Effective tax rate

Great question LWEME,

Income taxes are computed on your TAXABLE INCOME (after taking the Standard Deduction or Itemizing more direct Deductions).

Each income tax bracket applies a tax rate to each level of income on a progressively growing level.

Once all the applicable income taxes are computed on the income falling within those tax brackets, the sum of all your income tax liabilities, including Self-Employment Payroll Tax, are divided against your Adjusted Gross Income to give you an Effective Income Tax Rate average.

I prefer to use Taxable Income as the denominator, which provides a clearer and more reliable average rate and not Adjusted Gross Income.

The effective tax rate refers to the average percentage of your taxable income that you owe in federal taxes. It is calculated by dividing your total tax liability (the amount you owe) by your total taxable income. The effective tax rate takes into account the progressive nature of the tax system, where different income levels are subject to different tax rates.

In the TurboTax a TurboTax employee explains how the effective tax rate is determined using an example. They mention that income taxes are computed based on your taxable income, which is the income remaining after taking deductions such as the standard deduction or itemized deductions. Each income tax bracket applies a tax rate to the corresponding level of income. By calculating the tax liabilities for each bracket and summing them up, you can determine your total tax liability.

In the example given, they assume a taxable income of $100,000 for a single individual in the tax year 2022. They break down the income into different tax brackets and calculate the corresponding tax liabilities for each bracket. Finally, they divide the total tax liability by the taxable income to determine the effective tax rate.

It's important to note that the effective tax rate calculated by TurboTax may differ from the rate obtained by dividing total tax by taxable income. Some users in the discussion expressed their observations of a disparity between TurboTax's effective tax rate and the rate calculated using total tax and taxable income. This could be due to the specific method used by TurboTax to calculate the effective tax rate or other factors in their calculations.