Message Font: Serif | Sans-Serif
 
No. of Recommendations: 3
In determining effective tax rate,the numerator is the tax owed and the denominator is the taxable income, correct? I saw this formula online, plugged the numbers in and was surprised to see it was 31%! Just wanted to check to see if I am doing this correctly.

That depends on your purposes for this effective tax rate. As the two previous posters pointed out, sometimes you want to look at your tax as a percentage of your total income without deductions.

However, your method has uses as well. It's a middle picture to see how various changes might affect you. Take something like Congress proposing a change to the tax bracket structure without changes to deductions. Looking at your total tax as a percentage of your taxable income would be a good measure of how this change affects you. (I'll admit that looking at tax as a percentage of gross income is also a decent measure as well.)

Sometimes, comparing the situation of two people is easier looking at your metric. Take one self-employed person and one employee. It can simplify things to compare based on taxable income rather than AGI or gross income. The employee's gross income will already exclude health insurance benefits and some retirement contributions, but the self-employed person's gross income will not have those exclusions. AGI might make a better comparison in this case. But if the employee has to pay a lot of business expenses out of pocket, those are still included in AGI. The self-employed person would have deducted those before getting to gross income. So taxable income becomes the first place where things are reasonably comparable.

Again, it depends on what you want to do with this effective tax rate.

--Peter
Print the post  

Announcements

Disclaimer:
In accordance with IRS Circular 230, you cannot use the contents of any post on The Motley Fool's message boards to avoid tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions.
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.