Effective Tax Rate

What is Effective Tax Rate?

Effective Tax Rate refers to the average taxation rate for an individual or a corporation wherein for an individual it is calculated by dividing total tax expense by the total taxable income during the period and for the corporation it is calculated by dividing total tax expense by the total earning before tax during the period.

For Individual

Effective Tax Rate Formula Individual = Total Tax expense / Taxable Income

For Corporation

Effective Tax Rate Formula Corporation = Total Tax Expense / EBT

Since EBT is effectively net income plus total tax expense and as such the above formula can be modified as,

Effective Tax rate Corporation = Total tax expense / (Net income + Total tax expense)

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Effective Tax Rate (wallstreetmojo.com)

Effective Tax Rate Calculation (Step by Step)

  1. Firstly, determine the total expense of the individual from the income tax filing submitted.

  2. Next, determine the taxable income of the individual. It can be computed by subtracting total exemptions and total deductions from the gross total income of the individual. i.e., Taxable income = Gross total income – Total exemptions – Total deductions

  3. Finally, calculate the effective tax rate of the individual by dividing the total tax expense by the taxable income, as shown above.

The formula for a corporation can be derived by using the following steps:

  • Step 1: Firstly, determine the total expense of the corporation, which will be easily available as a line item just above the net income in its income statement.
  • Step 2: Next, determine the net income of the corporation, which will also be available as a line item in the income statement. The EBT can be calculated by adding the total tax expense to the net income. i.e EBT = Net income + Total tax expense
  • Step 3: Finally, the effective tax rate of the corporation is calculated by dividing the total tax expense by its EBT, as shown above.

Tax rate Corporation = Total tax expense / (Net income + Total tax expense)

Examples

You can download this Effective Tax Rate Formula Excel Template here – Effective Tax Rate Formula Excel Template

Example #1

Let us determine the tax rate for an individual with a taxable income of $600,000 under the following hypothetical progressive tax regime.

effective tax rate formula example 1.1

As per above table,

  • Total tax expense = $100,000 * 10% + $200,000 * 15% + $200,000 * 25% + $100,000 * 35%
  • = $125,000

Therefore, the calculation of this formula will be as follows

effective tax rate formula example 1.2
  • Effective Tax Rate = Total tax expense / Taxable income
  • = $125,000 / $600,000
effective tax rate formula example 1.3
  • Tax Rate = 20.83%

Example #2

Let us take the example of John to understand the calculation for the effective tax rate. John joined a bank recently where he earns a gross salary of $200,000 annually. While filing for his income tax returns his accountant gave him information that he is eligible for tax exemption worth $20,000 and deductions worth $25,000. Calculate the tax rate if his total income tax payable as per IT filing is $45,000.

Use the following data for the calculation –

effective tax rate formula example 2.1

Taxable income

effective tax rate formula example 2.2

Therefore, the calculation of the tax rate is as follows,

effective tax rate formula example 2.3
  • Tax Rate = $45,000 / $155,000

The Tax Rate will be –

effective tax rate formula example 2.4
  • Tax Rate = 29.03%

Therefore, the tax rate for John is 29.03%.

Example #3

Let us take the real-life example of Apple Inc.’s annual report as on Sep 24, 2016, Sep 30, 2017, and September 29, 2018. The following information is available.

example 3.1

For the calculation, we will first calculate the EBT as follows –

EBT for Sep 24, 2016

example 3.2
  • EBT = Net income + Total tax expense
  • =$45,687 + $15,685
  • =$61,372

Similarly, we will calculate the EBT for 2017 and 2018.

example 3.3

After calculating EBT, we will do the calculation as follows –

The calculation for Sep 24, 2016, will be as follows –

example 3.4

Tax Rate for Sep 24, 2016, will be –

example 3.5
  • = $15,685 Mn / $61,372 Mn
  • = 25.56%

Similarly, we will calculate the Tax Rate for 2017 and 2018.

example 3.6

Effective Tax Rate Calculator

You can use the following calculator.

Total Tax Expense
Taxable Income
Effective Tax Rate Formula
 

Effective Tax Rate Formula =
Total Tax Expense
=
Taxable Income
0
= 0
0

Relevance and Use

It is very important to understand the concept of an effective tax rate because it is one metric that can be used by the investors as a profitability indicator of a company. However, the rate may fluctuate dramatically from year to year due to the taxable income falling into different tax slabs in a progressive tax regime. Otherwise, it is difficult to straightaway assess the reason behind a sudden jump or drop in the tax rate. For example, the change in the tax rate may be due to asset accountingAsset AccountingAssets in accounting refer to the organization's resources that hold specific economic value and facilitate business operations, meet expenses, and generate cash flow. They create the company's worth and are recorded in the balance sheet.read more manipulation by the company intended to reduce the tax burden. Nevertheless, the tax rate is a good indicator of the tax burden imposed by the government.

Recommended Articles

This has been a guide to Effective Tax Rate Formula. Here we discuss how to calculate Effective Tax Rate for the Individuals and the Corporation along with the practical examples, calculator, and downloadable excel sheet. You can learn more about accounting from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *