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It is a little frustrating when our marginal rate is 35% and our effective rate is 34% and then we hear about people with effective rates of 15-20%. What gives?

In some cases they do. One way of reducing your taxes is to give away a lot of your income.

There really are few ways of reducing your taxes without winding up with less in your pocket than had you ignored the taxes and gone about your business. There are all sorts of things you, for example, could do to gin up itemized deductions, but for every dollar of expenditure you reduce your taxes by 35 cents. That leaves you 65 cents poorer than when you started.

I've seen a lot of different ways of calculating "effective tax rate," which seems on the surface to be a simple concept. I think the best way is:

YTD gross pay from final paystub for the year
plus non-wage income
equals gross income.

We'll pause here for a lecture, with advance request for forgiveness if I'm out of line. If you're making high six figures there should be substantial investment receipts in addition to your W-2 wages. These may, through proper planning, not show up on your tax return as current income, but they should show up when you look at your net worth. Unless, of course, it's been a bad year for the markets.

Anyway, add up all of the income-related taxes:

Boxes 4 and 6 from your W-2's; plus
Total tax from your state return; plus
Total tax from your Federal return equals
Total taxes

Divide total taxes by gross income to get what I'd call your effective tax rate.

As for financially sound ways of reducing it, make sure that you're taking full advantage of salary deferrals and pre-tax spending plans available at work. Beyond that there's not a lot you can do except reflect on your well-deserved success.

I hate to end on a downer note, but don't forget that if your 2013 wage income jointly exceeds $250,000 you're going to get hit with the Medicare surtax on the excess. You'll notice it in your withholding if your wages reach $200,000 YTD, and there will be a reconciliation on your 2013 1040.

Rule Your Retirement Home Fool
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