Although the IRS has specifically prescribed detailed tax tables and tax rates and brackets for taxpayers of all types, the actual tax rate for a given taxpayer will often differ substantially from his tax bracket. The effective rate of tax is the real gauge of a taxpayer's true tax liability.
Prepare your income tax return as usual, including all income, deductions and credits. The computation of your effective tax rate begins when you determine your actual tax liability after subtracting all credits.
Divide your actual tax liability by the amount of your taxable income. The quotient is your effective tax rate. This can be expressed as a percentage. For example, if you have a gross income of $72,000 and an actual tax liability of $6,742 after all deductions and credits, then the effective tax rate is about 9 percent.
Compare your effective tax rate to your actual tax bracket to see the difference. In the previous example, the taxpayer would be in the 25 percent tax bracket, assuming she is single. This is obviously a great deal higher than the effective tax rate.
Use your effective tax rate as a means of evaluation of your tax situation. If your taxable income lands you in a high tax bracket but your effective rate is low, then you are paying a relatively low amount in taxes. Most taxpayers with low effective rates are eligible for one or more tax credits that reduce their actual liability on a dollar-for-dollar basis.
Repeat the process for any and all state tax returns. The same principle applies to state returns. Your effective tax rate is again a simple ratio of actual tax paid divided by gross income.