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Effective vs. Marginal Tax Rates – Tax Brackets Explained

Understanding marginal and effective tax rates can help taxpayers quickly clarify how much they owe the IRS based on their tax bracket and annual income. The US uses a progressive, marginal tax system, meaning that higher income is taxed at a higher rate, and lower income is taxed at a lower rate. These rates are determined by tax brackets which factor in both filing status and income. 

What is the effective tax rate?

The effective tax rate is the averaged percentage of income that an individual pays in taxes. Once you know your tax liability, this can be calculated by dividing your tax liability by your taxable income. Typically, effective tax rate refers only to federal income taxes. While state taxes can be calculated similarly, some states impose a flat tax, while others do not have any income tax.

What is the marginal tax rate?

The marginal tax rate is the tax rate that would be paid on an additional dollar of income. In our progressive tax system, your tax rate increases as a portion of your income moves into a higher tax bracket. It is important to note that not all income is taxed at your marginal tax rate – your first dollar earned is taxed at the lowest tax rate for the lowest tax bracket, and the last dollar earned will be taxed at the rate of the highest tax bracket for your income. The money earned in between will be taxed at the rate for the range it falls into.

For example, below are the tax rates for single, married filing joint, and head of household filers for the 2022 tax year, for taxable income over each threshold:

Tax RateSingleMarried Filing JointHead of Household

It is also important to note that taxable income includes any subtractions for standard or itemized deductions from your adjusted gross income before the above rates are applied.

Under current tax rates, if a single taxpayer earned $170,000 in taxable income, they would owe the following from each tax bracket:

10%: ($10,275 – $0) x 10% = $1,027.50

12%: ($41,775 – $10,275) x 12% = $3,780.00

22%: ($89,075 – $41,775) x 22% = $10,406.00

24%: ($170,000 – $89,075) x 24% = $19,422.00

Which equals a total tax liability of $34,635.50. To calculate their effective tax rate, we can divide this total by their taxable income ($34,635.50 / $170,000) for an effective tax rate of 20.4%.

What is the difference?

The effective tax rate is a more precise representation of overall tax liability and is usually lower than the marginal tax rate. Given the large ranges of income in each tax bracket, it is possible for two individuals to be in the same tax bracket but have very different effective tax rates.

Should I turn down a raise or work less to avoid going into the next tax bracket?

While reducing your taxable income will reduce your tax liability, opting to earn less will not usually result in a net improvement to your financial situation. One could erroneously think that if they are a single filer earning $170,000 then all their income is taxed at 24%, while if they were to increase their income to $180,000, they would be taxed on all of that income at 32% and end up with less than before! This is simply not true as previously demonstrated – only the portion of income above $170,050 (the 24% tax bracket) would be taxed at the 32% rate.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal, or accounting advice. If you have any questions about tax planning strategies, please do not hesitate to contact us at Lear & Pannepacker.