UK Accounting Glossary
The effective tax rate thus measures the average rate of taxation for all income. Here’s an example of an effective tax rate: assume a taxpayer pays 5% on the first $10,000 ($500) in income and 10% on the second $10,000 ($1,000) in income. The effective tax rate would be $1,500/$20,000, or 7.5%. The effective tax rate can be contrasted to the marginal tax rate, which is the rate paid on each additional dollar in income. The effective tax rate for a corporation is usually income tax expense for financial reporting purposes divided by pretax accounting income. Analysts examine the effective tax rate to determine a company’s ability to manage its tax burden. Calculating a corporate effective tax rate raises can raise difficult issues, however, because taxes for reporting purposes and taxes paid will ordinarily not match owing to timing differences.
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This glossary post was last updated: 9th February 2020.