Marginal vs. Effective Tax Rate: Two different ways to measure what you're paying the IRS

Tax time is a great time to pause and reflect on your financial situation. The returns sent along to the IRS offer a valuable snapshot of your current earnings, applicable deductions, available credits, and taxes due.

The US system of income tax is ‘progressive’ in nature. Therefore, different earned income amounts may be taxed at different rates. Knowing the fundamental differences between a ‘marginal tax rate’ (i.e., the top rate on taxable income, per tax tables) and an ‘effective tax rate’ (i.e., your average tax rate) will provide a clearer understanding of your tax situation and year-over-year trends.

Recently, I was contacted by Business Insider: Personal Finance to discuss the key differences and applications of these two tax rates:

When people refer to their marginal tax rate, they're usually referring to the highest tax bracket they fall into.

"You might hear people say, 'I'm in the 35% tax bracket,' but it's not really true," says Adam Scherer, a CFP® professional, IRS enrolled agent, and president of Greenbeat Financial. "They paid 35% on the last dollars they earned in that year."

Proactive management and purposeful planning of taxes throughout one’s lifetime are essential. Be sure to give me a shout if you’re interested in a tax review and discussion on strategies to optimize your tax situation.