• Income tax is a tax governments levy on money that individuals and businesses earn. In the U.S. the Internal Revenue Service (IRS) administers and enforces federal income tax law; most states and some localities also impose their own income taxes. Revenue from income tax funds government programs such as Social Security, defense, education, and infrastructure.
Key takeaways
– Federal income tax in the U.S. is progressive: higher earners pay higher marginal rates (for tax years 2023–2024 federal rates range roughly from 10% to 37%). (IRS)
– Taxable income is your adjusted gross income (AGI) minus either the standard deduction or your itemized deductions; credits then reduce the tax you owe. (IRS)
– Businesses and individuals are both subject to income tax, but the way income is reported and taxed depends on business structure (C corporations, partnerships, sole proprietors, S corporations). (IRS)
– Nine U.S. states have no broad-based personal income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, Wyoming), but living in such states doesn’t automatically mean a lighter overall tax burden. (Tax Foundation)
How income taxes are collected (overview)
– Federal: taxpayers file an annual Form 1040 (and supporting schedules) with the IRS. Employers usually withhold income and payroll taxes from wages during the year; self-employed people make estimated quarterly payments. (IRS)
– State/local: most states require a separate return; rules, rates, deductions, and credits vary widely. Some local governments (cities, counties) also levy income taxes.
– Types of reportable income include wages and salaries, tips, interest and dividends, capital gains, rental and business income, and some fringe benefits. Some receipts are nontaxable or partially exempt under IRS rules. (IRS)
A brief history (U.S. context)
– The U.S. first imposed an income tax in 1862 to help finance the Civil War; it was repealed after the war and reintroduced by the Revenue Act of 1913. Form 1040 was also introduced in 1913. (IRS Historical Highlights)
Types of income tax
– Individual (personal) income tax: levied on individuals’ wages, salaries, investment income, retirement distributions, etc. Deductions and credits reduce taxable income or the tax owed. (IRS)
– Business income tax: taxable income for a business depends on legal form. C corporations pay tax at the corporate level; many small businesses and partnerships report business income on owners’ individual returns (pass-through taxation). Business deductions offset operating and capital expenses. (IRS Publication 535; Topic No. 407)
– State and local income tax: most states tax personal income; rules and rates differ. Nine states currently do not impose broad personal income tax. (Tax Foundation)
Important tax concepts
– Gross income: all income from whatever source unless excluded by law.
– Adjusted Gross Income (AGI): gross income after allowable adjustments (e.g., certain retirement contributions, student loan interest adjustments). AGI is a starting point for many tax calculations. (IRS)
– Taxable income: AGI minus either the standard deduction or total itemized deductions and any qualified business income deduction.
– Marginal tax rate: the rate applied to the last dollar you earn; used to compute incremental tax on additional income.
– Effective tax rate: total tax paid divided by total income — reflects the average rate you actually pay, often much lower than your top marginal rate.
– Tax credits vs. deductions: deductions reduce taxable income; credits reduce tax due dollar-for-dollar (and some credits are refundable). (IRS)
What percent of income is taxed?
– There is no single “percent” applicable to everyone. Federal marginal rates range (roughly) from 10% to 37% (2023–2024). Your effective tax rate depends on your income composition, deductions, credits, and whether state/local taxes apply. Lower-income taxpayers often have very low effective tax rates (or net refunds) after credits.
Which states have no broad-based personal income tax?
– Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, Wyoming. Note: New Hampshire and Tennessee historically taxed certain investment income and have phased/tapered rules, so check current state law. Also consider other tax types (sales, property, excise) that can be higher in no-income-tax states. (Tax Foundation)
How to calculate your income tax — step‑by‑step (practical)
1. Gather records
• W-2s, 1099s (interest, dividends, nonemployee compensation), K-1s (partnership/S-corp income), 1098 (mortgage interest), receipts for deductible expenses, records of estimated tax payments, prior-year return.
2. Add up gross income
• Sum wages, business income, interest, dividends, capital gains, rental income, retirement distributions, and other taxable receipts. (IRS “What Is Taxable and Nontaxable Income?”)
3. Compute Adjusted Gross Income (AGI)
• Subtract allowable adjustments (above-the-line deductions) such as certain retirement plan contributions, self-employment health insurance, student loan interest, and educator expenses. (IRS Definition of AGI)
4. Choose standard deduction or itemize
• Use whichever yields a larger deduction. Itemizable items commonly include mortgage interest, state/local taxes (subject to caps), charitable gifts, and certain medical expenses (above thresholds). (IRS Credits and Deductions)
5. Calculate taxable income
• Taxable income = AGI − (standard deduction or itemized deductions) − any other allowable deductions.
6. Apply tax rates
• Use the federal rate schedule for your filing status to compute tax on taxable income. This is a marginal schedule: compute tax in brackets or use tax tables. Add other taxes if required (self-employment tax, AMT if applicable). (IRS Federal Income Tax Rates and Brackets)
7. Subtract credits
• Apply any tax credits (e.g., Child Tax Credit, Earned Income Tax Credit, education credits) to reduce your tax liability. (IRS Credits and Deductions)
8. Account for payments and withholding
• Subtract federal income tax withheld and any estimated payments or refundable credits to arrive at refund owed or balance due.
9. File return and pay any balance
• File Form 1040 and state return(s), pay any balance or arrange payment/extension if needed.
Simple illustrative example (conceptual)
– Gross income: $100,000
– Adjustments: $2,000 retirement contribution → AGI $98,000
– Deductions: $20,000 (itemized or standard whichever applies) → Taxable income $78,000
– Tax: apply marginal tax schedule to taxable income to compute gross federal tax (use IRS tables)
– Credits: subtract any credits to determine final tax owed
– Subtract withholding/estimated payments to determine amount due or refund
Practical steps to reduce your tax bill (for individuals)
– Maximize tax-advantaged contributions: traditional 401(k), 403(b), 457, SEP/SIMPLE IRAs, and deductible IRA contributions reduce AGI now; Roth contributions give tax-free growth instead.
– Use Health Savings Accounts (HSAs): contributions are pre/post-tax advantaged, and qualified withdrawals are tax-free.
– Defer income or accelerate deductions (when sensible) to manage taxable income across years.
– Harvest capital losses to offset capital gains (and up to $3,000 of ordinary income per year).
– Choose the correct filing status and claim all eligible credits (e.g., earned income tax credit, child tax credit, education credits).
– Keep good records: deductibility often depends on substantiation (receipts, mileage logs, invoices).
– Consider timing of deductible expenses (medical, charitable) if you’re near the threshold for itemizing.
Practical steps for businesses and self‑employed taxpayers
– Choose the right business structure: consider tax implications of C corporation vs. S corporation vs. sole proprietorship/partnership.
– Track and substantiate business expenses; ordinary and necessary business expenses reduce business taxable income. (IRS Publication 535)
– Use retirement plans (SEP IRA, Solo 401(k)) to reduce taxable business income.
– Pay estimated taxes quarterly and maintain sufficient withholding to avoid underpayment penalties.
– Retain advisors for complex issues (depreciation, business tax credits, multistate tax nexus).
Filing and payment practicalities
– Watch deadlines: federal returns are normally due mid-April; extensions extend filing but not payment obligations. State deadlines may vary.
– If you expect to owe tax and are self-employed or have significant nonwage income, make estimated quarterly payments to avoid penalties.
– Keep copies of returns and supporting documents for several years (IRS recommends generally at least three years).
Common pitfalls to avoid
– Relying only on marginal rate when estimating real tax burden — use effective rate for a truer picture.
– Missing credits and deductions due to poor recordkeeping.
– Underpaying estimated taxes if you have significant nonwage income.
– Assuming a no-income-tax state is automatically lower-tax: sales, property, and other taxes can offset savings.
The bottom line
Income tax is a principal means by which federal and state governments raise revenue. U.S. federal tax is progressive and complex; the actual percent of income you pay depends on your income, deductions, credits, and the interplay of federal, state, and local taxes. Understanding AGI, the difference between deductions and credits, marginal vs. effective rates, and the specific rules for business income will help you plan and minimize taxes within the law.
Sources and further reading
– Internal Revenue Service (IRS), “Historical Highlights of the IRS.”
– Internal Revenue Service (IRS), “IRS Provides Tax Inflation Adjustments for Tax Year 2024.”
– Internal Revenue Service (IRS), “Federal Income Tax Rates and Brackets.”
– Internal Revenue Service (IRS), “Credits and Deductions for Individuals.”
– Internal Revenue Service (IRS), “Definition of Adjusted Gross Income (AGI).”
– Internal Revenue Service (IRS), “Topic No. 407 Business Income.”
– Internal Revenue Service (IRS), “What Is Taxable and Nontaxable Income?”
– Internal Revenue Service (IRS), “Publication 535, Business Expenses.”
– Tax Foundation, “State Individual Income Tax Rates and Brackets, 2024.”
– Tax Foundation, “Taxes in Tennessee.”
– Tax Foundation, “Taxes in Florida.”
– Walk through a numerical tax calculation for your specific situation (income, filing status, deductions), or
– Provide a checklist and timeline for year‑round tax recordkeeping and estimated payments. Which would you prefer?