Effective Tax Rate

Key Takeaways

• Effective tax rate is the actual percentage of your income that you pay in federal income taxes, calculated by dividing total tax paid by total gross income
• Your effective tax rate and your marginal tax rate are different as marginal tax rate refers to the rate you pay on your last dollar of income while effective rate represents your average rate across all income
• Effective tax rate calculation involves dividing total federal income tax paid by total income from all sources including salaries, investments, capital gains, rental income, and business income
• Standard deduction of $15,750 for single filers in 2025 ($31,500 for married filing jointly, $23,625 for head of household) reduces taxable income before tax calculation
• Progressive tax brackets mean different portions of income are taxed at different rates ranging from 10% to 37%, resulting in effective rates typically lower than top marginal rates
• Tax credits and deductions lower effective tax rate by reducing either taxable income (deductions) or tax owed directly (credits)
• Businesses calculate effective tax rate differently by dividing corporate income tax paid by pre-tax earnings, with the corporate tax rate at 21% for 2025
• Understanding effective tax rate is useful for evaluating true tax burden, comparing tax situations across years, and assessing the impact of tax planning strategies

Effective Tax Rate Definition

Your effective tax rate is the actual rate of tax you pay on your income. To be more specific, it's the percentage of your income that you pay in federal income taxes. Typically, that doesn't include other taxes like Medicare, Social Security, and state taxes, or others like sales tax that are unrelated to your income.

You might be in the income bracket where you pay a 37% income tax, for example, but a lot of your income is still taxed less than that. The standard deduction alone is $15,750 in 2025, so your effective rate might be lower.

How Do You Calculate Your Effective Tax Rate?

To calculate your effective tax rate, start by adding up the total amount that you pay in federal income tax. Then, calculate your total income including:

• Income from salaries
• Investment income and dividends
• Capital gains
• Rental income
• Business or self-employment income
• Interest income
• Any other taxable income (such as bonuses, royalties, or pensions)

Divide your total tax by the total income, multiply it by 100 and you have your effective tax rate.

Effective Tax Rate Example

Let's say you have a total income of $80,000. After the standard deduction of $15,750 for single filers in 2025, that leaves a total taxable income of $64,250. Applying the 2025 tax brackets, you get:

• 10% on the first $11,925 → $1,192.50
• 12% on the next $36,550 ($48,475 − $11,925) → $4,386.00
• 22% on the remaining $15,775 ($64,250 − $48,475) → $3,470.50

Your total federal tax is: $1,192.50 + $4,386.00 + $3,470.50 = $9,049.00

That means your effective tax rate is: $9,049 ÷ $80,000 = 11.3%

How Does Effective Tax Rate Work for Businesses?

Businesses calculate their effective tax rate by taking the total amount that they pay in corporate income tax and dividing that by their total pre-tax earnings. In that case, your business might be subject to a 21% corporate income tax, but after deductions the effective rate could be lower.

What's the Difference Between Effective Tax Rate and Marginal Tax Rate?

Whereas your effective tax rate is the rate of federal income tax you pay overall, your marginal tax rate is the rate of tax you pay on your last dollar of income.

What's the difference? Your effective tax rate is calculated by including all your income and every dollar you pay in federal income tax. Your marginal tax rate, by contrast, is calculated based on the highest rate of tax you pay.

For example, suppose you earn $100,000 a year: 

• Your effective tax rate would be approximately 13.5%, since lower portions of income are taxed at 10% and 12% rates, with only a portion reaching the 22% rate, and the first $15,750 isn't taxed due to the standard deduction. 
• Your marginal tax rate is 22%, because that's the rate applied to your last dollar of income after accounting for the standard deduction.

Both are still important measures. Your effective tax rate is often the best measure of your overall tax burden, but if you're wondering how much you can expect to take home from any extra income then your marginal rate will likely be a better indicator.