I've talked to some neighbors recently, regarding personal income taxes, and found that there were several that seemed to be confused about the difference between marginal and effective tax rates.

 

Effective Tax Rate is the rate that you actually pay into the IRS.  For example, if you and your spouse make $100,000, and you pay in $15,000, your effective tax rate is 15%.  Pretty simple.

 

Whenever you look at most tax tables, you are looking at Marginal Tax Rate.  Typically you will see a table such as this:       

 

Source:  http://www.irs.gov/pub/irs-drop/rp-07-66.pdf

 

So how would you and your spouse filing jointly with $100,000 use this table?  The first $16,050 would only be calculated at 10% bracket.  The amount between $16,051 - $65,100, (totaling $49,049) would be calculated in the 15% bracket.  Any of the money from $65,101 - $131,450 (totaling $34,899) would be calculated in the 25% bracket.  The calculation would look like this:

 

Income from $0 - $16,050 bracket = $16,050 - 0 = $16050 x 10% = $1,605

Income from 16051 - 65,100 bracket = 65,100-$16050 = $49,049 x 15% = $7,357.35

Income from $65,101 - $131,450 bracket = 100,000 - $65,101 = $34,899 x 25% = $8724.75

 

Added together all 3 brackets, you will have a total of $17,687.10 of taxes owed.  This example shows the Effective Tax Rate at 17.687%, where the Marginal Tax Rate on the table shows it as 25%.  It shows there is a large difference between both types of rates.

 

Other things to consider

 

Keep in mind that this is just an explanation of the difference between Marginal vs. Effective tax rates.  In your own taxes, there are many other things to determine, such as deductions and other factors to figure out.  Only filling out the appropriate tax form will give you the real answer to the amount of taxes you owe.

 

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