Your effective tax rate is a good indicator of how well you’ve been managing your tax situation. It’s smart to calculate your effective tax rate each year to help you make adjustments to your withholding amount and budget for the year ahead. Your tax preparer may provide you with your effective tax rate, but it’s simple to calculate on your own.
[Related:How to Find a Reputable Tax Preparer Near You]
What Is an Effective Tax Rate?
Your effective tax rate is the percentage of your taxable income you pay in taxes — essentially an average of the various rates at which your income is taxed.
You can calculate the rate using only your federal tax liability, but experts say it’s wise to add in state and local taxes to get a full picture.
“A lot of people are focused primarily on the federal effective rate because some states don’t have a personal income tax,” says Ryan L. Losi, a CPA and the executive vice president of Piascik, an accounting firm in Glen Allen, Virginia. “But in states like California, New York and New Jersey, they’re creeping up into double digits.”
It’s a common misconception that your marginal tax rate, which determines your tax bracket, is what you pay in taxes. You may fall in the 22% tax bracket, for example, but your full income isn’t taxed at 22%.
[Related:Filing 2024 Taxes: What’s My Tax Bracket?]
Your income is taxed at different rates for different income thresholds. If you’re single, the first $11,000 in taxable income earned in 2023 is taxed at 10%, from $11,001 to $44,725 is taxed at 12%, and from $44,726 to $95,375 is taxed at 22%. The income cut-offs for each level are different for people filing jointly or as head of household — see the IRS federal income tax rate and brackets tables for details.
Your effective tax rate measures the portion of your income you paid in taxes overall, making it a much more accurate way to understand the impact of taxes each year.
How to Calculate Your Effective Tax Rate
To calculate your effective tax rate, you need two numbers: the total amount you paid in taxes and your taxable income for that year.
You can access both numbers on your tax return.
Your total tax is located on Form 1040, line 24 of your federal tax return.
Your taxable income is your gross income minus the standard deduction or your itemized deductions.
For the 2023 tax year, the standard deduction is $13,850 if you’re single or married filing separately, $20,800 for head of household filers, and $27,700 if you’re married filing jointly.
Taxpayers age 65 and older get an extra $1,850 if they are single or filing as head of household, or $1,500 each if they are married filing jointly. Your taxable income is listed on line 15 of Form 1040.
[Read: Married Couples: Is It Better to File Taxes Jointly or Separately?]
For the 2024 tax year, the standard deduction increases to $14,600 for single filers, $21,900 for head of household filers and $29,200 for joint filers, plus $1,950 for taxpayers 65 and older who are single or filing as head of household, or $1,550 each if they are married filing jointly.
Effective Tax Rate Formula
This is the formula you need to use to calculate your effective tax rate:
Effective Tax Rate = Total Tax ÷ Taxable Income.
Effective Tax Rate vs. Marginal Tax Rate
While an effective tax rate represents the percentage of your taxable income allocated to taxes, your marginal tax rate is the amount of additional tax you pay on each additional dollar you earn as income.
If your marginal tax rate is 24%, for example, that means 24% of the next dollar you earn — 24 cents — will be taken as tax. This number typically equates to your tax bracket.
Both your marginal tax rate and your effective tax rate can be useful for financial planning.
“The effective tax rate is useful in planning and estimating the amount of taxes you need to withhold from your paycheck or pay through estimated taxes,” says Tracie L. Miller, a CPA and program chair at Franklin University in Columbus, Ohio. “It’s a quick, easy way to get a general rule-of-thumb for how much you pay in taxes on average.”
“The marginal tax rate, though, is helpful in thinking about future earnings,” Miller says.
“For example, suppose you are considering taking a new job with a significant pay raise. This new job could move you into a higher tax rate, which would increase your marginal tax rate. You would want to know that your marginal tax rate is going up so you can understand the tax implications of the new job. The marginal rate tells you what each additional dollar you earn over what you earned last year will be taxed at,” she says.
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How to Calculate Your Effective Tax Rate originally appeared on usnews.com
Update 04/12/24: This story was previously published at an earlier date and has been updated with new information.
