What Is an Effective Tax Rate?

Definition and Examples of the Effective Tax Rate

A taxpayer calculates his effective tax rate.
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Your effective tax rate is the percentage of your overall taxable income that you pay in taxes. “Effective” is a tax way of saying “average,” and this rate is usually considerably less than your marginal tax rate, which is hinged to your highest tax bracket.

Your effective rate is the average of all the various rates you’ll pay on increments of your income after taking any deductions you’re entitled to. A relatively easy mathematical equation can help you figure it out.

What Is an Effective Tax Rate?

Your effective tax rate is the average of all the tax brackets the IRS uses for income tiers. To understand your effective rate, you first have to know the IRS’ tax brackets.

The IRS assesses a 10% rate for single filers with income up to $9,875 in the 2020 tax year. After that, you’ll face the following marginal tax rates based on your income: 

  • 12% for incomes of $9,876–$40,125
  • 22% for incomes of $40,126–$85,525
  • 24% for incomes of $85,526–$163,300
  • 32% for incomes of $163,301–$207,350
  • 35% for incomes of $207,351–$518,400
  • 37% for incomes above $518,400

If you are married filing jointly, your marginal tax rates are: 

  • 12% for incomes of $19,751–$80,250
  • 22% for incomes of $80,251–$171,050
  • 24% for incomes of $171,051–$326,600
  • 32% for incomes of $$326,601–$414,700
  • 35% for incomes of $414,701–$622,050
  • 37% for incomes above $622,050

You’d be in the 22% tax bracket if you earn $60,000 in 2020 and you’re single, but you won’t pay 22% of your total income in taxes. You’d pay 22% on just your top dollars—the portion over $40,125 as of the 2020 tax year. 

 The chart below shows the effective tax rate by income for single individuals for the 2020 tax year, the tax return you’ll file in 2021.

How the Effective Tax Rate Works

To calculate your effective tax rate, you divide your income by the taxes you paid. What makes effective tax tricky is that two people in the same tax bracket could have different effective tax rates. 

Here’s an example. Someone who earns $80,000 would pay the 22% rate on $39,875 of their income over $40,125 in 2020, whereas you would only have to pay a 22% rate on $19,875 of your income at $60,000 in taxable earnings. Yet you would both have the same marginal tax rate of 22% and fall into the same tax bracket.

You would owe $8,991 in taxes on $60,000 in income:

  • $988 on the first $9,875 at 10%
  • $3,630 on $9,876 up to $40,125 at 12%
  • $4,373 on $40,126 up to $60,000 at 22%

The taxpayer who earned $80,000 in taxable income would owe $13,390 in tax:

  • $988 on the first $9,875 at 10%
  • $3,630 on $9,876 up to $40,125 at 12%
  • $8,772 on $40,126 up to $80,000

The first person’s effective tax rate would be 14.99%, while the second person’s rate would be 16.74%. The second person has a higher effective tax rate because they made $20,000 more than the first person and therefore paid more taxes.

Your effective tax rate doesn’t include taxes you might pay to your state, nor does it factor in property taxes or sales taxes. It’s only what you owe the federal government in the way of income tax.

Knowing your effective tax rate can help with tax and budget planning, particularly if you’re considering a significant change in life, such as getting married or retiring.

Effective Tax Rate vs. Marginal Tax Rate

The U.S. tax system is known as a “progressive” system because it uses marginal tax rates instead of a single tax rate. The more you earn, the more of a percentage you’ll pay on your top dollars.

At a total taxable income of $60,000, 22% is your marginal tax rate. The marginal rate is applied only to your additional income over a certain tax-bracket threshold amount. Your effective tax rate is the average rate you pay on all $60,000 and is a much clearer indication of your real tax liability.

Effective Tax Rate Marginal Tax Rate
$9,875 taxed at 10% = $987 22% on income over $40,125
$30,250 taxed at 12% = $3,630  
$19,875 taxed at 22% = $4,372  
Average of three rates: 14.9%  

How To Get Your Effective Tax Rate

Look at your most recent completed tax return and identify the total tax you owed on line 24 of the 2020 Form 1040.

The IRS has redesigned Form 1040 three times, once for the 2018 tax year, again for the 2019 tax year, and once more for 2020. Your taxes owed are on a different line in 2020 than they were in 2019. 

Now, divide the number on line 24 by what appears on line 15 (taxable income) of the 2020 Form 1040. The result of that calculation is your effective tax rate.

Do You Need To Pay the Effective Tax Rate on Your Take-Home Pay?

No, you won’t pay the government your effective tax rate on what you earn during the tax year. Rather, you pay the rate on your taxable income, which is what’s left after you subtract from your gross income any deductions (standard or itemized) and above-the-line adjustments.

For example, if your gross income for 2020 was $60,000 and you took the $12,400 standard deduction for a single taxpayer, your taxable income would be $47,600. And this assumes that you’re not eligible for any other tax breaks at all; you’re only taxed on the balance of your income after you take every tax break that you’re eligible to claim.

Key Takeaways

  • The federal tax system is progressive. You pay a higher percentage on spans of your taxable income as that income increases.
  • Your effective tax rate is the average of all the percentages you pay on these spans of income.
  • Your marginal tax rate is the top percentage you pay on your highest dollar.
  • Your effective tax rate tells you the exact percentage of your overall taxable income that you give to the IRS.