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Every spring, Americans engage in the common ritual of filing income taxes. Everyone scrambles to gather forms and receipts, pore over tax filing software and eagerly await their refunds. What was once the season of rebirth is now more commonly known as income tax season.
Income tax is a portion of your income you pay to the government each year to help fund government services and infrastructure. Depending on your circumstances, filing your taxes can be quick and painless or time-consuming and difficult. Here are the basics of income taxes.
How Does Income Tax Work?
The Internal Revenue Service (IRS) collects income taxes from U.S. individuals and businesses according to the U.S. tax code. Federal income taxes fund the federal government, including services like Medicare, Medicaid and Social Security; transportation and infrastructure; defense and national security; the postal service; and the government itself.
The IRS collects two basic types of income taxes: business income taxes and individual (or personal) income taxes. Individual tax returns are due each year on or around April 15. Tax returns report the amount of income you earned during the year, as well as deductions and credits you may use to reduce your tax liability. Your tax return also shows any taxes you've paid in through paycheck withholding or estimated taxes. After calculating how much tax you owe, your return helps you figure out whether you owe additional tax or are owed a tax refund.
How Are Income Taxes Calculated?
Calculating income taxes on an individual tax return can be a lengthy and complicated process. If you're planning to file a return with the IRS, take the time to fill out your tax return forms carefully and accurately so you don't under-report your income—and so you don't miss out on deductions and tax credits you're entitled to.
For the purposes of understanding how income taxes work, here's a quick example that shows the three basic steps to calculating federal income taxes. Say you're a single taxpayer who made $100,000 in salary, savings account interest and income from investments in 2022. Follow these three steps to estimate your 2022 income taxes:
1. Find Your Adjusted Gross Income
Your adjusted gross income (AGI) is all of your income for the year minus IRS-designated income adjustments. Your gross income may include wages, dividends, capital gains, business income, retirement distributions (withdrawals) and miscellaneous income such as tips, rental property income or unemployment benefits. Adjustments to income could include student loan interest, alimony you've paid, educator expenses or retirement contributions.
Example: You earned $100,000 in gross income in 2022 and made $15,000 in retirement contributions to your employer's 401(k) plan. Your AGI is $85,000 ($100,000 - $15,000).
2. Figure Your Deductions
You can itemize deductions such as mortgage interest, property taxes and charity deductions, but most taxpayers use standard deductions that don't require calculations or documentation. Just choose your filing status and subtract your deduction from your AGI.
These are the standard deductions for 2022:
| Standard Deductions for 2022 | ||
|---|---|---|
| Single or Married Filing Separately | Head of Household | Married Filing Jointly |
| $12,950 | $19,400 | $25,900 |
Source: IRS
Example: Here, your taxable income is $72,050: $85,000 (your AGI) minus the standard deduction for a single filer ($12,950).
3. Check Marginal Tax Rates
What percentage of your taxable income goes to taxes? That depends on how much income you have. Federal income tax rates range from 10% to 37%. These rates are applied in brackets and they increase as your income increases.
Here are marginal tax rates and tax brackets for the 2022 tax year:
| 2022 Federal Tax Brackets by Taxable Income | ||||
|---|---|---|---|---|
| Tax Rate | Unmarried | Head of Household | Married Filing Separately | Married Filing Jointly |
| 10% | $0 - $10,275 | $0 - $14,650 | $0 - $10,275 | $0 - $20,550 |
| 12% | $10,276 - $41,775 | $14,651 - $55,900 | $10,276 - $41,775 | $20,551 - $83,550 |
| 22% | $41,776 - $89,075 | $55,901 - $89,050 | $41,776 - $89,075 | $83,551 - $178,150 |
| 24% | $89,076 - $170,050 | $89,051 - $170,050 | $89,076 - $170,050 | $178,151 - $340,100 |
| 32% | $170,051 - $215,950 | $170,051 - $215,950 | $170,051 - $215,950 | $340,101 - $431,900 |
| 35% | $215,951 - $539,900 | $215,951 - $539,900 | $215,951 - $323,925 | $431,901 - $647,850 |
| 37% | $539,901 or more | $539,901 or more | $323,926 or more | $647,851 or more |
Source: IRS
Example: Using our example of $72,050 in taxable income, your tax bill as a single taxpayer would be $11,468, calculated as follows:
| Income Brackets | Income x Tax Rate | Tax Owed |
|---|---|---|
| $0 - $10,275 | $10,275 at 10% | $1,028 |
| $10,276 - $41,775 | $31,499 at 12% | $3,780 |
| $41,776 - $72,050 | $30,274 at 22% | $6,660 |
| $11,468 |
Of course, the numbers you'll use to compute your actual taxes are likely to be more detailed and nuanced. Still, these three steps illustrate, broadly, how your federal income taxes are calculated: Total up your income, subtract eligible deductions and apply marginal tax rates to what's left.
Which States Have No Income Tax?
Everyone who makes money in the United States is subject to federal income taxes. At the state and local levels, however, income taxes vary. Currently, nine U.S. states do not collect state income taxes from their residents. They are:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
States that don't collect income taxes still need revenue to fund government services and infrastructure. For that reason, states that don't collect state income taxes often collect more in sales tax, property tax and fees like vehicle registrations.
The Bottom Line
Your individual tax burden will depend on how much money you've made, which deductions you claim and where your income fits on the scale of marginal tax rates. Within this basic three-step structure, there are many potential deductions, credits, adjustments and rules that may affect your tax filing—and how much tax you owe.
If scouring the thousands of pages of U.S. tax code seems overwhelming to you, you may want to use tax preparation software or work with a qualified tax pro when you prepare your tax return. They can help you ensure that you account for all of your income and receive the deductions and credits you're entitled to.