Income Tax Rate - Effective Tax Rate?

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Income Tax Rate - Effective Tax Rate?

Post by mountainsoft »

For the "Income Tax Rate" field, I assume this is my effective tax rate and not my marginal tax bracket?

If so, I have seen two different methods used to calculate the effective tax rate.

One divides the total tax by the "taxable" income (after standard deduction). In my case this results in 15-16% over the last few years, which doesn't make sense as I am in the 12% tax bracket.

The other method divides the total tax by the "Total" income. This gives me a rate of around 7-9% over the last few years which seems to make more sense.

Which method should I use for the Income Tax Rate in FRP?

Also, should I use this same rate for the Investment Tax Rate?
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Re: Income Tax Rate - Effective Tax Rate?

Post by jimr »

You are correct that the tax rates are not intended to be marginal tax rates, but rather an average or effective tax rate.

The best numbers to plug into these rates are so dependent on personal circumstances that I can't be of much help with that, except to mention that these rates should account for all federal, state, and local income taxes. It sounds like the way you're approaching the problem is reasonable, but that's as far as I an help. In truth, we all face the same dilemma here, because we're trying to distill something fairly complicated and also changeable down to a single number.

One thing that can be helpful is to run sensitivity analysis using income or investment tax rate as one of the sensitivity parameters and then portfolio return/std dev as the other. This can give you an idea of how much impact changes to the tax rates might have on your plan's performance. In the past when I've experimented with this, it surprised me that the difference in probability of success between using 10% and 20% for those tax rates was relatively small.
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Re: Income Tax Rate - Effective Tax Rate?

Post by angelodan »

The rates apply to taxable income—adjusted gross income minus either the standard deduction or allowable itemized deductions. Income up to the standard deduction is thus taxed at a zero rate. Federal income tax rates are progressive. As taxable income increases, it is taxed at higher rates. The most straightforward way to calculate the effective tax rate is to divide the income tax expenses by the earnings (or income earned) before taxes. I wonder what would the tax rate be for being able to fill in the printable 941 blank forms. The truth is that if you don't know that at you can find it for free, you deserve the highest tax rate possible.
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