What is the effective tax rate? Definition, examples & more

The IRS processes millions of tax returns each year. While each federal tax return is unique, there’s at least one metric they have in common—the effective tax rate.

The effective tax rate represents the share of income that a person or corporation pays after accounting for tax breaks such as credits, deductions and exemptions. Why does this matter? Because it accurately reflects the amount of federal taxes you pay, while your tax bracket may not.

Key takeaways

  • The effective tax rate gives you an idea of how much you owe—as a percentage—to the IRS in a given year.
  • Your effective tax rate is based on the federal government’s marginal tax rates, which are set each year.
  • Marginal tax rates fall into seven tax brackets, ranging from 10% to 37% for the 2023 tax year, and are based on annual income.
  • Effective tax rates are lower than marginal tax rates, thanks to deductions and other tax breaks.

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How the effective tax rate works

The effective tax rate is the average tax rate paid by a person or corporation. It’s shown as a percentage and represents the share of a person’s or corporation’s income that will go toward federal taxes.

To figure out their effective tax rate, individuals must know two numbers: their gross annual income and their tax liability for that year.

Effective tax rate vs. marginal tax rate

The effective tax rate and marginal tax rate are related but not the same.

The marginal tax rate refers to the taxation rate based on your income tax bracket. Marginal tax rates for 2023 range from 10% for taxpayers in the lowest tax bracket to 37% for taxpayers in the highest tax bracket.

But this rate doesn’t apply to all of your income. Portions of your income will be taxed at the corresponding tax rate. So, you’ll pay the lowest tax rate for the first dollar you earn—10% for the first $10,275 for single filers or $20,550 for married joint filers. Each dollar after will be taxed at the rate for its bracket, up to your last dollar in the highest bracket.

A taxpayer’s effective tax rate is usually lower than their marginal tax rate. In other words, someone in the 24% tax bracket typically doesn’t hand over 24% of their annual income to the IRS. Instead, their effective tax rate might be 18%, meaning they’re paying 18% of their taxable income to the federal government.

Marginal tax rates for 2023

Every year, the IRS adjusts the marginal tax rates to account for inflation. A person’s marginal tax rate falls into one of seven brackets, based on their income.

The following table shows the 2023 marginal tax rates for single taxpayers and married taxpayers filing jointly.

Marginal tax rate Total income for single filers Total income for married couples filing jointly
10% $10,275 or less $20,550 or less
12% $10,276 to $41,775 $20,551 to $83,550
22% $41,776 to $89,075 $83,551 to $178,150
24% $89,076 to $170,050 $178,151 to $340,100
32% $170,051 to $215,950 $340,101 to $431,900
35% $215,951 to $539,900  $431,901 to $647,850 
37% $539,901 or higher  $647,851 or higher

How to calculate effective tax rate

An individual can use a simple formula to calculate their effective tax rate. Divide the amount of taxes due—line 24 on IRS Form 1040—by the amount of taxable income—line 15 on IRS Form 1040.

Formula for calculating effective tax rate.

Taxable income is the portion of gross income that’s subject to taxes before deductions and other tax breaks. For an individual, taxable income—or adjusted gross income—generally includes items like salary or wages, tips, bonuses, sales commissions, unemployment benefits, interest on bank accounts, investment dividends and gains from investment sales.

Corporations calculate their effective tax rate by dividing their tax burden by their pre-tax earnings.

Effective tax rate example

The effective tax rate varies by a person’s income, tax breaks and other factors. Here’s an example of how it works.

Let’s say your taxable income for the year totals $75,000 and you paid $11,250 in taxes. You would divide the amount paid in taxes ($11,250) by your taxable income ($75,000) to get an effective tax rate of 15%.

Example of calculating effective tax rate.

Effective tax rate in a nutshell

Taxes can be confusing. That’s why many people turn to professionals for help with their federal tax returns. Whether you ask an adviser or take a DIY approach to filing, it’s helpful to figure out what your effective tax rate is.

With tax season approaching, here’s what you need to know about filing taxes.

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