Effective vs marginal rates
Understanding the difference between effective and marginal tax rates is crucial for managing your tax obligations. Here’s a clear explanation of each: ### Marginal Tax Rate 1. **Definition**: - The marginal tax rate is the rate at which your last dollar of income is taxed. It represents the highest tax bracket that applies to your income. 2. **How It Works**: - The U.S. tax system is progressive, meaning that different portions of your income are taxed at different rates. As your income increases, it may be taxed at higher rates according to the tax brackets. 3. **Example**: - Suppose the tax brackets are as follows (for simplicity): - 10% on income up to $10,000 - 12% on income from $10,001 to $40,000 - 22% on income from $40,001 to $85,000 - If your taxable income is $50,000, your marginal tax rate is 22%, because that’s the rate applied to your last dollar of income. ### Effective Tax Rate 1. **Definition**: - The effective tax rate is the average rate at which your total income is taxed. It is calculated by dividing your total tax liability by your total taxable income. 2. **How It Works**: - The effective tax rate gives you a better sense of your overall tax burden, as it takes into account the various tax brackets and the
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