Calculate Effective Tax Rate?

[mountainsoft]

I'm trying to calculate my effective tax rate to use with retirement calculators.

Everything I find online says to divide the "Total Tax" (line 16 on the 2019 1040) by the "Taxable Income" - after standard deductions (Line 11b on the 2019 tax return).

When I do this I get effective tax rates of around 15-16%, even though we're in the 12% tax bracket?

Common sense would tell me to divide the Total Tax by the "Total Income" (line 7b on the 2019 1040). This would give me an effective tax rate around 9% which seems more accurate.

Which is the correct method of calculating the effective tax rate?

 

[COcheesehead]

If you use TurboTax, it calculates it for you. It’s on the summary page.

 

[mountainsoft]

If you use TurboTax, it calculates it for you. It’s on the summary page.

I do not use TurboTax and I want to be able to calculate several years back to get an average estimate (or at least the highest rate we paid).

 

[cathy63]

For a retirement calculator, I would use line 7b unless the instructions specifically said otherwise, which would imply that it's somehow estimating deductions and applying the rate you enter to the remainder. I don't think most calculators do that, so I'd use total income.

I'm curious about the 15% number you're coming up with though if you think you're in the 12% bracket. Do you have anything on Schedule 2 that's adding to the income tax number from line 12a on your 1040? Maybe ACA premium repayment, self-employment tax, household employee taxes? Or kiddie tax from form 8814?

 

[mountainsoft]

For a retirement calculator, I would use line 7b unless the instructions specifically said otherwise, which would imply that it's somehow estimating deductions and applying the rate you enter to the remainder. I don't think most calculators do that, so I'd use total income.

I'm curious about the 15% number you're coming up with though if you think you're in the 12% bracket. Do you have anything on Schedule 2 that's adding to the income tax number from line 12a on your 1040? Maybe ACA premium repayment, self-employment tax, household employee taxes? Or kiddie tax from form 8814?

I'm using Flexible Retirement Planner and it just asks for "Income Tax Rate". Originally I was just using our 12% tax bracket, but with further research I realized I should be using our effective tax rate.

Yeah, we have tax on self-employment income and roth conversions. But it's the Standard Deduction that throws off the effective rate calculation.

Total Tax divided by our Total Gross Income seems to make the most sense in this context. It has varied from 7.4% to 9.5% over the last seven years, so I think I'll just use 10% in my estimations to be safe.

 

[RetireBy90]

Effective tax seems to me a measure of what portion of your income goes to the tax man, therefore I would use total income.

 

[cathy63]

If you won't have self-employment tax once you retire, then you should remove that when calculating your future tax rate. The Roth conversions are just ordinary income that will persist as you continue to draw down tax deferred accounts, so those funds should stay in your calcs.

 

[mountainsoft]

Effective tax seems to me a measure of what portion of your income goes to the tax man, therefore I would use total income.

Yeah, that's what I thought too. I don't really care how all the deductions and credits stuff works. All that matters is how much of our total income is paid in taxes.

 

[Midpack]

Everything I find online says to divide the "Total Tax" (line 16 on the 2019 1040) by the "Taxable Income" - after standard deductions (Line 11b on the 2019 tax return).

When I do this I get effective tax rates of around 15-16%, even though we're in the 12% tax bracket?

I don’t think your effective tax rate can be more than your marginal rate unless you have other taxes from Schedule 2 or 3, 2019 1040 lines 12b thru 15.

 

[pb4uski]

+1. Since income tax rates are progressive it is mathematically impossible for the effective income tax rate to exceed the marginal tax rate unless self-employment tax or some other tax credit or something is bugging up the effective tax rate calculation.

I'm talking line 12a Tax, divided by 11b Taxable Income

That said, for the purpose of a retirement calculator I think I would take line 12a divided by total income unless the program specifies something different.

 

[SevenUp]

+1. Since income tax rates are progressive it is mathematically impossible for the effective income tax rate to exceed the marginal tax rate unless self-employment tax or some other tax credit or something is bugging up the effective tax rate calculation.

Not exactly the OP's question, but the chart in Worth pushing through the Social Security hump and/or IRMAA cliffs? shows how the effective ("cumulative" in that chart) rate for a specific income component can be higher than the marginal rate for that component.

 

[mountainsoft]

Since income tax rates are progressive it is mathematically impossible for the effective income tax rate to exceed the marginal tax rate unless self-employment tax or some other tax credit or something is bugging up the effective tax rate calculation.

Yep, as I suspected. Total Tax divided by Total Gross Income seems to be the confirmed method.

Thanks Everyone!

 

[lem1955]

Yep, as I suspected. Total Tax divided by Total Gross Income seems to be the confirmed method.

Thanks Everyone!

This method makes the best sense to me too, but it is not the way TurboTax calculates effective tax rate. Does anyone know why there is a difference?

 

[kaneohe]

Yep, as I suspected. Total Tax divided by Total Gross Income seems to be the confirmed method.

Thanks Everyone!

https://www.google.com/search?q=eff...0l2j69i57j0.5478j1j7&sourceid=chrome&ie=UTF-8

seems to be 2 schools of thought here........doesn't matter as long as you know what the other person is thinking since it is a derived , and not a fundamental,
quantity.

 

[Alan]

Yep, as I suspected. Total Tax divided by Total Gross Income seems to be the confirmed method.

Thanks Everyone!

This is what TurboTax does. It uses Gross Income from line 7b before any deductions are applied.

 

[audreyh1]

I'm trying to calculate my effective tax rate to use with retirement calculators.

Everything I find online says to divide the "Total Tax" (line 16 on the 2019 1040) by the "Taxable Income" - after standard deductions (Line 11b on the 2019 tax return).

When I do this I get effective tax rates of around 15-16%, even though we're in the 12% tax bracket?

Common sense would tell me to divide the Total Tax by the "Total Income" (line 7b on the 2019 1040). This would give me an effective tax rate around 9% which seems more accurate.

Which is the correct method of calculating the effective tax rate?

Total income makes sense, IMO. Certainly some number before deductions! It’s silly to Exclude your deductions in calculating effective tax rate IMO.

 

[Midpack]

Total income makes sense, IMO. Certainly some number before deductions! It’s silly to Exclude your deductions in calculating effective tax rate IMO.

I'm fine with using taxable or total income as the denominator and it sounds like the OP is satisfied. I can find credible sources online recommending either. But there's no way your effective tax rate could be more than your marginal tax rate either way unless you have unless you have other taxes from Schedule 2 or 3, 2019 1040 lines 12b thru 15. Your taxes are derived directly from your taxable income.

 

[cathy63]

This is what TurboTax does. It uses Gross Income from line 7b before any deductions are applied.

On the summary page it uses AGI, which is line 8b on a 2019 return. I just looked at it yesterday when this thread came up, and thought it was a little odd to subtract the HSA contribution before figuring the tax rate. I don't use tax rate for anything, so I don't really care, but I did think line 7b would be a better choice for the denominator than line 8b.

 

[audreyh1]

Yes, I’m familiar with TurboTax using AGI which means that tax exempt interest is excluded as are adjustments to income such as IRA deductions, HSA deductions, and perhaps also QCD deductions from RMD income. These all lower your effective tax rate and shouldn’t be excluded IMO.

 

[kaneohe]

Yes, I’m familiar with TurboTax using AGI which means that tax exempt interest is excluded as are adjustments to income such as IRA deductions, HSA deductions, and perhaps also QCD deductions from RMD income. These all lower your effective tax rate and shouldn’t be excluded IMO.

you might have meant that the adjustments ARE included in AGI which lowers your AGI and makes your effective tax rate higher and that Total income (plus tax exempt interest) should have been used instead of AGI.

 

[monte1022]

Try this:


https://www.irscalculators.com/tax-calculator

 

[RetireBy90]

So why use effective tax rate ? Compare to previous year(s) rates ? I'm not sure that there is any other use for it. Guess for planning purposes several years out but then rates change to this year or last year effective rate is meaningless. If I'm doing any planning on lumping together charitable contributions to exceed standard deduction; if I'm planning Roth conversions; If I'm looking at impact of taking a withdraw from tIRA, I can use marginal tax rate to feed into the plan or evaluation.



Maybe I'm just not seeing something, for what purpose would you use effective tax rate ?

 

[target2019]

This page explains the tax rate input, but not to the extent you'd like.
https://www.flexibleretirementplanner.com/wp/documentation/user-input/

I guess the big impact of the tax rate you enter will be when RMDs come into play.

I saw your question posted on FRP forum, and will be interested in the answer you get.

 

[kaneohe]

This page explains the tax rate input, but not to the extent you'd like.
https://www.flexibleretirementplanner.com/wp/documentation/user-input/

I guess the big impact of the tax rate you enter will be when RMDs come into play.

I saw your question posted on FRP forum, and will be interested in the answer you get.

Looks like 1 response. You might also consider contacting the forum folks:
https://www.flexibleretirementplanner.com/support/memberlist.php?mode=contactadmin

from the "contact us" links on that forum.

 

[mountainsoft]

Maybe I'm just not seeing something, for what purpose would you use effective tax rate ?

Income taxes are calculated using a complicated system of progressive tax brackets, deductions that lower your taxable income, credits that lower your tax bill, etc.

The effective tax rate is just the overall percentage of your income you end up paying in taxes after doing all those complicated calculations. This single rate makes more sense when you're trying to estimate how much of your income will go to taxes in the future.

I'm sure it depends on individual circumstances, but our effective tax rate has held fairly steady around 7%-9% over the last eight years, despite different tax brackets, different tax rates, and different life situations over those years.