Effective Tax Rate
Effective Tax Rate
Income tax expense divided by pretax income for the same reporting period. This is an accrual accounting tax rate, not necessarily the cash tax paid rate.
When to use: Use to gauge tax efficiency and identify firms with unusual tax situations. Wide gaps from the statutory rate (e.g. US 21%) signal tax engineering, foreign-income mix, NOLs being used, or credit utilization. Multinational tech firms often run effective rates well below statutory.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| EffectiveTaxRate | Effective Tax Rate | Tax expense divided by pretax income | % |
| TaxExpense | Income Tax Expense | Income tax expense for the period | $ |
| PretaxIncome | Pretax Income | Income before taxes (EBT) | $ |
Real-Life Examples
Example 1: Multinational Tech
Pretax income $1,000M, income tax expense $150M.
Given
Step-by-Step
15% effective tax rate — well below the US 21% statutory rate. Common for multinationals with significant foreign income taxed at lower rates, or firms with large R&D credits. Investigate the gap before assuming it's sustainable — tax-law changes can move it materially.
Frequently Asked Questions
No. Current/deferred tax accounting, settlements and timing differences can make tax expense differ from cash payments.
A pretax loss or unusually small denominator can make the ratio difficult to interpret. Reconcile unusual tax items before comparing periods.