What Is an Effective Tax Rate?

Definition and Examples of the Effective Tax Rate

Effective tax rate
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Your effective tax rate is the percentage of your overall taxable income that you actually 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 tax bracket.

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’ll pay 22% on just your top dollars—the portion over $40,125 as of the 2020 tax year.

What Is an Effective Tax Rate?

Your effective tax rate is the average of all the various rates you'll pay on increments of your income after taking any deductions that you're entitled to. A single taxpayer is assessed a 10% rate on income up to $9,875 in the 2020 tax year, and this increases to 12%, 22%, 24%, 32%, 35% and 37% tax brackets as their taxable income increases. The 37% rate applies to incomes over $518,400 for single individuals.

Your effective rate would be the average of all these percentages on the income ranges they apply to. It's a cumulative tax burden.

The chart below shows the effective tax rate by income for single individuals for the 2019 tax year, the tax return you'll file in 2020.

How the Effective Tax Rate Works

Two individuals with the same marginal tax rate might have much different effective rates depending on how much over the limit for the top tax bracket that each earns. 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 $8,989 in taxes on $60,000 in income:

  • $987 on the first $9,875 at 10%
  • $3,630 on your income from $9,876 up to $40,125 at 12%
  • $4,372 on the balance over $40,125 up to $60,000 at 22%

The taxpayer who earned $80,000 in taxable income would owe $13,389 in tax:

  • $987 on the first $9,875 at 10%
  • $3,630 on their income from $9,875 up to $40,125 at 12%
  • $8,772 on the balance over $40,125 up to $80,000 because the portion of their income that falls into the 22% marginal tax rate is greater

Your effective tax rate would be 14.9%, or $8,989 divided by $60,000. The taxpayer with $80,000 in taxable income would have an effective tax rate of 16.7%, or $13,119 divided by $80,000. Yet you both have the same marginal tax rate of 22%.

Types of Effective Tax Rates

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.

You can use the same equation with your state taxable income and state taxes owed to determine your effective tax rate at that level.

Effective Tax Rate vs. Marginal Tax Rate

The U.S. tax system with all its tax brackets is progressive. 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 threshold amount. Your effective tax rate is the average rate you pay on all $60,000, and it's 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%  

Pros and Cons of the Effective Tax Rate

Knowing your effective tax rate can help with tax and budgetary planning, particularly if you’re considering a significant change in life such as getting married or retiring. And calculating your state-level effective rate might help you do a little planning if you’re thinking of relocating to another state.

Otherwise, the federal effective rate is more or less just a comparison between you and other taxpayers. It's not the rate you're paying on all your taxed dollars.

How to Get Your Effective Tax Rate

Look at your most recent completed tax return and identify the total tax you owed. You’ll find the number on line 16 of the 2019 Form 1040.

The IRS redesigned Form 1040 twice, once for the 2018 tax year and again for the 2019 tax year. Your total tax appears on line 15 of the 2018 version of the tax return.

Now divide this number by line by what appears on line 11b on the 2019 return, or line 15 of the 2018 Form 1040. Your taxable income appears in these spaces. The result is your effective tax rate.

Do I Need to Pay My Effective Tax Rate? 

You’re not giving the federal government 22% or almost a quarter of what you earn, because you pay that percentage only on your top dollars. And both your effective and marginal rates are based on your taxable income—what’s left after you take the standard deduction or itemize your deductions, and after you claim any above-the-line adjustments to income that you might be entitled to.

The standard deduction for a single taxpayer is $12,400 as of the 2020 tax year, so you might have a gross income of at least $72,400, not $60,000, because that $12,400 comes off your gross income to arrive at your taxable income. You don't pay your effective tax rate on all your income.

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 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. 

Article Sources

  1. Tax Foundation.org. "2020 Tax Brackets." Accessed June 23, 2020.

  2. Tax Policy Center.org. "What Is the Difference Between Marginal and Average Tax Rates?" June 23, 2020.

  3. Center on Budget and Policy Priorities.org. "Policy Basics: Marginal and Average Tax Rates." Accessed June 23, 2020.

  4. IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed June 23, 2020.