Calculating Effecte Tax Rates and Brackets
1. Understand Marginal vs. Effective Tax Rates
- Marginal Tax Rate: This is the rate applied to your last dollar earned. In a progressive system like in the U.S., your income is divided across brackets, each taxed at different rates. For instance, income up to a certain threshold might be taxed at 10%, then income above that at 12%, and so on.
- Effective Tax Rate: This is the average rate at which your total income is taxed. To find it, divide total tax paid by your gross income. This gives a more accurate picture of the tax burden than the marginal rate since not all income is taxed at the highest rate you fall into.
2. Calculating Effective Tax Rate
To get an effective tax rate, sum up taxes owed for each bracket portion of your income, then divide that total by your gross income. For example, if you’re a single filer with a taxable income of $115,000, the first $11,000 might be taxed at 10%, the next portion at 12%, and so on, progressively adding to your tax owed. This average rate will generally be lower than your highest (marginal) tax rate because of the tiered structure.
3. Consider Tax Deductions and Credits
- Deductions (like standard or itemized deductions) reduce taxable income, potentially lowering both marginal and effective rates. Contributing to retirement accounts or deducting mortgage interest are common methods.
- Credits (e.g., earned income tax credit) reduce your tax liability directly, which can notably impact the after-tax income calculation. Credits are subtracted from the total tax owed after calculations from marginal rates