What is the Effective Tax Rate?
What will be an ideal response?
The effective tax rate is the average rate at which an individual is taxed on earned income, or the average rate at which a corporation is taxed on pre-tax profits
.
The formulas for effective tax rate are as follows:
Individual: Total Tax Expense / Taxable Income
Corporation: Total Tax Expense / Earnings Before Taxes
Effective tax rates simplify comparisons among companies or taxpayers. This is especially true where a progressive, or tiered tax system is in place. Those subject to progressive taxes will see different levels of income taxed at different rates. The following is a hypothetical example:
Company AAnnual Pre-Tax Earnings = $600,000Total Taxes Paid = ($100,000 10% + $400,000 15% + 100,000 * 25%) = $95,000Effective Tax Rate = $95,000 / $600,000 = 15.8%
Company BAnnual Pre-Tax Earnings = $900,000Total Taxes Paid = ($100,000 10% + $400,000 15% + $400,000 * 25%) = $170,000Effective Tax Rate = $170,000 / $900,000 = 18.9%
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