January 24, 2014 Admin | January 24, 2014 What is your marginal tax rate? What is your effective tax rate? Why should you care?
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Your marginal tax rate is your tax based off your income. As your income increases your marginal tax rate increases.
Your effective tax rate is your average tax rate. To get your effective tax rate you take your total taxes paid and divide it by taxable income.
Because of tax brackets your effective tax rate is a better representation of your tax liability.
Marginal tax is the additional amount of tax that you could end up paying if you have additional higher total income for a year. Your effective rate is another way if saying the market rate. You should always know which tax bracket you are in so that you know what to expect when tax season comes around, there should be no surprises.
Both answers provide insight, now let’s drill down to the specifics.
The marginal tax rate is the tax on your last dollars. If you made $75,000 in gross income as a single person in 2013 this would theoretically identify your marginal tax rate as 25% based on that figure landing in the 25% tax bracket.
Credits and deductions could reduce that amount until at some point you may reach the 15% tax bracket. This deals with federal income tax. You can also add in state income tax when considering your marginal tax rate.
In this example, you might be looking at a marginal tax rate of 33% or more. Why should you care? You can reduce your taxes by that amount when you apply tax deductions to your return. An easy solution would be to invest in your traditional company retirement plan (401k,403b,TSP,457) at work. This will provide you an immediate 33% reduction in taxes based on this scenario.
The effective tax rate is what you ultimately pay in federal income tax in relation to your income. I would encourage you to run the numbers on state income tax as well if that applies. This is the number you are trying to shrink as best you can. Why? So you can use the money you saved in not paying taxes to pay down debt, increase savings/investments, and plan ahead toward your future. Take control of YOUR tax situation!