Welcome back. We're now going to look at some examples

to help us understand the concepts of average,

effective, and marginal tax rates.

In our first example,

we have Tim, who is a single taxpayer.

He earns $87,000 in wages and $10,000 in interest from a City of Chicago bond.

We'll learn a little bit later in the course that

municipal bond interest is exempt from federal taxation.

The only deduction on Tim's return is a standard deduction of $12,000.

So here, we have four questions.

One, what is Tim's federal income tax liability?

Two, what is his average tax rate?

Three, what is his effective tax rate?

And then finally, what is his marginal tax rate?

Because Tim is single,

we'll use the tax table for the single filing status.

His taxable income is $75,000, which is his wages of

$87,000 minus the standard deduction of 12,000.

Here, you can go down the income intervals until you find the row where $75,000 falls.

Now, we can calculate Tim's federal tax liability.

We start with $4,453.50, and then

we add 22% of the amount over $38,700.

So that's $4,453.50 plus

22% multiplied by $75,000 minus $38,700.

So that gives us Tim's federal tax liability of $12,439.50.

Next, let's calculate Tim's average,

effective, and marginal tax rates.

You'll recall that the average tax rate is your total tax

divided by your tax base, which here is taxable income.

Tim's total tax is $12,439.50.

When we divide this number by his total taxable income of $75,000,

we get an average tax rate of approximately 16.6%.

Next, we want to determine Tim's effective tax rate,

which is the total tax divided by Tim's total income.

So here we'll add back the standard deduction and

that municipal bond interest, which wasn't

included in gross income, back into the denominator.

This results in an effective tax rate for Tim of roughly 12.8%.

Finally, Tim's marginal tax rate is 22%.

This means that, if Tim were to earn one more dollar taxable income,

it would be taxed at a rate of 22%.

We can see this by looking back at the row in the tax table

that we use to compute Tim's total tax liability.

Let's try another example.

Here, we have Dick and Jane, who are a married couple filing a joint tax return.

Because Dick and Jane are filing jointly,

they'll get a larger standard deduction, and we'll be using a different tax rate schedule.

But the four questions we're trying to answer will remain the same.

What is Dick and Jane's federal income tax liability?

What is their average tax rate?

What is their effective tax rate?

And, what is their marginal tax rate?

First, let's compute their taxable income.

They have taxable wages of $344,000, and

their only deduction is the married filing jointly standard deduction of $24,000.

So, their taxable income is $320,000.

Next, looking at our tax rate schedule,

we need to find the row that contains $320,000.

In this case, it'll be the fifth row highlighted here.

So, Dick and Jane's tax liability will be $64,179

plus 32% of the excess over $315,000.

So, we take $64,179 and we add in

32% of $320,000 minus $315,000.

This gives us a total tax for Dick and Jane of $65,779.

This total tax is going to make their average tax rate about 20.6%,

which is their total tax, divided by their tax base, or taxable income.

Their effective tax rate, which is computed by taking total tax

divided by total income, is roughly 19.1%.

And finally, their marginal tax rate, which is the tax on

the next dollar of income they were to earn, is 32%.

But remember, the marginal tax rate is just the tax on the next dollar of income.

In this example, only a small portion of Dick and Jane's income is actually

taxed at 32 percent, with the remainder taxed at the lower rates on the table.

But, if they were to earn one more dollar,

that extra dollar would be taxed at the marginal rate, 32%.