any income earned in excess of $500,000 might be taxed at 40%.

An individual's effective tax rate equals his total tax burden divided by his adjusted gross income. Even though there are no official tiers for the effective tax rate, the marginal brackets do impact the effective rate.

For instance, suppose that an individual earns $100,000 and pays $20,000 in taxes. His highest marginal tax bracket might be much larger than 20%, but he only ended up paying 20% because part of his income fell into a lower marginal rate.

Calculating Adjusted Gross Income

The denominator in the effective tax rate formula, adjusted gross income, only takes into account taxable income or tax base. Most individuals have a lower adjusted gross income than they actually earned because they can take advantage of deductions, adjustments and exemptions in the IRS tax code.

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