Effective tax rate (ETC) means how much percentage of tax an individual or organization is paying from its income. It is an average rate of tax that people are paying from their monthly income or stocks.
As far as an organization or corporation is concerned, the tax rate is the average rate of tax which that organization or corporation is paying from the profits pre-taxed.
How to calculate:
Every person or organization must know the exact amount of tax he has to pay on his taxable income.
To know that, the following method is applied to know the exact amount:
For an individual:
By looking at the form 1040, an individual gets to know about the taxable income. Then an individual divides the total tax with taxable income to get the exact amount of ETC on taxable income.
For an organization:
For an organization, they can calculate the amount of effective tax rate by dividing total tax by earnings with taxes. It is important for the department of tax for any organization to reduce the amount of effective taxes by adopting relevant strategies.
It helps to indicate the amount the money the organization is paying and is effective in minimizing them.
Difference between effective tax rate and marginal tax rate
There exists a lot of confusion among people about the ETC and marginal tax rate. Every person or organization pays taxes as minimum as it can. So, they prefer to calculate their amount of taxes from the tax rate.
The marginal tax rate seems to be similar to the effective tax rate but it is different from it. The marginal tax rate usually falls in the upper tax bracket. It is the amount the tax person or organization has to pay on its last income of dollar.
Contrarily, effective tax rates comprise the actual amount of tax every person or organization needs to pay on its taxable income.
So, the effective tax rate is smaller than the marginal tax rate. It is convenient for people to choose an ETC to pay less tax as compared to the marginal tax rate.
Importance of effective tax rate:
The following points describe the importance of effective tax rates for individuals, organizations, or federal governments:
It helps organizations to lower their amount taxes by adopting tax strategies. It helps the federal government to work effectively for the best of its people. The financial statement of any organization can be expressed by knowing the effective tax rate. An individual can pay a lower amount of tax with an effective tax rate as compared to a marginal tax rate.
People do not need to pay an effective tax rate on all the earnings of the year in which they are taxed. They only need to pay a taxable income. From the total income of people or organizations, standard deductions have taken place.
They pay only that amount for whom they are eligible. If someone is not eligible for tax breaks, there is no need to pay anything for that.
In a nutshell, it is concluded that it is very important for every individual or organization to pay the taxes for which they are eligible. It is the responsibility of every citizen or corporate sector to pay taxes.
An tax rate is the best one to estimate the total amount of taxes every person or organization needs to pay to the government. It is also important to minimize the total amount of taxes which can be possible by correctly estimating the amount of taxable income.
Hence, an tax rate is an efficient method to calculate payable taxes so that every nation provides the best services to its people.
How can someone reduce one’s tax rate?
One can reduce one’s tax rate by gaining tax-free income, tax deferral, and tax credits or deductions.
2. Can the effective tax rate be negative?
The effective tax rate can be negative. If the total amount of credits or tax deductions of any individual is more than its total tax amount, its ETC is found to be negative.
- It is possible to avoid tax-paying?
It is possible to avoid tax paying by doing investments in stocks and bonds. But, this is not legitimate because it is included in the domain of tax evaders.
- Is effective tax rate important?
Every individual or organization needs to know about the total amount of taxes that they need to pay on their total income. It is easily determined by the tax rate.
