Real Effective Tax Rate Calculator

When I decided to write this post, I started like I always do by opening my excel spreadsheet in order to start drafting the template for the case study; and I knew there were many types and categories of taxes, but I had no idea how many there were.

The purpose of this article is to create a simple but compressive, real effective tax rate calculator. Many people just like to take the amount they pay on their IRS Form 1040 and divide it by the figures on the W2 taxable income form; which actually don’t account for all the taxes that we pay for every day. They forget to account for payroll taxes and sales taxes, among many others.

Not a Real Effective Tax Equation Formula

In fact, I found a list with over 60 different kinds of taxes; for a single state. Just to give you an idea of how many taxes we pay, think about the telephone service surcharge tax; a tax on top of another tax. However, building a calculator with a list of over 60 categories of taxes is very inefficient; given that we don’t have a good source of information to track all tax expenses because most of them are hidden within the cost of products and services; for example tariffs. But by applying the good old Pareto Principal, we are only going to focus in the categories and brackets that have the most impact in our tax bill.

“Surcharge definition: an extra fee added onto another fee or charge; Wikipedia”

The Main Types of Taxes That We Pay the Most:

1. Income Tax: the final amount you pay in your 1040 each year, including capital gains, deductions and credits.
2. Payroll Tax: the Medicare and Social Security contributions, FICA taxes.
3. Sales Tax: what we pay at the register for products and services.
4. State Tax: what you pay to your local government and cannot be deducted from you federal taxes.
5. Property Tax: the consequence, burdens and responsibilities of being an owner.
6. Excise Tax: special taxes added to products, think of tobacco and alcohol.
7. Fees & Licenses Tax: for example vehicle tag.
8. Fines: we earn and deserve this one, but still the money goes to the same place; think speeding tickets.

The Bottom Line

Knowing your effective “actual” tax rate is a crucial metric to be aware of; especially if you have a regular job where you trade your time for money (hours for dollars).