Effective tax rate

The effective tax rate is the average tax rate at which a taxpayer is taxed. A business calculates its effective tax rate by dividing its total federal and state income tax expense by its pre-tax earnings. The effective tax rate is used to calculate the tax expense in an organization’s annual budget. A key goal of a company’s tax department is to reduce the effective tax rate paid to the lowest amount possible by employing tax strategy, since doing so allows the entity to retain more cash for other purposes.