Effective Tax Rate

The effective tax rate for an individual is usually the ratio of taxes to adjusted gross income. The effective tax rate thus measures the average rate of taxation for all income. Here's an example of an effective tax rate: assume a taxpayer pays 5% on the first $10,000 ($500) in income and 10% on the second $10,000 ($1,000) in income. The effective tax rate would be $1,500/$20,000, or 7.5%. The effective tax rate can be contrasted to the marginal tax rate, which is the rate paid on each additional dollar in income. The effective tax rate for a corporation is usually income tax expense for financial reporting purposes divided by pretax accounting income. Analysts examine the effective tax rate to determine a company's ability to manage its tax burden. Calculating a corporate effective tax rate raises can raise difficult issues, however, because taxes for reporting purposes and taxes paid will ordinarily not match owing to timing differences.