Effective Tax Rate
The actual percentage of income paid as taxes, calculated by dividing total tax expense by pretax income, reflecting the combined impact of multiple tax laws.
Effective Tax Rate
The actual percentage of income paid as taxes, calculated by dividing total tax expense by pretax income, reflecting the combined impact of statutory rates, tax credits, deductions, and other tax provisions.
For instance, a corporation reporting $10 million in pretax income and $2.1 million in total income tax expense would have an effective tax rate of 21%, even if the statutory federal rate is 21% plus additional state taxes, due to offsetting tax credits and deductions.
Effective tax rates typically differ from statutory rates due to permanent differences (non-taxable income or non-deductible expenses), tax credits, foreign income taxed at different rates, and state/local taxes. This metric provides insight into a company’s overall tax efficiency and planning effectiveness. For financial reporting, the rate reconciliation in tax footnotes explains major differences between statutory and effective rates. Comparisons between companies or time periods help analyze tax strategy changes, though differences may reflect legitimate business activities rather than aggressive tax planning.