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Effective Tax Rate vs. Marginal Tax Bracket: What You Need to Know

Effective Tax Rate vs. Marginal Tax Bracket: What You Need to Know

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Your marginal tax bracket, or marginal tax rate, and the actual tax rate you pay on your income are usually two different numbers. This is because you don't pay your marginal tax rate on your entire income, thanks to deductions, exemptions, tax credits, and the way the tax brackets are structured. Here's what the marginal tax brackets are, what they mean, and what an effective tax rate means.

The 2017 U.S. tax brackets

As of this writing, there are seven U.S. tax brackets, ranging from 10% to 39.6%. Households that earn higher incomes are in higher tax brackets. For the 2017 tax year, here are the seven U.S. tax brackets and the income ranges for the four main filing statuses.

Tax BracketSingleMarried Filing
Married Filing
Head of Household
10%$0 to $9,325$0 to $18,650$0 to $9,325$0 to $13,350
15%$9,326 to $37,950$18,651 to $75,900$9,326 to $37,950$13,351 to $50,800
25%$37,951 to $91,900$75,901 to $153,100$37,951 to $76,550$50,801 to $131,200
28%$91,901 to $191,650$153,101 to $233,350$76,551 to $116,675$131,201 to $212,500
33%$191,651 to $416,700$233,351 to $416,700$116,676 to $208,350$212,501 to $416,700
35%$416,701 to $418,400$416,701 to $470,700$208,351 to $235,350$416,701 to $444,550
39.6%$418,401 and above$470,701 and above$235,351 and above$444,551 and above

Data source: IRS.

Note that these are only applied to your taxable income. In other words, before these rates are applied, your personal exemption of $4,100 per person is subtracted, as are the tax deductions to which you are entitled. If you're entitled to any tax credits, these are applied after your income tax is calculated. The point is that your taxable income is usually significantly lower than your total, or gross income.

Your marginal tax bracket

The key takeaway from the tax brackets is that different rates can be applied to your income. For example, even if you're single and earn $1 million per year, you'll still pay a tax rate of 10% on the first $9,325 of your taxable income.

This is why the tax brackets are also referred to as "marginal" tax rates. They refer to the tax rate you pay on your last dollar of income, not on your entire taxable income. If you're single and have a taxable income of $1 million, you'll only pay the top 39.6% tax rate on the amount above $418,401.

Effective tax rate: How much you're actually paying

In a nutshell, your effective tax rate is the total amount of federal income tax you pay, as a percentage of your total income. For example, if  I earned a total of $50,000 last year and paid $5,000 in federal income tax, my effective tax rate would be 10%, even though our marginal tax bracket would be a  higher rate.

Image source: Getty Images.

An example of calculating an effective tax rate

As an example, let's say that a married couple with two children earns a total of $100,000 this year. They choose the $12,700 standard deduction, and also get a $4,100 personal exemption for each person, for a total of $29,100 in exemptions and deductions, making their taxable income $70,900.

This puts them in the 15% marginal tax bracket. They pay 10% on the first $18,650 of this amount, or $1,865, per the tax brackets listed above. Then, they pay 15% on the rest of their income, which translates to an additional $7,838. Therefore, their total federal income tax is $1,865 plus $7,838, for a total of $9,703.

Based on their total income of $100,000, this couple's $9,703 in federal income tax implies an effective tax rate of 9.7%.

The bottom line

Your effective tax rate is the important number to know, as it tells you the actual percentage of your income that you're paying to the IRS, and is often significantly lower than your marginal tax bracket.

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