In the United States and around the world, tax rates are coming under increased scrutiny as individuals and corporations attempt to gain a clearer understanding of their overall tax liabilities and better manage the financial impact of tax requirements.
Federal, state, local, and special-purpose governmental jurisdictions all may impose taxes at various tax rates on income, property or activities. Income tax is usually the largest tax, both in terms of absolute dollars paid and the tax rate, but taxpayers also contribute through payroll taxes, property tax, sales tax, excise taxes, estate taxes and gift taxes and a host of other taxes.
With respect to income tax, there are three primary types of tax rates that impact U.S. taxpayers:
- Statutory – Statutory tax rates are the rates that are mandated by federal and state legislation. Since the U.S. tax system is progressive (i.e. the tax rate rises as taxable income increases), not all income is taxed at the same rate. In fact, there are multiple statutory tax rates that apply to different portions of taxpayer income.
- Marginal – In progressive tax systems, the marginal tax rate is defined as the tax associated with an additional dollar of income. Unlike a flat tax rate (in which the tax percentage is the same for all income), marginal tax rates apply higher percentages at higher income levels, incentivizing taxpayers to develop strategies to avoid higher tax brackets.
- Effective – The effective tax rate is generally defined as the average rate or percentage at which individual or corporate income is taxed. It is calculated by dividing total tax liability by gross income. Taxpayers often attempt to lower their effective tax rate by reducing their total tax liability.
Statutory tax rates are legislated and are beyond the control of taxpayers and tax professionals. However, through the development and execution of tax planning strategies, it may be possible to reduce the effective tax rates and marginal tax rates for individual and corporate taxpayers.