Written by a TurboTax Expert • Reviewed by a TurboTax CPAUpdated for Tax Year 2023 • May 29, 2024 2:27 PM
OVERVIEW
It's possible to lower your effective tax rate and pay less on your taxes through a mix of tax-free income, tax deductions and credits, and the proper use of a tax deferral.
Key Takeaways
- The highest tax rate you pay is typically referred to as your "marginal tax rate," but you usually only pay it on the amount of income in the highest bracket.
- Your "effective tax rate" is the average percentage of your taxable income that you owe in federal taxes.
- You can reduce your taxable income using your standard deduction or by itemizing deductions for state and local taxes or sales tax, charitable donations, casualty and theft losses, medical expenses, and mortgage interest and points.
- You can reduce the tax you owe on a dollar-for-dollar basis if you qualify for credits, including the Child and Dependent Care Credit, education tax credits, and adoption tax credit.
Lower rate means less tax
As you examine your taxes and seek ways to pay less, you might wonder if lowering your effective tax rate can help you reach that goal. The good news is that there are many legitimate options to lower your tax rate.
Before we get to the list of options for lowering your tax rate, you should first understand the difference between your effective tax rate and your marginal tax rate.
Marginal and effective tax rates
The first term we'll discuss is the "marginal tax rate." This is the highest tax bracket by which your income will be taxed.
- For instance, if you're a single person whose taxable income was $60,000 in 2023, then you fall into the 22% tax bracket. Therefore, your marginal tax rate is 22%.
However, when talking about your marginal tax rate, it's important to understand how tax brackets work. Many people believe that your tax bracket (aka your marginal tax rate) determines the rate you pay in taxes for your total taxable income. But being in the 22% bracket does not mean that you'll pay 22% of your income in taxes.
It is true that the higher taxable income you have, the more you will pay in taxes. But it's important to understand that the higher tax rate only applies to the amount of income above the minimum amount for that tax bracket.
Figuring out your tax liability, or how much you owe based on tax brackets, is easier to understand if you look at an example.
- So, let's imagine a couple — John and Judy — that's married filing jointly, and both are under the age of 65.
- Together, their taxable income in 2023 was $100,000.
This chart explains how much they will pay in taxes due to their marginal tax rate.
| Taxable Income (Married Filing Jointly) | Tax Rate | Calculation | Amount John and Judy Pay at This Rate |
| $0 | 10% | $22,000 – $0 = $22,000 x 10% tax rate = $2,200 | $2,200 |
| $22,000 | 12% | $89,450 – $22,000 = $67,450 x 12% tax rate = $8,094 | $8,094 |
| $89,450 | 22% | $100,000 – $89,450 = $10,550 x 22% tax rate = $2,231 | $2,231 |
Based on this tax bracket for 2023, John and Judy will owe a total tax liability of $12,615.
- $2,200 + $8,094 + $2,231 = $12,615
Your “effective tax rate” is the average percentage of your taxable income that you owe in federal taxes. In order to calculate this rate, you simply divide your tax liability (what you owe) by your total taxable income.
- In our example above, the effective tax rates calculation for John and Judy would be $12,615 divided by $100,000.
- Therefore, their effective tax rate is about 12.6%, which is much lower than their marginal tax rate of 22%.
It's useful to know your effective tax rate so that you can make informed budget and planning decisions and lower your tax liability.
TurboTax Tip:
A tax bracket calculator can help you understand your marginal tax rate and your effective tax rate. You can then see if you will qualify for various credits and deductions to minimize your taxes.
Options for lowering your effective tax rates
Now that you understand the term "effective tax rates," let's discuss how you can lower that percentage in order to minimize the amount you owe in taxes.
Consider tax-free income opportunities
Remember that the tax brackets and tax rates only apply to taxable income. There are several opportunities for you to make income or invest your income so that it isn't taxable.
Some common types of tax-free income and investments include:
- Financial gifts received from others
- Disability insurance payments
- Qualified withdrawals from a Roth IRA account
- Selling your home and meeting the requirements to exclude the gain
- Qualified municipal bonds interest income
Be strategic and smart about tax credits and deductions
As you make payments and purchases throughout the year, try to strategically plan them to maximize their effectiveness on your taxable income and tax rate. Additionally, it helps to keep some of the most common tax credits and deductions in mind, so you know what you’re working toward when it comes times to file.
- Child and dependent care tax credit
- Education tax credits
- Adoption tax credit
- Investment interest expense deduction
- Charitable donations deductions
- Casualty and theft losses deductions
- Medical expenses deductions
- Mortgage interest and points deductions
Getting started
Whether you’re setting yourself up for success in the beginning of the year or making adjustments in the latter half, there are multiple options for lowering your effective tax rate and paying less when the tax deadline comes.
To start, use a tax bracket calculator to understand your marginal tax rate and your effective tax rate. From there, you can consider applicable credits and deductions you qualify for and be well on your way to minimizing your taxes.
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