Wednesday, April 13, 2011

Effective Tax Rate

Just learned something by looking at the tax returns I'm about to file in a few days: effective tax rate. As we've seen earlier, we use a progressive income tax system, which means that as your income gets bigger (progresses), so does the rate of tax. Maybe on the first $50,000, you pay 15%, then 20% up to $100,000, then 25% up to $150,000. Therefore, if you earned $150,000 of taxable income, what is the "effective rate" that you paid? What you do is figure out the total tax paid and divide that into/compare it to the $150,000 of taxable income. So, how would this work out? You paid 15% on the first $50,000 ($7,500) You paid 20% on the next $50,000 ($10,000) You paid 25% on the next $50,000 ($12,500) In total, you paid $30,000 on $150,000, which is an "effective tax rate" of . . . 20%. The 65/66 exam ask all kinds of far-flung taxation questions, so, just in case, know what the "effective tax rate" means. And, as always, keep moving.

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