What is Effective Tax Rate ?
According to Untied State of America Income Tax Rate there is various tax slab rate on income earned during the relevant year from 1 January to 31 Decembers of every year. Effective Tax Rate is a average tax rate which ultimately paid to Government by a taxpayers. Efective tax rate for individuals is the average rate at which need to pay tax to a taxpayer on his total income earned during the financial year. The effective rate for a corporate tax payer is also the average rate at which its pre tax profit are taxed while the statutory tax rate is the legal percentage established by law. Effective tax typically refers to federal income tax it do not include state taxes, local taxes, property taxes, sales taxes, but it can be computed to reflect an individual’s or a company’s total tax paid during the relevant financial year.
Formula for effective tax rate calculation is
For individual = Total tax paid/ total income earned during the relevant financial year.
For Coporatation + Total Tax paid/ Total income earned before tax during the relevant financial year.
Example
Imagine if a graduated tax system where income tax rate 10% upto $1,20,000, 15% on income between $ 120001 to $3,20,000 and over and above $ 3,20,000 at the rate 25%. Now consider two individuals Mr A & Mr.B who both hit the upper tax rate of 25% although Mr.A had a taxable income of $6,00,000 and the Mr. B had a taxable income of $ 4,00,000
Both individual would pay on their fi 10% on their first $ 1,20,000 of income, tax $12,000 and second slab 15% both would pay their income between $ 1,20,001 to $ 3,20,000 tax $ 30,000. Finally both would pay at the rate 25%on their earnings over and above the income $3,20,000. The individual with income $ 6,00,000
| Computation of effective tax rate | |||
| Particulars | Tax rate | Mr. A | Mr. B |
| Total taxable Income during the financial year | 600,000 | 400000 | |
| First $ 1,20,000 | 10% | 12000 | 12000 |
| Second from $1,20,001 to $3,20,000 up to | 15% | 30000 | 30000 |
| Third Over and above $ 3,20,000 | 25% | 70000 | 20000 |
| Total tax Payable | 112000 | 62000 | |
| Taxpaid/ total taxable income | 11200/600000 | 62000/400000 | |
| Effective tax rate in percentage | 18.67 | 15.5 |
Internal Revenue Services is a tax collection and operation in United State of America.
You can visit on Official website of IRS