Effective Tax Rate

Written by Fmi.Online Friday January 6, 2023
Effective tax rate is the average percentage that companies and individuals pay in taxes on their taxable income. It’s typically calculated by dividing total taxes paid by the total taxable income. In other words, this is the rate that you are actually paying on your total income, not your marginal or bracket rate.

Explanation :

  Often, the effective rate for individuals pertains only to income taxes without including other types of taxes. However, financial analysts include all sorts of taxes when calculating the burden tax on a firm, thus being able to perform a comparison between firms that operate in the same industry. Since the tax code treats individuals and companies differently, each effective tax rate formula is slightly different. Individuals calculate their rate by dividing taxes paid by taxable income. Companies, on the other hand, typically divide their tax expenses by EBIT.

In a nutshell :

  • Effective tax rate represents the percentage of their taxable income that individuals pay in taxes.
  • For corporations, the effective corporate tax rate is the rate they pay on their pre-tax profits.
  • Effective tax rate typically refers only to federal income tax, but it can be computed to reflect an individual's or a company's total tax burden.
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