Understanding a Negative Effective Tax Rate

Whether you’re doing your taxes by hand or using tax software like TurboTax or H&R Block, you’ll get a decent amount of insight into your financial stability. However, you might be a little confused when you see that you have something called a “negative effective tax rate.” Suddenly, the government owes you money at the end of the year.

So, what is negative effective tax rate? Your effective tax rate is calculated by dividing your paid income tax by your actual annual income. A negative effective tax rate usually occurs when your tax credits are more valuable than your actual paid taxes. If that’s the case, you’ll get a rebate rather than owe the government taxes.

Just how you might find yourself in a position where the government actually owes you money depends on quite a few circumstances. So, we’re going to go over everything you need to know about personal and corporate negative effective tax rates.

Personal Negative Effective Tax Rate

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When you file your taxes as an individual (rather than a corporation), you’re basing your tax information on your yearly income and possible tax credits that you might be entitled to. For every credit that you’re eligible for, that’s more money taken out of the taxes you owe.

Negative effective tax rates are typically seen in lower-income communities. That’s usually because these individuals are already paying a minimal amount of taxes on their income. Add that to being eligible for extra tax credits, and you’ve got yourself a negative effective tax rate.

For personal tax filers, the amount of income tax paid will vary based on your level of income. 

If you’re on the lower end of the income spectrum, you might be paying as little as 10% tax on your income and having access to a greater amount of tax credits. Those making more a year might be paying up to 37% tax on their income. That means they’ll need to be eligible for more tax credits to end up in the negatives.

Refundable Credits for Individuals

There are plenty of ways that you can build up your tax credits to lead you to a situation where the government is giving you a tax refund at the end of the year. Here’s a list of some examples of these tax credits:

  • Child Tax Credit & Dependent Care Credit. You’re entitled to this credit if you’re spending money on child care for a minor under the age of 13 while you’re currently employed. You might be able to claim between $3,000 and $6,000 in credit, depending on how many children you have.
  • Earned Income Tax Credit. This is also called EITC or EIC and is available to you if you’re considered to be in the low or moderate-income brackets. The less you owe on your annual income, the more of a refund you’ll be entitled to by the federal government.
  • Foreign Tax Credit. You might be able to claim this credit if your income is taxed in both the United States and another country. However, it has to be an income tax that you’re paying in both nations, not any other type of tax.
  • Residential Energy Efficient Property Credit. You might be entitled to this type of credit if you have energy-efficient installations on your property (i.e., Solar panels). The amount of credit you can get will depend on when it was actually installed and what it is.
  • Premium Tax Credit (Affordable Care Act). Also known as PTC, this credit will help you to cover any health insurance premiums on insurance plans that have been purchased through the insurance marketplace. There are certain income requirements for this credit, and you can’t be a dependent to be entitled to it.
  • American Opportunity Credit and Lifetime Learning Credit. Sometimes referred to as AOTC, this credit will help you to cover any costs associated with furthering your education. You can get a maximum credit of up to $2,500 a year (maximum of four years), as long as you’re enrolled in a degree or credit program at least half-time.

As you might be able to tell, you do have to jump through quite a few hoops to achieve a negative effective tax rate when you’re filing as an individual. When your credits total up higher than your taxes owed, you’ll get a refund.

Corporate Negative Effective Tax Rate

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The average federal corporate tax rate was recently adjusted to 21% but can be a lot higher when you factor in state and local taxes (sometimes up to 40%). Based on the 21% value, corporations might actually be paying a lower percentage of income tax than you are.

Big corporations are able to find several loopholes to secure tax rebates at the end of the year. The major difference between personal and corporate effective tax rates is that corporate effective tax rates consider earnings before taxes are taken out.

How Corporations Get Negative Effective Tax Rates

One of the major reasons that corporations are actually getting paid by the federal government come tax time is because they’re carrying deductions or refunds over from one year to another. 

There are two benefits that come along with that.

The first is that a company can get some money back on taxes they paid years prior by claiming losses in the current year. The second is that a company can reduce the amount of taxes it has to pay in the future by posting gains. Overall, major corporations are either saving money or getting money back.

There are also companies that write off accelerated depreciation. This basically means that companies are purchasing pricey equipment and then paying lower taxes based on the eventual wear and tear of this equipment. 

Other corporation strategies include handing off company stocks to employees or investing a lot more cash in employee benefit plans to secure greater federal tax deductions. They might also take advantage of lower income tax rates in other countries throughout the world. 

Corporations are looking for the perfect combination of methods of reporting lower income and then claiming greater tax credits.

Personal vs. Corporate Effective Tax Rate

The major difference between personal and corporate effective tax rates is who’s impacted by it. Personal effective tax rates affect American citizens, while corporate effective tax rates impact big businesses. 

On the other hand, the ability to get a negative effective tax rate is very different between individuals and corporations.

The major issue is that the middle or upper-class American citizen has to go out of their way to guarantee a negative effective tax rate to get a refund. You’ll have to install solar panels, go to college, have children, or settle for a job that doesn’t pay so well. It usually requires you to spend a lot of money to get a little extra money back at the end of the year.

And, unless you have in-depth knowledge of these credits, you might not even know they exist.

On the other hand, the income tax for corporations was recently dropped from about 35% to 21%. In addition to lower federal tax rates, corporations are finding loopholes in the tax system to help them to spend less money on income taxes and get taxes back that they’ve already paid in years past.

Conclusion

It might be difficult to find yourself in a situation where you have a negative effective tax rate and are entitled to a rebate or refund from the government. The only way to guarantee this situation is by claiming more tax credits than the taxes you’ve already paid on your income. 
You can find your possible tax credits here.

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