Investopedia: What is a 'Tax Rate'?

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Tax Rate

What is a 'Tax Rate'

A tax rate is the percentage at which an individual or corporation is taxed. The tax rate is the tax imposed by the federal government and some states based on an individual's taxable income or a corporation's earnings. The United States uses a progressive tax rate system, where the percentage of tax increases as taxable income increases.
BREAKING DOWN 'Tax Rate'

To help build and maintain the infrastructures used in a country, the government usually taxes its residents. The tax collected is used for the betterment of the economy and all living in it. In the US and many other countries in the world, a tax rate is applied to some form of money received by a taxpayer. The money could be income earned from salary, capital gains from investment, dividends received as additional income, payment made for goods and services, etc. The percentage of the taxpayer’s earnings or money is taken and remitted to the government.

When it comes to income tax, the tax rate is the percentage of an individual's taxable income or a corporation's earnings that is owed to the state, federal and in some cases, municipal governments. In certain municipalities, regional income taxes are also imposed, increasing the tax burden for those residents. The tax rate that is applied to an individual’s earnings depends on the marginal tax bracket that the individual falls under. The marginal tax rate is the percentage taken from the next dollar of taxable income above a pre-defined income limit. The marginal tax rate used by the US government is indicative of the progressive tax system implemented by the country.  A progressive tax rate results in a higher dollar amount collected from individuals with higher incomes.
Effective Tax Rates

Let’s use an example to illustrate the marginal and progressive tax rates. The marginal tax bracket for 2017 is:

Annual Income
   

Tax Rate

≤ $9,325
   

10%

$9,326 to $37,950
   

15%

$37,951 to $91,900
   

25%

$91,901 to $191,650
   

28%

$191,651 to $416,700
   

33%

$416,701 to $418,400
   

35%

>$418,400
   

39.60%

An individual who earns $62,000 in 2017 will be taxed as follows: [10% x first $9,325] + [15% x ($37,950 - $9,325] + [25% x ($62,000 – $37,950)] = $932.50 + $4,293.75 + $6,012.50 = $11,238.75. Another individual who earns $120,000 will be marginally taxed [10% x first $9,325] + [15% x ($37,950 - $9,325] + [25% x ($91,900 – $37,950)] + [28% x ($120,000 - $91,900)] = $932.50 + $4,293.75 + $13,487.50 + $7,868 = $26,581.75. Following this example, the single taxpayer who falls under the third marginal tax bracket will pay less tax than the single filer who falls in the fourth and higher bracket.

Although both individuals fall in the third and fourth marginal brackets, they don’t pay tax rates of 25% and 28%, respectively, due to the nature of the marginal tax calculation. If they paid their respective marginal tax rates, the first individual will pay 25% x $62,000 = $15,500 and the second will pay 28% x $120,000 = $33,600, which clearly is not the case. In effect, individual A in fact pays $11,238.75/$62,000 = 18.13% and the individual with the higher income pays $26,581.75/$120,000 = 22.15%. These rates are called the effective tax rates, and represent the actual tax rate a household pays on income earned for the tax year.
Filer Status

The dollar threshold for each tax rate is dependent upon the status of the filer, whether s/he is single, the head of a household, married filing separately, or married filing jointly.

Tax Rate
   

Single
   

Head of Household
   

Married Filing Separately
   

Married Filing Jointly

10%
   

≤ $9,325
   

≤ $13,250
   

≤ $9,275
   

≤ $18,550

15%
   

$9,326 to $37,950
   

$13,251 to $50,400
   

$9,276 to $37,650
   

$18,551 to $75,300

25%
   

$37,951 to $91,900
   

$50,401 to $130,150
   

$37,651 to $75,950
   

$75,301 to $151,900

28%
   

$91,901 to $191,650
   

$130,151 to $210,800
   

$75,951 to $115,725
   

$151,901 to $231,450

33%
   

$191,651 to $416,700
   

$210,801 to $413,350
   

$115,726 to $206,675
   

$231,451 to $413,350

35%
   

$416,701 to $418,400
   

$413,351 to $441,000
   

$206,676 to $233,475
   

$413,351 to $466,950

39.60%
   

> $418,400
   

> $441,000
   

> $233,475
   

> $466,950
Corporate Tax Rates

Companies are also required to pay a percentage of their profits as tax to the government to fund federal programs. As of 2017, the marginal corporate tax rates schedule is:

Taxable net income from
   

But not over
   

Tax Rate

$0
   

$50,000
   

15%

$50,000
   

$75,000
   

25%

$75,000
   

$100,000
   

34%

$100,000
   

$335,000
   

39%

$335,000
   

$10,000,000
   

34%

$10,000,000
   

$15,000,000
   

35%

$15,000,000
   

$18,333,333
   

38%

$18,333,333
   

-
   

35%

A small business with a bottom line of $100,000 at the end of its fiscal year will pay [15% x $50,000] + [25% x ($75,000 - $50,000)] + [34% x ($100,000 - $75,000)] = $7,500 + $6,250 + $8,500 = $22,250. The business’ effective tax rate is thus, $22,250/$100,000 = 22.25%.
Other Tax Rates

Tax rates don’t only apply to earned income and corporate profits. Tax rates can also refer to other occasions where taxes are imposed, including sales tax on goods and services, real property tax, short-term capital gains tax, and long-term capital gains tax rate. When a consumer purchases certain goods and services from a retailer, a sales tax is applied to the sales price of the commodity at the point of sale. Since sales tax is governed by individual state governments, the sales tax rate will vary from state to state. For example, the sales tax rate in Georgia is 4%, while the tax rate in California is 7.5%, as of 2017. Not all states impose a sales tax rate though as can be seen in states such as Delaware and Oregon with 0% sales tax rate.

Since additional income gained from investments are categorized as earnings, the government also applies tax rates on capital gains and dividends. When the value of an investment rises and the security is sold for a profit, the tax rate that the investor pays depends on how long s/he held the asset for. The tax rate on the capital gain of a short-term investment or an investment held for less than a year is equal to the investor’s ordinary income tax. So, an individual who falls into the 25% marginal tax bracket will pay 25% on his or her short-term capital gains. The tax rate on profits from investments held longer than a year ranges from 0% to 20%, with individuals who fall in the 10% and 15% marginal bracket paying 0% taxes, and investors in the last bracket paying 20% tax rate on capital gains. Qualified dividends are subject to the same tax rate schedule that applies to long-term capital gains. Nonqualified dividends have the same tax rates as short-term capital gains.

Tax rates vary from country to country. Some countries implement a progressive tax system, while others use regressive or proportional tax rates. A regressive tax schedule is one in which the tax rate increases as the taxable amount decreases. Countries such as Poland, Belgium, and Iceland use the regressive tax rates structure in which a larger percentage of tax is taken from low-income earners than from high-income earners. The proportional or flat tax rate system applies the same tax rates to all taxable amounts, that is irrespective of income levels. Russia, Hungary, and Saudi Arabia are examples of countries that have this system of taxes in place.
Effective Tax Rate
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Video Definition

The effective tax rate is the average rate at which an individual or corporation is taxed. The effective tax rate for individuals is the average rate at which their earned income is taxed, and the effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed.
BREAKING DOWN 'Effective Tax Rate'

An individual's effective tax rate is calculated by dividing total tax expense from line 63 of his 1040 Form by his taxable income from line 43 of that form. For corporations, the effective tax rate is computed by dividing total tax expenses by the firm's earnings before taxes.
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