Effective Tax Rate

What it means

Your effective tax rate is the share of your income that actually goes to tax. Add up every tax you owe for the year (federal income tax, AMT, Social Security, Medicare, the 3.8% investment income tax, state and local tax) and divide by your total income.

It is different from your marginal rate, which is the rate on your next dollar, and from your withholding rate, which is only what your employer set aside (often a flat 22% on RSUs, and 37% only on the part above $1 million).

A simple example

Maria earns $200,000 in salary and $300,000 of RSUs vest. Her top federal bracket is 35%, but because the lower brackets are taxed at 10% to 32%, her federal income tax is about 28% of her income. Add Medicare and state tax and her effective rate is about 38%. Her company withheld only 22% federal on the RSUs, so she still owes a gap.

Why it matters to you

• It tells you how much of an equity payout you really keep.
• Comparing it with your withholding rate shows whether you will owe in April.
• Each kind of income has its own effective rate: long-term stock gains are taxed far lower than RSUs.

Common mistakes to avoid

• Using your top bracket to estimate tax on everything, which overstates it.
• Assuming the withheld amount equals your tax.
• Forgetting state tax, AMT or the 3.8% investment income tax.

Words used on this page

• Marginal rate: the rate on your last dollar of income.
• Withholding: tax your employer sends in for you.
• AMT: a parallel tax that can apply after exercising ISOs.