What Is My Income tax Rate? (Federal Income Tax Rates Explained) Marginal Tax vs Effective Tax.

This video will cover:
- How to determine your income tax rate
- It will explain Federal tax Rates
- It will explain marginal tax and effective tax

2018 tax brackets:
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In this video we are going to help you expand your tax knowledge so you can better understand how much tax you are truly paying on the income you earn as we discuss the differences between Marginal tax rates and effective tax rates. Lets get after it.

Most people do not know the difference between these two tax terms so why should we even care to learn this?

1. Knowing these this will help you better budget your finances and manage cashflow.
2. Potentially think of new ways to reduce or minimize your taxes
3. Confuse the heck out of people with your new found tax knowledge, because 90% of the population will have no idea what you are talking about if your drop these terms.

Starting with ‘Marginal Tax Rate’ What is the Marginal Tax Rate’

This is the amount of tax you pay on each additional dollar of income of you earn. Remember the tax rates follow the tax brackets. As your income increases so will your tax rate. Let’s take Chipper’s income for example: Chipper is a single tax filer in this example. Note the tax rates and income thresholds are coming from the 2018 tax brackets.

On January 1 Chipper income is $0 so his marginal tax rate is $0

On January 2nd Chipper starts working and making money at his job. The moment his income exceeds $0 his tax rate jumps into the 10% bracket. This means his marginal tax rate is now 10%. On each additional dollar Chipper earns he will pay a 10% tax rate until the point his income exceeds $9,525.

By the end of March Chipper’s total income for the year begins to exceed $9,525. Every dollar Chipper makes above $9,525 will be taxed at the 12% rate. Chipper’s marginal tax rate is now 12%. It will remain this way until his income exceeds $38,700. Ok lets recap

In this example we saw a portion of Chipper’s income was taxed at 10%. The portion above $9,525 was taxed at 12%. If his income exceeded $38,700 then his income above that amount would be taxed at what rate? Well if we look back at the 2018 tax brackets it would be 22%.

So when you think of marginal tax, think of the highest rate of tax you will pay on your next dollar earned. Your marginal tax rate increases throughout the year as you earn more income throughout the year.

Where I see people get messed up or confused is they tend to think all of their income is taxed at one tax rate. This is totally incorrect. Each portion of your income is taxed at a different rate as your income increases. 10%, 12%, 22%, etc. Just follow the tax bracket.

People tend to say things like I’m in the 12% bracket or I’m in the 22% bracket. When you hear people say things like this now you will know that they are referring to their marginal tax rate.

Just remember though that only the highest portion of your income is taxed at a higher rate. Nothing is taxed at that rate until your income begins to exceed each level of the tax brackets.
$0 - $9,525 is taxed 10%
$9, 525 – $38,700 is taxed at 12%
$38,701 - $82,500 is taxed at 22%
And so on and so forth.

Now let’s talk about effective tax rate. It’s very quick and simple to explain.

The Effective Tax Rate is my favorite way to measure my income taxes. I think of it as my real income tax rate.

The effective tax rate is the average rate of income tax we pay on each dollar we earn.

The easiest way to get a feel for your effective tax rate is to look at your prior year tax return.

1. Find your total taxable income on page 2 line 43 of your 1040.
2. Locate your total tax on page 2 line 63 of your 1040.
3. Divide your total tax by your total taxable income.

Total Tax/Taxable Income = Effective Tax Rate.

With this information you now know how much tax you pay on average for every dollar you earn.

In summary
- Your marginal tax rate will usually be the same, or higher than your effective rate.
- Marginal tax rate and effective tax rate both only cover income taxes. They do not cover other type of taxes such as social security taxes, sales taxes, property taxes, etc.
- Your marginal tax rate is the highest rate of tax you pay on each additional dollar earned.
- Your effective tax rate is the average rate of income tax you pay on each additional dollar earned.
- If you live in a state that has state income taxes such as California or New York you will have a marginal state tax rate and an effective state tax rate as well.

If you want to learn more about how income tax brackets work or taxes in general You can follow the links the description of this video to learn more.

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