Misunderstandings about two different types of tax rates often create confusion in discussions about taxes. A taxpayer’s average tax rate (or effective tax rate) is the share of income that he or she pays in taxes. By contrast, a taxpayer’s marginal tax rate is the tax rate imposed on his or her last dollar of income.

Taxpayers’ average tax rates are lower — usually much lower — than their marginal rates. People who confuse the two can end up thinking that taxes are much higher than they actually are.

One reason why these two concepts are often misunderstood is because of the concept of tax brackets.  The U.S. has a progressive income tax, which means generally, the more money you make, the more money you will have to pay in taxes.  And we have a bracket system in place to make our income tax progressive.

It achieves this by applying higher marginal tax rates to higher levels of income. For example, the first portion of any taxpayer’s taxable income is taxed at a 10 percent rate, the next portion is taxed at a 15 percent rate, and so on, up to a top marginal rate of 39.6 percent. For example, for someone filing taxes as a single person in 2015 their first $9,225 of income is taxed at 10%.  And then the amount over $9,226 up to $37,450 is taxed at 15%, and so one.

The bracket system often leads to people saying “I’m in the X percent tax bracket.”  It’s often heard from a person who files as a single person in 2015 and earns a salary of $50,000, “I’m in the 25% tax bracket.”

But this does not mean that all of this person’s income is going to be taxed at 25%.  It just means that the marginal tax rate is 25%.

The Marginal Tax Rate is the amount of tax paid on an additional dollar of income.

This means that any income in addition to the base $50,000 salary will be taxed at 25% (up to $90,750).  If this person gets a raise to $56,000, that extra $6,000 will be taxed at 25%  allowing $4,500 in after-tax money to be received from the $6,000 raise.

Looking at how the $56,000 income is taxed as filed as a single person in 2015  will allow us to determine the effective tax rate.

  1.  The first $9,225 of income is taxed at 10%, for a tax liability of $922.50.
  2.  The income over $9,226, up to $37,450, is taxed at 15%.  This bracket of income leaves a tax liability of $4,233.75.
  3.  The income above $37,450, up to $90,750, is taxed at 25%.  This leaves $18,550 ($56,000 – $37,450) of income that will be taxed at 25%.  This bracket’s tax liability is $4637.50.
  4.  To find the total tax we add the $922.50 in taxes from step 1, the $4,233.75 from step 2, and the $4,637.50 from step 3.  This gives a total tax liability of $9,793.75.

The Effective Tax Rate is the amount of tax owed divided by the taxable income.

Hypothetically, this person owes taxes $9,793.75 on the income of $56,000.  $9,793.75 divided by $56,000 is 17.49%.  So the effective tax rate is 17.49%.

The effective tax rate is the percentage of your taxable income that you pay in taxes.  The marginal tax rate is the percentage of tax that you will pay on your next dollar of taxable income.  A lot of people think their effective tax rate is higher than it actually is because they focus on their marginal rate when they say things like “I’m in the 25% tax bracket.”  Some people might take that statement to mean all of that person’s income is taxed at 25%, when in reality, that person’s effective tax rate will probably be significantly lower than 25%.

Your federal income tax bracket tells you at what tax rate your income (your taxable income) will be taxed. Tax rates often vary by Tax Year and may be different for each filing status. The rate of taxation is applied only to your taxable income.

2015 Tax Year Brackets (Jan. 1 – Dec. 31, 2015) Tax Return due on April 18, 2016

Tax Rate Single Married/Joint
& Widow(er)
Married/Separate Head of Household
10% $1 – $9,225 $1 – $18,450 $1 – $9,225 $1 – $13,150
15% $9,226 to $37,450 $18,451 to $74,900 $9,226 to $37,450 $13,151 to $50,200
25% $37,451 to $90,750 $74,901 to $151,200 $37,451 to $75,600 $50,201 to $129,600
28% $90,751 to $189,300 $151,201 to $230,450 $75,601 to $115,225 $129,601 to $209,850
33% $189,301 to $411,500 $230,451 to $411,500 $115,226 to $205,750 $209,851 to $411,500
35% $411,501 to $413,200 $411,501 to $464,850 $205,751 to $232,425 $411,501 to $439,200
39.6% over $413,200 over $464,850 over $232,425 over $439,200


Steven Z. Freeman, CPA provides trustworthy and professional Tax Planning and Business Accounting and can assist you with these services. If you have any questions on this matter, or to schedule an initial consultation, Please call us at (805) 495-4211.

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