An effective tax rate represents the rate of tax as a percentage of your total income, before any exemptions, deductions or other adjustments. In nearly all cases, the effective tax rate will be less -- sometimes much less -- than the marginal rate charged on net taxable income. Calculating your effective rate is a short, easy exercise that will lend some useful perspective on how much tax you're really paying.
Calculating Your Gross
The first part of your tax return adds up your total income over the year. This number includes wages, commissions, tips, rents, and royalties. It also includes investment income, such as interest earned on bonds or capital gains from the sale of stocks or other assets. Any self-employment income you may have earned, or business income earned as a sole proprietor, is added to your gross income. This is the number used, before any adjustments allowed by the Internal Revenue Service, to calculate your effective tax rate.
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The adjustments to income result in your net taxable income. Adjustments start with exemptions and deductions, which can be significant if you're itemizing. Even if you don't itemize, you can choose a standard deduction that amounted to $6,200 for individuals and $12,400 for married filers in 2014. You can also deduct contributions to qualified savings accounts, such as individual retirement accounts, and charitable contributions. Under certain conditions, the IRS also allows the deduction of student loan interest, tuition and educational fees, moving expenses and alimony.
Getting to Line 61
Calculating taxable income means subtracting all adjustments from gross income. The tax due on this amount may be further reduced by credits, such as the child tax credit, the foreign tax credit and residential energy credits. The total tax due after all adjustments appears on line 61 of your return. If you're curious about the rate of income tax on everything you've earned, before adjustments, you can calculate an effective tax rate. While there are six tax brackets with fixed rates for everyone, the effective rate will be different for every tax return.
To figure the effective tax rate, divide the amount on line 22 into the total tax bill showing on line 61. If your taxable income is $150,000, your marginal rate is 28 percent -- the rate on your last dollar of income. However, if your gross income is $150,000 but your total tax bill -- after deductions and credits -- is $15,000, your effective rate is 10 percent, which is less than half the marginal rate. The many deductions and credits allowed in federal law complicate tax return preparation, but they also reduce the effective tax rate for the vast majority of taxpayers.