Do you know your effective tax rate for 2024? What about your marginal rate? Don’t worry if the answer is no—you’re not alone. The difference between effective and marginal tax rates can be a little confusing, especially if you’re used to receiving a tax refund instead of a bill.
Put simply, your effective tax rate references an average rate based on your total income, while your marginal rate applies to each income bracket you fall into. Below, you’ll find everything you need to know about these rates, including what they mean for your taxes and how to calculate them.
Effective Tax Rate
First, let’s go into the specifics of the effective tax rate. For most people, this is the number that matters most. Your effective tax rate is the average rate you’ll pay on the entirety of your taxable income.
Here’s how to calculate the exact number:
- Determine your total amount of taxes owed
- Divide this number by your taxable income.
Let’s say you make $40,000 in 2024 after applying applicable deductions and credits. This number represents your taxable income.
If you pay $8,000 in taxes, your effective tax rate is 20% or $8,000/$40,000.
Marginal Tax Rate
Your marginal tax rate doesn’t require any calculation. It’s simply the rate you’ll pay on your last taxed dollar.
The U.S. follows a progressive tax system. This means that you’ll pay more taxes as your income rises. The extra taxation is enforced through tax brackets.
There are currently seven distinct tax brackets in the U.S:
- 10%
- 12%
- 22%
- 24%
- 32%
- 35%
- 37%
Each bracket corresponds to a specific income range. When it’s time to figure out your taxes, your income is separated into the applicable brackets and taxed accordingly.
For example, if you’re single and make $40,000 per year, the first $0 to $10,275 is taxed at 10%. The rest of your income falls into the 12% tax bracket ($10,276 to $41,775).
In this scenario, your marginal tax rate is 12%. If you get an end-of-the-year bonus that pushes your income up to $50,000, you’d move into the 22% tax bracket ($41,776 to $89,075). Click here for a detailed breakdown of each tax bracket.
Planning Your Taxes
Understanding your effective and marginal tax rates gives you a heads-up when it’s time for tax planning. You can use the information to figure out where you land after claiming deductions and tax credits. And, if you run your own business, you can assess how much you need to set aside for estimated quarterly taxes.
Which rate to focus on depends on your earnings and goals. Typically, the effective tax rate provides more information to taxpayers. However, there are reasons to consider your marginal tax rate as well. For example, if you’re in a higher tax bracket and wish to reduce your burden, you might decide to contribute to a retirement account to lower your taxable income.
Get Expert Help
Your effective and marginal tax rates can change every year, altering with both your income and changes in legislation. While your effective rate gives you an average, overall view of your taxes, your marginal rate allows for strategic planning to potentially reduce your burden.
Consult with a professional to ensure you stay on top of changes and always pay the lowest taxes. The expert team at Kondler & Associates, CPAs, is well-versed in identifying deductions and credits that could save you money.
So, whether you’re filing as an individual or running a small business, reach out today and schedule a free consultation.
