When it comes to figuring out how much you’ll pay to the IRS, it helps to understand the difference between marginal and effective tax rates. Marginal tax rate is the rate of tax imposed and is based on your income. Your effective tax rate is the percentage of your income you actually pay in taxes.
Knowing how to calculate marginal vs. effective tax rate can give you perspective on how much you’re paying in taxes. You can also use the comparison between the two to look for opportunities to maximize tax savings.
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Marginal vs Effective Tax Rate: What’s the Difference?
Comparing effective vs. marginal tax rate can be a useful way to see what you’re paying in taxes compared to how you’re being taxed. In terms of the key differences, here are some of the most important things to know when assessing marginal tax rate vs. effective tax rate.
• Purpose. Marginal tax rates determine the tax rate that you’re subject to, based on your income. Your effective tax rate reflects the percentage of income you pay in taxes.
• Calculation. Your marginal tax rate is calculated by applying the appropriate tax rate to each level of income you have. Effective tax rates are calculated by dividing your tax liability by your taxable income.
• Range. Marginal tax rates range from 10% to 37%. There is no upper or lower limit for effective tax rates; they’re typically lower than marginal tax rates.
• Application. Your marginal tax rate can give you an idea of how much tax you’re likely to pay in dollar amounts, based on your filing status and what you earned for the year after deductions and exemptions are taken out. The effective tax rate lets you see how big (or small) a share of your income went to taxes.
| Marginal Tax Rate | Effective Tax Rate |
|---|---|
• Marginal tax rates determine how much you pay in taxes, based on income. • They’re calculated by applying tax rates to each level of income. • The highest marginal tax rate is 37% while the lowest is 10%. • Marginal tax rates can help you estimate how much tax you owe. | • Effective tax rates reflect the percentage of income paid in taxes. • They’re calculated by dividing taxes paid by taxable income. • There is no highest or lowest effective tax rate. • Effective tax rates can help you see how much of your income goes to taxes. |
What Is a Marginal Tax Rate?
The marginal tax rate is the amount of tax that applies to each additional dollar of income earned. The higher your income, the higher your marginal tax rate ends up being.
The U.S. uses a progressive tax system in which your tax rate increases as your taxable income increases. Taxable income is the amount of income subject to tax, after deductions and exemptions are factored in. Your marginal tax rate corresponds to your tax bracket, which is determined by your income and your filing status.
As of 2023, there were seven tax brackets, ranging from 10% at the lowest end to 37% at the highest. Marginal tax rates increase once you cross certain income thresholds. A difference of just one dollar can determine whether you land in a higher or lower tax bracket.
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How Does Marginal Tax Rate Work?
Marginal tax rates work by determining which tax rate applies at various income levels. As mentioned, they’re based on taxable income only. The more tax credits and tax deductions you’re able to claim, the more you can reduce your taxable income for the year.
When you file your tax return, your taxable income, minus deductions and exemptions, is what determines which marginal tax rates you pay. Different marginal tax rates can apply for each tier of income you have across different tax brackets.
Are you wondering, What tax bracket am I in? Here’s how marginal tax rates add up for tax years 2022 and 2023.
2022 Tax Brackets | |||
|---|---|---|---|
| Tax Rate | For Single Filers | For Married Individuals Filing Joint Returns | For Heads of Households |
| 10% | $0 to $10,275 | $0 to $20,550 | $0 to $14,650 |
| 12% | $10,276 to $41,775 | $20,551 to $83,550 | $14,651 to $55,900 |
| 22% | $41,776 to $89,075 | $83,551 to $178,150 | $55,901 to $89,050 |
| 24% | $89,076 to $170,050 | $178,151 to $340,100 | $89,051 to $170,050 |
| 32% | $170,051 to $215,950 | $340,101 to $431,900 | $170,051 to $215,950 |
| 35% | $215,951 to $539,900 | $431,901 to $647,850 | $215,951 to $539,900 |
| 37% | $539,901 or more | $647,851 or more | $539,901 or more |
Here are marginal tax rates for the 2023 tax year.
2023 Tax Brackets | |||
|---|---|---|---|
| Tax Rate | For Single Filers | For Married Individuals Filing Joint Returns | For Heads of Households |
| 10% | $0 to $11,000 | $0 to $22,000 | $0 to $15,700 |
| 12% | $11,000 to $44,725 | $22,000 to $89,450 | $15,700 to $59,850 |
| 22% | $44,725 to $95,375 | $89,450 to $190,750 | $59,850 to $95,350 |
| 24% | $95,375 to $182,100 | $190,750 to $364,200 | $95,350 to $182,100 |
| 32% | $182,100 to $231,250 | $364,200 to $462,500 | $182,100 to $231,250 |
| 35% | $231,250 to $578,125 | $462,500 to $693,750 | $231,250 to $578,100 |
| 37% | $578,125 or more | $693,750 or more | $578,100 or more |
Calculating Marginal Tax Rates
Calculating marginal tax rates is a simple process that requires you to do two things.
• Calculate your total taxable income for the year
• Apply the appropriate marginal income tax rates to each level of taxable income
For example, say that you and your spouse made $100,000 in 2022. You file a joint return and claim the standard deduction, which is worth $25,900. That reduces your taxable income to $74,100.
Here’s how your marginal tax rates would apply:
• $20,550 x 0.10 = $2,055
• $53,550 x 0.12 = $6,426
In this example, you’d be subject to two marginal tax rates: 10% and 12%. Your total tax owed based on the marginal tax rate calculation would be $8,481. The higher your income, the more tax rates you’d be subject to.
What Is an Effective Tax Rate?
The effective tax rate, also referred to as average tax rate, is the total tax paid divided by taxable income. Average tax rates tell you how much of your income you paid in taxes overall.
Your effective tax rate includes federal taxes but excludes other taxes you pay, such as:
• FICA taxes (which stands for Federal Insurance Contributions Act payroll taxes)
• State and local taxes
• Self-employment tax
Compared to marginal tax rates, determining your effective tax rate can be a simpler calculation. Average tax rates are usually lower than marginal tax rates due to the way each one is determined.
How Does Effective Tax Rate Work?
Effective tax rates tell you what percentage of your income you paid in taxes, after deductions are taken out. In other words, they’re a way to gauge how much of your money the IRS takes for taxes each year relative to what you earn.
There’s no standardized chart that breaks down effective tax rates. They’re different for every person, since they’re dependent on your income, the deductions and exemptions you claim, and the amount of tax you pay based on your marginal tax rate.
You can, however, compare your effective tax rate vs. marginal tax rate charts to get a sense of how they differ. Again, you will likely see that even though you may be in a higher tax bracket, the actual percentage of income you pay in taxes is a lower number.
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Calculating Effective Tax Rates
Determining your effective tax rate is a fairly simple calculation. It requires you to know two things:
• Your annual income
• Your federal tax liability
To get your effective tax rate, you’d divide your federal taxes paid by your taxable income. Again, this is income after deductions which reduce your taxable income.
Going back to the previous example, a married couple had an income of $100,000 which was reduced to $74,100 after taking the standard deduction. If you divide the $8,481 they paid in taxes by their $74,100 in taxable income, you’ll see that their effective tax rate works out to 11.44%.
Tips for Paying Your Taxes
Knowing how to prepare for tax season can make the process of filing your return easier. Here are a few tips that can help you get ready for tax filing with less stress.
• Get organized. Keeping track of receipts, paystubs, and other forms means you’ll have everything you need to file once tax season begins. Starting the process early can prevent a potentially anxiety-provoking rush to figure out what is a W-2 and whether you received the 1099s you need to complete your return.
• Track income. If you’re self-employed or have a side hustle, it’s a good idea to keep your own records for income even if you expect to get one or more IRS Form 1099.
• File early. Filing early can help you get your refund faster if you’re owed one since you’re beating the rush. It might also reduce the risk of being targeted by scammers looking for potential tax fraud victims. Once your done, those fraudsters’ messages won’t distract you.
• Get help if you need it. If you need tax season help, tax filing software programs can make putting your return together easier. Or you might want to work with a professional tax preparer.
If you’re looking for free or low-cost options, you can find a list of resources at the IRS website.
• Choose direct deposit. If you’re getting money back when you file, direct deposit can be the fastest way to get paid. For example, a refund from an electronically filed return could be with you in less than three weeks.
The Takeaway
Understanding the difference between marginal tax rate vs. effective tax rate can give you perspective on where your hard-earned dollars go. Marginal tax rates show you the different percentages of taxes you may pay on your income, while effective tax rate tells you how much of your income you paid in taxes overall.
While you’re working on your return, consider how you can make the most of a refund if you expect to get one. One smart move: Deposit it into a SoFi Checking and Savings account. When you open an online bank account with us, you’ll earn a competitive annual percentage yield (APY) and pay no account fees, both of which can make your money grow faster. What’s more, you will spend and save in one convenient place and also have features like Vaults and Roundups which can further help your financial life flourish.
FAQ
Between marginal and effective tax rates, which one is higher?
Marginal tax rates are usually higher than effective tax rates. Your effective tax rate takes into account taxes you’ve paid as well as amounts you deduct. For example, you might have a marginal tax rate of 35% but an effective tax rate of 27%.
How can I lower my effective tax rate?
Claiming more deductions can lower your effective tax rate. For example, if you normally claim the standard deduction, you might consider how you could reduce your taxable income by itemizing things like charitable contributions or interest paid on a mortgage loan.
What does it mean if the effective tax rate is negative?
A negative effective tax rate means that you have no income the IRS can tax or that even after tax was applied, you got money back in the form of a refund. Getting a tax refund isn’t necessarily a bad thing. However, it does mean that you’ve effectively lent the government your money tax-free all year. You can avoid getting a refund by adjusting your tax withholding on your W-4 form.
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