Ever wonder what the difference is between a "marginal tax rate" and an "effective tax rate"? Wonder no more.
Your marginal tax rate is the rate at which your last and your next dollar of taxable income are taxed. It's not the rate at which all your dollars are taxed. It's the maximum rate you're paying on any of your dollars of taxable income. If you're single, for example, according to the rules at the time of this writing, your marginal tax rate for 2003 would be 0%, 10%, 15%, 25%, 28%, 33%, or 35%.
Remember that your marginal tax rate only deals with the specific tax on your income. There are other taxes that you may have to pay, such as self-employment taxes, alternative minimum tax, and even penalty taxes on retirement plan distributions. There are also credits that you may benefit from, such as the child tax credit, the dependent care credit, or the education credits.
So, after considering the jumble of other taxes and credits, your marginal tax rate may lose a bit of its relevance. Which is why you'll want to take a peek at your effective tax rate. Your effective tax rate reveals the average rate of taxation for all your dollars. It's your total tax obligation (including your income tax and any other additional taxes and/or credits), divided by your total taxable income.
After all is said and done, it is very likely that your effective tax rate will be higher or lower than your marginal rate.
Believe it or not, the world of taxes isn't as mind-numbingly boring as you might think. Get the scoop on taxes from the horse's mouth -- the IRS website -- and also at the Fool's Tax Strategies area. Also, check out our book, The Motley Fool Tax Guide. It's slightly outdated, but its main value lies in the somewhat timeless scoops and strategies it offers, not its tax rate tables. And for a tax book, we think it's surprisingly readable and even amusing.
Meanwhile, if you'd like an actual person (a financial pro, no less) to talk to about your tax concerns and your financial planning needs, look into our TMF Money Advisor. It's a valuable new service we're offering, featuring customized independent advice from objective financial experts. You need to make sure you're saving enough and well enough to meet all your needs -- if you need some help doing that, look into this offering.
