What Is the Effective Tax Rate
How to Calculate Your Effective Tax Rate and Why It Matters
You’ll earn $60,000 in 2019 and you’re single, so you’re in the 22% tax bracket, right? You would think that means you’ll pay 22% of your income in taxes.
It’s true that you’ll pay 22% on your top dollars—the portion you earn over $39,475 as of the tax year 2019—but you won’t pay this much on all your income. Your effective tax rate is the true measure of how much you’ll give the IRS. “Effective” is a tax way of saying “average,” and it’s usually considerably less than your marginal tax rate, which is hinged to your tax bracket. Your effective tax rate works out to the percentage of your overall taxable income that you actually pay in taxes.
The chart below shows the 2019 effective tax rate by income for single individuals.
Marginal Tax Rate vs. Effective Tax Rate
The U.S. tax system is progressive. Increments of your income are taxed at different rates, and the more you earn, the more of a percentage you’ll pay on your top dollars.
As of 2019, you’ll pay only 10% on income up to $9,700 if you’re single. Then you’ll pay 12% on the portion of your income from $9,701 up to $39,475. The balance of your income—$20,525 in the example of $60,000 in overall taxable income—is what’s taxed at that 22% rate.
22% is your “marginal” tax rate. It’s applied to your additional income over a certain threshold amount. Your effective tax rate, on the other hand, is the average rate you pay on all $60,000. It’s a much clearer indication of your real tax liability.
How to Calculate Your Effective Tax Rate
The equation for figuring out your effective tax rate is really very simple. Look at your completed tax return and identify the total tax you owed. You’ll find this number on line 15 of the new 2018 Form 1040. Now divide this number by line by what appears on line 10, your taxable income. The result is your effective tax rate. That’s it. It’s that easy.
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 all about what you owe the federal government in the way of income tax. But you can use the same equation using your state taxable income and state taxes owed to determine your effective tax rate at that level.
Two individuals with the same marginal tax rate might have much different effective tax rates depending on how much over the top tax bracket each earns. Although you would only have to pay a 22% rate on $20,525 of your income at $60,000 in taxable earnings, someone who earns $80,000 would pay the 22% rate on $40,525 of his income, even though you have the same marginal tax rate and fall into the same tax bracket.
For example, you would owe $9,057 in taxes on $60,000 in income: $970 on the first $9,700 plus $3,572 on your income up to $39,475, and $4,515 on the balance. As for that guy who earned $80,000 in taxable income, he would owe $13,457 in tax: $970 plus $3,572 plus $8,915, because the portion of his income that falls into the 22% marginal tax rate is greater.
Your effective tax rate would be 15%, or $9,057 divided by $60,000. The taxpayer with $80,000 in taxable income would have an effective tax rate of almost 17%: $13,457 divided by $80,000. But you both have the same marginal tax rate of 22%.
Remember, It’s Taxable Income
The number that appears on line 10 of the 2018 Form 1040 isn’t the entirety of what you earn. We used $60,000 and $80,000 taxable income figures in this scenario, but in all likelihood, you and the other taxpayer earned a fair bit more than this.
Both your effective and marginal tax 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 you might be entitled to. The standard deduction for a single taxpayer is $12,200 as of 2019, so you might have a gross income of at least $72,200—not $60,000—assuming that you’re not eligible for any other tax breaks at all. Your gross income works out to $60,000 plus the $12,200 standard deduction you could subtract from what you earned. You’re only taxed on the balance of your income after you take every tax break you’re eligible to claim.
How to Use Your Effective Tax Rate
Why does your effective tax rate matter? Mostly, it might just make you feel better as you pay Uncle Sam. You’re really not giving the federal government 22% or almost a quarter of what you earn.
Knowing your effective tax rate can help with tax and budgetary planning as well, 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.
IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2019," Accessed Oct. 3, 2019.