BizBoost News
Volume 10, Issue 20
For distribution 3/22/21; publication 3/25/21

What is the Difference Between Your Marginal Tax Rate and Your Effective Tax Rate?

Have you heard the phrases “marginal tax rate” (or tax bracket) and “effective tax rate” and wondered what the distinction is between them? In order to explain the difference, it is first important to note that in the United States, we do not pay a flat tax – we are on a graduated system and therefore pay taxes in tiers.

Let’s say that you are a Single filer, and you have taxable income of $60,000 for the 2020 tax year. According to the IRS tax tables, that puts you in the 22 percent tax bracket – in other words, that is your marginal tax rate. Twenty-two percent of $60,000 is $13,200, but luckily, you don’t have to pay that much.  If you calculate the tax based on the 2020 IRS Tax Tables, the amount of tax is $8,990, which is less than the $13,200 based on the 22 percent marginal rate.

This scenario illustrates the difference between your marginal tax rate (tax bracket) and your actual effective tax rate. Even though you would be in the 22% bracket based on $60,000 of income, you do not pay 22 percent flat tax.  You would pay less than that since there is one bracket below your tax bracket: the 12 precent bracket. (There are really two for you math geeks: 12 percent and 0 percent.)

The rate that you actually pay in taxes is your effective tax rate. This rate is unique to you individually and is simple to calculate.  Just take your total tax liability and divide it by your taxable income. In our example, that would be $8,990 / $60,000 = just about 15 percent.  Compare that to the 22 percent marginal rate and it sounds pretty good! 

The effective rate is often more useful because it gives you an average rate you pay on all the money you make during the year. It is much more accurate in terms of gauging what you might owe based on your projected taxable income. In most cases, the effective tax rate is less than the marginal rate.

The marginal tax rate is still helpful to know for tax planning.  For example, you can get a feel for how much potential benefit you could receive from an additional deduction. For example, how much would you benefit from making a $6,000 IRA contribution?  Your taxes would be reduced by $1,320, or 22 percent of $6,000. Looking it up in the tax tables is another way to double-check the math and yields the same savings.  

Understanding the difference between your effective and marginal tax rates makes you a smarter taxpayer!

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Our latest blog article: “What is the Difference Between Your Marginal Tax Rate and Your Effective Tax Rate?” is available now! Subscribe here: [link]

Have you heard the phrases “marginal tax rate” (or tax bracket) and “effective tax rate” and wondered what the distinction is between them? Find out in our latest blog article![link]

Business Tip: While the marginal tax rate is often what you hear about/reference when reviewing your tax situation for the year, the effective rate is really a much more useful indicator. Learn more about the difference here!   [link]

Marginal and effective tax rates are both useful, but serve different purposes when trying to understand your tax situation. Find out how these two differ and which one is best to use in our latest blog article here.: [link]

DID YOU KNOW… While the marginal tax rate helps you to get a feel for where your tax situation might land (and how certain deductions might help your overall situation), the effective tax rate will be more accurate in terms of nailing down what your overall tax liability might look like for the year. Learn how these calculations differ here: [link]

DID YOU KNOW… The tax brackets used for marginal tax rates cover a range of income and you pay tax on a graduated system based on where your income falls within the range applicable to you. Therefore, the effective tax rate is much more useful in understanding your specific tax situation, as you can calculate based on your unique position. Learn how to calculate these tax rates here: [link]

You can determine your effective tax rate by taking your total tax liability and dividing it by your taxable income. Click here to learn why your effective tax rate is more useful than the more common marginal tax rate. [link]

Sign up for our newsletter to learn how the marginal tax rate and effective tax rate differ, and how you can gain a better understanding of your unique tax situation.: [link]