How to Calculate Your Effective Tax Rate

Knowing your effective tax rate offers you a clear picture of your tax liability each year.

It’s smart to calculate your effective tax rate each year to 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 if not.

In addition to being useful for planning purposes, your effective tax rate is also a good indicator as to how well you’ve been managing your tax situation.

What Is an Effective Tax Rate?

Your effective tax rate is the percentage of your taxable income that you pay in taxes – essentially an average of the various tax rates at which your income is taxed.

This rate is often calculated 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, certified public accountant and executive vice president of Piascik, an accounting firm in Glen Allen, Virginia. “But states like California, New York, 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 24% tax bracket, for example, but your actual tax liability is based on your effective tax rate. Oftentimes, your effective tax rate is different from your marginal tax rate because your income is taxed at different rates at different income thresholds – making your effective tax rate a more accurate way to understand how much you’re paying in taxes each year.

How to Calculate Your Effective Tax Rate

To calculate your effective tax rate, you need two numbers: the total amount paid in taxes in 2021 and your taxable income in the same year.

Both numbers are easily accessible 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 less the standard deduction ($12,550 if filing single, $25,100 if married filing jointly) or itemized tax deductions and any tax adjustments. This amount is listed on Form 1040, line 15.

Here’s the Formula 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 paid for every additional dollar earned 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.

Your marginal tax rate and your effective tax rate can be the same or different, because that next dollar could push you into a higher tax bracket. But both rates can be useful in financial planning for the future.

“The effective rate is very helpful as far as cash planning and estimating what you need to be paying in via withholding or estimated taxes,” says Larry Harris, director of tax services at Parsec Financial in Asheville, North Carolina. “The marginal rate is more helpful if you’re planning and thinking about, ‘What happens if you have an ordinary income of X dollars more in 2022 on top of what your 2021 number is?’ You know you’re going to be taxed at the marginal rate.”