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Your Tax Rate Is Tricking You

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If the merest glance at your tax rate prompts grim visions of a massive bill from the IRS, take heart. The often-overlooked difference between marginal and effective tax rates means you could pay less than you fear.

That's one effective margin!
Suppose you've sold your shares in Mr. Cluck's Chicken (Ticker: HRLEY), only to realize that the tidy gain you pocketed will kick you from your current 28% tax bracket into the lofty realm of 33%. Egad! Now your entire income will suffer a bigger bite from the IRS!

Not so fast. Only the amount of your income above the limit for the 28% tax bracket will get taxed at 33%. The next chunk down will get taxed at 28%, then at 25%, and so on, as you work backward past the various income thresholds. The highest rate, the bracket you claim, is your "marginal" rate -- the rate at which your last dollar (and your next) is taxed. But if you take your entire tax bill, and divide it by your total taxable income, you'll get your "effective" tax rate, which is usually far lower.

Marginal and effective corporations
This principle works the same with corporations. Thanks to various credits, loopholes, and such, many companies pay far less than the seemingly steep 35% corporate tax rate about which they occasionally complain. According to the Center for Public Integrity, the 275 biggest companies in America pay, on average, about 17%. That's less than the rate for many individual taxpayers.

And many companies pay much less than that. According to the Government Accountability Office, roughly a quarter of all large U.S. corporations pay no taxes at all in any given year!

If you're starting to get irate about this seemingly sweet deal for big businesses, calm down. Many companies do pay a hefty sum in taxes, as a glance at their income statements will usually reveal. Here's what the IRS collected in the past 12 months from a few familiar names:

Company

Operating Income

Income Tax Expense

Tax as % of Operating Income

Goldman Sachs (NYSE: GS  )

$19.8 billion

$6.4 billion

32%

McDonald's (NYSE: MCD  )

$6.3 billion

$1.9 billion

29%

AT&T (NYSE: T  )

$21.5 billion

$6.2 billion

29%

ExxonMobil (NYSE: XOM  )

$64.9 billion

$16.4 billion

25%

Halliburton (NYSE: HAL  )

$2.7 billion

$762 million

28%

Wal-Mart (NYSE: WMT  )

$23.4 billion

$7.2 billion

31%

Microsoft (Nasdaq: MSFT  )

$19.5 billion

$4.8 billion

25%

Data: Yahoo! Finance. Figures are for past 12-month period.

As you can see, these companies pay a fairly wide range of effective tax rates. Just remember that from year to year, a company may have special circumstances and tax breaks that alter these numbers. Some companies also enjoy lower effective rates, thanks to earnings generated outside the U.S. and other factors.

The sums collected may look like a lot, but corporations generate less than a quarter of total taxes collected by the IRS. That leaves our income and payroll taxes to pick up the slack for the government's needs.

Are effective tax rates still a bit too effective for your liking? Should the government make corporations shoulder more of the burden? Let us know what you think via the comment box below.

Longtime Fool contributor Selena Maranjian owns shares of McDonald's, Microsoft, and Wal-Mart. Microsoft and Wal-Mart are Motley Fool Inside Value recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft. Try any of our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (8) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 21, 2010, at 1:11 PM, mdtopper wrote:

    Hold on a second.

    If the taxes you indicate in the article above as paid by corporations are actually the Income Tax Expense from the Income Statement (as you say they are), then you have some additional work to do.

    Taxes paid is a different number and can be found on the Cash Flow Statement.

    Often very different, as the tax on the income statement is reflective of various accounting rules about the recognition of tax expense in the period it is incurred. Deferred tax assets and deferred tax liabilities (and other factors) can skew the income statement tax dramatically away (in either direction) from the actual cash taxes paid.

    thanks

    Martin Topper

  • Report this Comment On January 21, 2010, at 3:42 PM, aggie9711 wrote:

    How about we ALL shoulder less taxes by not spending so much money on so many useless government programs? Can we have that discussion, rather than debating who to soak more?

  • Report this Comment On January 21, 2010, at 3:43 PM, Reddrummer wrote:

    Martin,

    You are right that taxes actually paid is found on the cash flow statement, but using that would be incorect for what he is doing. Since he is using net income based on US GAAP, he should also use the tax expense based on US GAAP. The defered tax assets/liabilities actually serve to reconcile taxes paid to the amount that matches the other accounting policies used in determining net income.

    The best method to use would be to use actual taxes paid/ taxable income, however i dont believe taxable income is disclosed. Therefore using GAAP taxes paid / GAAP income is much easier to use and probably gives pretty much the same %.

    Andrew

  • Report this Comment On January 21, 2010, at 3:56 PM, BMFPitt wrote:

    If I was in charge, I'd just cut the rate in half and get rid of all the credits and loopholes. Some rate but without giving special favors to any industry or specific company.

  • Report this Comment On January 21, 2010, at 4:51 PM, mdtopper wrote:

    Andrew

    Once upon a tine, I was in public accounting and helped my firm get all its clients to properly account for the deferred tax assets and liabilities when the rules were first promulgated. It's a faint, hazy memory at best, but I seem to remember the jist of the calculation was to present an income statement that had an "appropriate" tax expense (as a percentage of income) for the income presented.

    There were always differences (sometimes substantial) between that and the actual tax the entity paid that year. And they didnt seem to reverse over the next few years. In some cases the difference between income statement tax and cash tax continued to increase.

    I guess my initial reaction is, that if we are discussing what an entity's "tax rate" is, we should compare the actual economic gain from operations (cash flow maybe?) with the actual tax paid. Probably not an easy thing to do from outside a company.

    Thanks for your reminder.

    Marty

  • Report this Comment On January 21, 2010, at 5:41 PM, STORMSTOCKER wrote:

    NEGATIVES NOW OUTWAY THE POSITIVES.

    1,NASDAQ LARGE CAPS SEEM GOOD STOCKS GOING FORWARD

    2. LARGE BANK STOCKS HAVE AN AURA OF "BEING DIRTY" NOW.

    3. GOLD STOCKS SEEM POSITIVE, BECAUSE OF THE UNCERTANITY OF HUGE PUBLIC DEBT.

    4. CAR COMPANIES ARE "STILL ON THE ROCKS" AND FORD''S "BOATS" ARE JUST NOW STARTING TO GET OFF THE ROCKS.....

    5. HOUSING IS STILL IN THE TANK, AND GETTING DEEPER INTO THE HOLE.

    6. UNEMPLOYMENT IS CLIMBING, AND JOB OUTLOOK IS DIM...FOR 2010.

    7. GOVERNMENTS EVERYWHERE ARE IN FANTASY LAND, THINKING THEY CAN SPEND THEIR WAY OUT OF RECESSIONS. "ADDITION BY SUBTRACTION" HAS NEVER WORKED, EVER.

    8. COMMERCIAL REAL ESTATE IE.MALLS, ARE GETTING EMPTIER AND EMPTIER, INDICATING LESS CONSUMER SPENDING, AND SLOWING SALES.

    9. COMMODITIES ARE HOLDING THEIR OWN, BUT ONE WONDERS IF GOLD WILL BECOME EDIBLE.

  • Report this Comment On January 21, 2010, at 7:31 PM, Reddrummer wrote:

    Marty,

    Consider yourself lucky to be out of accounting, i just passed my last section of the cpa exam so all this garbage is all still in my head and i'm in the middle of busy season. Anyways, my feeling is the same as yours where we probably cant get the necessary information being outside the company to figure out the exact rate.

    Onto the articles question, any tax is always just pushed down onto the people. The more you tax corporations the less jobs there will be and the government is already far bigger than it ever should have gotten. So the focus should be on how to make it more efficient and having the government create a plan that doesn't put us farther in debt.

    Lastly, stormstocker you can turn caps lock off, its really pretty easy.

    Andrew

  • Report this Comment On January 24, 2010, at 2:08 PM, ikkyu2 wrote:

    Is there really anyone left in the 33% bracket who doesn't qualify for the AMT?

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Selena Maranjian
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Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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