May 2, 2013
What is the difference between an individual’s marginal tax rate and their effective tax rate?
What is the difference between an individual’s marginal tax rate and their effective tax rate?
Marginal tax rate is the rate of tax that applies to your next amount of income. It is used for decision making with your money. Your effective tax rate is your total taxes paid divided by your income. This percentage shows how much money goes to your taxes.
Right again, Katherine. Think of your marginal tax rate as the taxes you pay on the last dollar you earned for the year. That is the highest federal and state income tax you are paying on your earned income. Use that number to identify how specific deductions can reduce your taxable income. A traditional company retirement plan like a 401K could immediately reduce your marginal tax rate as you place money into your retirement account AND reduce your taxable income.
The effective tax rate should be a primary focus of the individual as he or she works at paying less and less tax based on their tax plan. You have a tax plan right? Focus on understanding all of the tax credits (reduce your tax dollar for dollar) as well as the tax deductions (reduce taxable income) as you review your own personal situation. Education and self sufficiency will take you in the right direction.