The marginal tax rate is the tax rate imposed on the very last dollar of taxable income. The effective tax for an individual is the average rate at which their income is taxed. The effective rate is often a more accurate representation of a taxpayer’s liability than its marginal rate. Observe the chart below.
Taxable Income Marginal Rate Effective Rate
$ 18,450.00 10.0% 10.0%
$ 74,900.00 25.0% 14.0%
$ 151,200.00 28.0% 19.0%
$ 230,450.00 33.0% 22.0%
$ 411,500.00 35.0% 27.0%
$ 464,850.00 39.6% 28.0%
So when is it proper to use marginal rates, and when should effective rates be used?
The marginal tax rate is used to measure at the margin the impact of a certain change or implementing a certain strategy. Effective rates are useful to understand the portion of an individual’s overall income that is consumed by taxes. For example, if the problem in divorce is to adjust a retirement account for future taxes, the effective rate is the proper rate to use.
For more information on taxes and divorce, see my blog post here.