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Effective Tax Rate vs. Tax Bracket

Published by Dave Danic on 26 Jan 2017

effective tax rate vs tax bracket


Do you know the difference between your effective tax rate and your tax bracket?

Though this can be a little tricky, it is not a trick question. For instance, when you know your tax rate it gives you an accurate reflection of your tax liability relative to your total income. Whereas, knowing your tax bracket is useful for planning purposes. For example, if you decide you want to spread a Roth conversion over several years in order to stay within the income limits of a certain tax bracket.

The main difference between effective tax rate and tax bracket is:

  • A tax bracket is a range of income to which a specific tax rate applies.
  • Your effective tax rate is the percentage of your income that you actually pay in tax.

Another way to think about it is that, not every dollar is taxed at the same rate.

  •  Your tax bracket shows the rate of tax on the last dollar you made during the tax year.
  •  Your effective tax rate reflects the actual amount you paid on all your taxable income.

For example, if you're single and in the 25% bracket for 2016. That means your taxable income is between $37,650 and $91,150.

Yet the tax you pay is less than 25% of your income. Why? Because the 25% tax rate only applies to the amount of taxable income within the 25% bracket. The tax on income below $37,650 is calculated using the rate that applies to income in the 10% and 15% brackets.

So, if your 2016 taxable income is $40,000, only $2,350 is taxed at 25%. The remainder is taxed at 10% and 15%, leading to a "blended" overall rate. The result: a tax bracket of 25%, and an effective tax rate of less than that.

At Summit CPA we offer multiple resources to assist you with all of your tax and financial planning needs. Contact our office at 866-497-9761 to schedule an appointment with our advisors.

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