Effective Tax Rates

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harvestmoon
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Effective Tax Rates

Post by harvestmoon »

Hi Bogleheads!

I have 2 questions related to calculating effective tax rates...

1. Do you include only your taxable income?

2. When you have state income taxes do you factor that in and come up with one effective tax rate or do you really need to calculate them separately and essentially have 2 different effective tax rates?

Thank you all!
jebmke
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Re: Effective Tax Rates

Post by jebmke »

The only tax rate that I pay any attention to is the marginal rate -- and then only if I have a decision in play that affects the amount of income I recognize.
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KlangFool
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Re: Effective Tax Rates

Post by KlangFool »

OP,

It is useless to calculate effective tax rate. It is useful to know your marginal tax rate. Do you file your own tax?

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retiredjg
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Re: Effective Tax Rates

Post by retiredjg »

I think people calculate effective tax rates different ways. Some start with total income. Some start with AGI (after 401k type reductions). Some start with taxable income (after 401k deductions and standard or itemized deductions). I don't know which is "right".

If you use tax software, it likely tells you your effective rate and you can backtrack to what numbers gave you that rate and maybe you can think of that as "right".

For the most part, effective rate is a useless number for many of us. It does not tell you the tax consequence of taking a certain action. Only the "marginal rate(s)" will tell you that. This is why marginal rate is always the rate asked for.

I've used effective rate very loosely once to estimate how much tax to pay in a year. It was close enough for that estimate because my situation had not changed much from the previous year. Otherwise, it does not have much use.
jebmke
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Re: Effective Tax Rates

Post by jebmke »

If I were to calculate an effective tax rate I would include all my income -- including income that doesn't appear on the tax return.
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Topic Author
harvestmoon
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Re: Effective Tax Rates

Post by harvestmoon »

Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
KlangFool
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Re: Effective Tax Rates

Post by KlangFool »

harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
You should use a tax software and play around with your numbers. It could be highly educational.

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muffins14
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Re: Effective Tax Rates

Post by muffins14 »

harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
Marginal is more helpful for decision-making
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jebmke
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Re: Effective Tax Rates

Post by jebmke »

muffins14 wrote: Sun May 28, 2023 3:08 pm
harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
Marginal is more helpful for decision-making
And as KF notes, the best way to discover it is using software. The marginal rate is often not the same as the statutory (bracket) rate.
Stay hydrated; don't sweat the small stuff
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FiveK
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Re: Effective Tax Rates

Post by FiveK »

harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
See Tax estimation tools - Bogleheads for some that you could use instead of build.

If you do want to build, you could get some ideas from the two Excel tools in that list: Excel1040 and Toolbox. The former is "prettier" and the latter is "more open". The latter will also calculate your marginal tax rates for a particular income type.

Assuming you have a worked example (your 2022 taxes) you could check any or all of the estimation tools to see how well it matches your example. If a perfect match, great! If significantly different - for the same inputs - then at least one is incorrect....
AnEngineer
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Re: Effective Tax Rates

Post by AnEngineer »

KlangFool wrote: Sun May 28, 2023 3:00 pm
harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
You should use a tax software and play around with your numbers. It could be highly educational.

KlangFool
I think there's more value in doing all the calculations yourself, but it may depend on your existing skill and comfort with computational tools, whether it be a calculator, spreadsheet, or programming.
AnEngineer
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Re: Effective Tax Rates

Post by AnEngineer »

harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
Just to be explicit: if this is your goal you have zero need or interest in finding your effective tax rate.
KlangFool
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Re: Effective Tax Rates

Post by KlangFool »

AnEngineer wrote: Sun May 28, 2023 4:46 pm
KlangFool wrote: Sun May 28, 2023 3:00 pm
harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
You should use a tax software and play around with your numbers. It could be highly educational.

KlangFool
I think there's more value in doing all the calculations yourself, but it may depend on your existing skill and comfort with computational tools, whether it be a calculator, spreadsheet, or programming.
Or, it does not justify the ROI of the time spent..... It is cheaper and more effective to buy a copy of tax software.

I could spend the time roasting my coffee.

KlangFool
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AnEngineer
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Re: Effective Tax Rates

Post by AnEngineer »

KlangFool wrote: Sun May 28, 2023 5:42 pm
AnEngineer wrote: Sun May 28, 2023 4:46 pm
KlangFool wrote: Sun May 28, 2023 3:00 pm
harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
You should use a tax software and play around with your numbers. It could be highly educational.

KlangFool
I think there's more value in doing all the calculations yourself, but it may depend on your existing skill and comfort with computational tools, whether it be a calculator, spreadsheet, or programming.
Or, it does not justify the ROI of the time spent..... It is cheaper and more effective to buy a copy of tax software.

I could spend the time roasting my coffee.

KlangFool
It depends on what you want. What I'm talking about has zero cost, as it involves using free tools or ones you already have, so it's definitely more cost effective than buying tax software. Time spent depends on your situation, but reading tax rules is going to be more efficient than trying to extract the rules from tax software. Reading the tax rules (e.g. summaries) separately from reading the tax instructions is generally more efficient than reading the tax form instructions though, which are lengthy, but can obfuscate some detail. In my experience, using tax software does not lead to an understanding of how taxes work.
fyre4ce
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Re: Effective Tax Rates

Post by fyre4ce »

At risk of being repetitive, I'll say:

"Effective" (ie. "average") tax rates have limited usefulness. Probably the best use is budgeting: say you have an annual income of $100,000 and a 12% effective tax rate. That tells you your total tax cost is $12,000 and you have $88,000 available for savings or spending. But for this purpose for myself, I calculate straight dollars of tax cost, rather than a percentage; this works well because my other costs (housing, food, etc.) are also in straight dollars so I can get a good picture of what my budget and cash flow will look like. Calculating an effective tax rate is an unnecessary extra step.

Your marginal tax rate is much more useful for making decisions, like whether to contribute traditional or Roth, whether to Roth convert, whether to shift income or deductions around, etc. Ideally, your marginal tax rate should be a single number that's inclusive of federal taxes, state taxes, phase-ins of other taxes, phase-outs of credits and deductions, and even some impacts not on the tax return, such as IRMAA, ACA health insurance credit, and maybe others. You can even make a curve of your marginal rate vs. additional income, which will show jumps as you cross into higher tax brackets, etc. These numbers are much more commonly discussed on these boards.
jebmke
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Re: Effective Tax Rates

Post by jebmke »

KlangFool wrote: Sun May 28, 2023 5:42 pm
AnEngineer wrote: Sun May 28, 2023 4:46 pm
KlangFool wrote: Sun May 28, 2023 3:00 pm
harvestmoon wrote: Sun May 28, 2023 2:29 pm Ah okay good to know. I haven't filed my own in the past, but I might be doing that next year. I was trying to build something in Excel because I am comfortable using it, but I am still learning about my taxes.
You should use a tax software and play around with your numbers. It could be highly educational.

KlangFool
I think there's more value in doing all the calculations yourself, but it may depend on your existing skill and comfort with computational tools, whether it be a calculator, spreadsheet, or programming.
Or, it does not justify the ROI of the time spent..... It is cheaper and more effective to buy a copy of tax software.

I could spend the time roasting my coffee.

KlangFool
Software also will automatically kick in less obvious parts of the tax calculation as well as contain the correct triggers. Especially with state income taxes, "rolling your own" can be very messy.
Stay hydrated; don't sweat the small stuff
AnEngineer
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Re: Effective Tax Rates

Post by AnEngineer »

jebmke wrote: Sun May 28, 2023 7:39 pm Software also will automatically kick in less obvious parts of the tax calculation as well as contain the correct triggers. Especially with state income taxes, "rolling your own" can be very messy.
It depends on your objective. If you don't know much about taxes, using software is a faster route to getting your taxes done correctly. If you want to learn what the rules are, it's a poor tool because it's not meant for that and it hides a lot of stuff in the automation you reference.
VanGar+Goyle
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Re: Effective Tax Rates

Post by VanGar+Goyle »

harvestmoon wrote: Sun May 28, 2023 2:00 pm I have 2 questions related to calculating effective tax rates...

1. Do you include only your taxable income?

2. When you have state income taxes do you factor that in and come up with one effective tax rate or do you really need to calculate them separately and essentially have 2 different effective tax rates?
Definitely include your non-taxable income. Why would you use non-taxable, if not for ( the lack of ) taxes?
I think of non-taxable income as municipal money markets, or Roth distributions, some Social security benefits,
but not rollover distributions or inheritances.
Is that what you mean by non-taxable income?
But realize that income is not as real as spending or net-worth, for some people.

Effective tax rates can be calculated at the end of the tax year, around April 15 for most.
It can be useful for some planning, say if you have $200,000 in a tax deferred retirement plan, and want an idea
what you may be able to spend from it over 20 years. But I don't think of it the rest of the year.
Well, you pay a little bit, we're a little bit tough. | You pay very much, very much tough. | You pay a too much, we're too much a tough. | How much you pay? ... Well, then we're plenty tough. - Marx
jebmke
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Re: Effective Tax Rates

Post by jebmke »

AnEngineer wrote: Sun May 28, 2023 8:58 pm
jebmke wrote: Sun May 28, 2023 7:39 pm Software also will automatically kick in less obvious parts of the tax calculation as well as contain the correct triggers. Especially with state income taxes, "rolling your own" can be very messy.
It depends on your objective. If you don't know much about taxes, using software is a faster route to getting your taxes done correctly. If you want to learn what the rules are, it's a poor tool because it's not meant for that and it hides a lot of stuff in the automation you reference.
Agree. If you want to learn, a great solution is to volunteer with TaxAide or VITA.
Stay hydrated; don't sweat the small stuff
AnEngineer
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Re: Effective Tax Rates

Post by AnEngineer »

VanGar+Goyle wrote: Sun May 28, 2023 10:25 pm Effective tax rates can be calculated at the end of the tax year, around April 15 for most.
It can be useful for some planning, say if you have $200,000 in a tax deferred retirement plan, and want an idea
what you may be able to spend from it over 20 years. But I don't think of it the rest of the year.
How does your effective tax rate now help you know what you will be able to spend?
Topic Author
harvestmoon
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Re: Effective Tax Rates

Post by harvestmoon »

First of all, thank you everyone for the replies, very helpful! I just want to make sure I understand, let's say I have a taxable income amount of $100K, would my federal marginal rate be: 24% and my state marginal rate (I live in NJ) be: 6.37%? I would think you would need 2 separate numbers for federal and state, or did I totally get that wrong?
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FiveK
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Re: Effective Tax Rates

Post by FiveK »

harvestmoon wrote: Mon May 29, 2023 10:30 am First of all, thank you everyone for the replies, very helpful! I just want to make sure I understand, let's say I have a taxable income amount of $100K, would my federal marginal rate be: 24% and my state marginal rate (I live in NJ) be: 6.37%? I would think you would need 2 separate numbers for federal and state, or did I totally get that wrong?
For a single filer, that would be the 22% federal and 6.37% state tax brackets, for a total of 28.37%. Whether that would be your marginal tax rate depends on more details about your situation.
Topic Author
harvestmoon
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Re: Effective Tax Rates

Post by harvestmoon »

Thank you so much!
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