Legal Definitions - tax rate

A tax rate is a mathematical figure, usually expressed as a percentage, used to calculate the amount of tax owed on a specific item, transaction, or income.

• Example 1 (Sales Tax): When you purchase a new bicycle for $500 in a state with a 6% sales tax rate, you will pay an additional $30 in sales tax ($500 * 0.06). This example shows how a percentage tax rate is applied directly to the price of a good to determine the tax amount.
• Example 2 (Property Tax): A local government might set a property tax rate of 1.2% on the assessed value of homes. If a house is assessed at $400,000, the homeowner would owe $4,800 in property taxes annually ($400,000 * 0.012). Here, the tax rate is applied to the value of an asset to calculate the recurring tax.

The term average tax rate (also known as the effective tax rate) refers to the total amount of tax paid by an individual or entity, divided by their total taxable income. It represents the overall percentage of income that goes towards taxes.

• Example 1 (Individual Income Tax): If an individual earns $80,000 in taxable income and pays a total of $12,000 in income taxes for the year, their average tax rate is 15% ($12,000 / $80,000). This illustrates the overall proportion of their income that was paid as tax, considering all deductions and credits.
• Example 2 (Corporate Tax): A corporation reports $1,000,000 in taxable profits and pays $250,000 in corporate income tax. Its average tax rate is 25% ($250,000 / $1,000,000). This shows the company's overall tax burden relative to its profits.

The marginal tax rate is the tax rate applied to the very last dollar of income earned by a taxpayer. It is particularly useful for understanding the tax implications of earning additional income or claiming additional deductions.

• Example 1 (Overtime Pay): An employee is considering working extra hours for an additional $500. If their marginal tax rate is 22%, they know that $110 of that additional $500 will go towards taxes ($500 * 0.22), helping them calculate their net take-home pay from the overtime. This demonstrates the tax rate applied to the "next" dollar of income.
• Example 2 (Investment Income): A retiree is evaluating an investment that is expected to generate an extra $10,000 in taxable income next year. If their marginal tax rate is 15%, they can anticipate that $1,500 of that new income will be paid in taxes ($10,000 * 0.15). This helps them understand the net financial benefit of the investment.