What is Marginal vs Effective Tax Rate?

Federal income tax uses graduated brackets: different portions of taxable income are taxed at increasing rates. That creates two different ways to describe "your tax rate."

Marginal tax rate

The marginal rate is the rate that applies to the last, or next, dollar of taxable income. If you are in the 24% bracket, an extra $1,000 of taxable income generally adds about $240 of federal income tax. Marginal rates are what matter for decisions such as whether to buy equipment before year end or contribute to a retirement plan.

Effective tax rate

The effective rate is total tax divided by total income. Because lower portions of income are taxed at lower rates, the effective rate is lower than the top marginal rate for an individual with graduated brackets.

A common misconception

Moving into a higher bracket does not increase tax on all your income, only on the portion above the bracket threshold. Phase-outs of some benefits can, however, create higher effective marginal rates in certain income ranges.

Other taxes

For business owners, the full marginal rate on business profit can include self-employment tax, state income tax and the effect of deductions such as the QBI deduction. Considering all of them gives a truer picture.

C corporations

C corporations pay a flat federal rate on taxable income, so their marginal and effective federal rates are the same before credits; see Form 1120.

The IRS publishes current brackets each year on its federal income tax rates and brackets page. Compare with tax credit vs deduction.

Related terms

• Debits and Credits: Debits and credits are the two sides of every bookkeeping entry; each account type increases on one side and decreases on the other.
• Tax Credit vs Tax Deduction: A deduction reduces taxable income; a credit reduces the tax itself, dollar for dollar.
• Self-Employment Tax: Self-employment tax is the Social Security and Medicare tax paid by people who work for themselves, calculated on net earnings from self-employment.

Browse more definitions in the small business glossary.