The percentage of income that an individual or corporation pays in taxes is known as the effective tax rate. The average rate at which a person’s earned income, such as wages, and unearned income, like stock dividends, are taxed is known as the effective tax rate. The statutory tax rate is the percentage set forth by law, but the effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed.
The term “effective tax rate” often solely refers to federal income taxes, leaving out state and local income taxes, sales taxes, property taxes, and any other taxes that a person may be subject to. People can tally up all of their taxes and divide that amount by their taxable income to get their overall effective tax rate. When attempting to compare the effective tax rates of two or more individuals, or what a specific individual may pay in taxes if they lived in a high-tax state as opposed to a low-tax state—a factor for many people contemplating about relocating in retirement—this computation can be helpful.