Effective Tax Rate - Explained
What is an Effective Tax Rate?
If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.
- Marketing, Advertising, Sales & PR
- Accounting, Taxation, and Reporting
- Professionalism & Career Development
Law, Transactions, & Risk Management
Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
- Business Management & Operations
- Economics, Finance, & Analytics
Table of ContentsWhat is the Effective Tax Rate?Effective Tax Rate vs. Marginal Tax RateAcademic Research on Effective Tax Rate
What is the Effective Tax Rate?
Effective tax rate is the average tax rate applied to a individual or corporations income. Formulas for calculating an effective tax rate are as following; For an individual: Effective tax rate = Total Tax Expense Taxable Income For a corporation: Effective tax rate = Total Tax Expenses Earnings before Taxes For individuals, the total tax expense (taken from line 63 of Form 1040) is divided by her taxable income from line 43. The effective tax rate does not consist of other types of taxes such as sales tax, import or export tax, or property taxes. Sometimes analysts may include excise and other types of taxes while calculating the effective tax rate.
Effective Tax Rate vs. Marginal Tax Rate
The marginal tax rate is the rate which is applied to each additional dollar earned. Tax is levied on different income levels, and the income levels fall into different tax brackets. Marginal income taxes will can fall into the next tax bracket (the marginal rate). Lets assume a tax system where income tax rate is 10% for $100,000, 15% for income from $100,000 to $300,000, and 25% for income over $300,000. Assume both firms fall into the highest tax bracket. However, one firm earned $500,000, while earnings of the other firm are $360,000. Both firms has to pay 10 % or $10,000 on their $100,000 of profit, and both firms pay 15% or $30,000 on profits between $100,000 and $300,000. Both firms also pay 25%on their profits over $300,000. But the tax for one firm is $50,000 and only $15,000 for the other firm. With a total tax of $90,000, the firm with $500,000 in sales pays an 18 percent effective tax rate, while firm with $360,000 in income pays a total income tax of $55,000, making its effective tax rate only 15.2 percent.