What Is Income Tax?

Seeing a portion of your paycheck go toward income tax can sting, but it’s important to know that those funds are designated to go toward national defense, Social Security, infrastructure, education, and other shared services.

Filing and paying taxes is a fundamental responsibility to help fund these vital programs. In this guide, we’ll explain everything you need to know about income tax, from levels to liability. Continue reading to strengthen your understanding of this complex but critical tax.

Income taxes are government-imposed taxes on an individual or business’s income. Federal income tax is an income tax specifically levied by the Internal Revenue Service (IRS). It applies to any entity earning income in the United States, whether or not they currently reside there.

The amount of federal income tax you owe is based on a progressive tax bracket. That means the more income you earn, the more you will owe in taxes. All types of income are taxed at the federal level, from wages and salaries to alimony and rental income. However, different types of income can be taxed at different rates to ensure equity.

Your earned income isn’t the only factor that determines how much tax you owe to the federal government. Every individual also has a filing status, typically based on their marital status and filing preferences. Granted that you meet the legal requirements, you may choose to file as:

• Single
• Married filing jointly
• Married filing separately
• Head of household
• Qualifying surviving spouse

Your filing status is used to determine:

• Your filing requirements (including whether or not you must file)
• Your standard deduction
• Your eligibility for certain credits
• Your correct tax
• Credits you can claim

As of the time of writing, federal tax rates range from 10% up to 37%.

Federal income tax in the United States follows a progressive tax system. It means that different tax brackets determine your tax rate for different components of your income. Your federal income tax percentage will vary based on your income level, as well as your filing status.

In other words, you do not pay a single tax rate on all of your earnings. Instead, your income is broken into different portions. Each portion is taxed at a different rate. You will only owe a high tax percentage on the highest portion of your income.

Your effective tax rate refers to the actual percentage of your income that you pay in taxes. This is nearly always lower than the highest tax bracket your total income falls into. Factors like tax credits and deductions can further reduce your effective tax rate.

Learn more about the difference between marginal and effective tax rates and how to better estimate your tax liability.

Many states also impose their own income tax. This is in addition to any federal income tax you owe. Each state has control over whether they require a state income tax. Individual states also determine how they tax individuals and businesses.

Your state may impose:

• A progressive state income tax, with brackets similar to federal tax brackets
• A flat rate, which applies to all taxpayers, regardless of income level
• No state income tax rate, instead charging higher sales or property taxes

Individuals who work in a given state will typically owe state taxes there, even if they live elsewhere. The exception is if you work in a state that neighbors your state of residence. If that state offers reciprocity, you may only need to pay state income tax in one state.

We recommend consulting your state’s tax board for more information about how you will be taxed.

Income tax liability refers to the total amount in taxes that you owe to the government. This number is calculated based on your taxable income.

The types of income considered taxable by the IRS include:

• Earned income (wages and salary)
• Investment and financial income
• Retirement and social security income
• Business and side income
• Unemployment and government benefits
• Miscellaneous income (jury duty pay, gambling winnings, forgiven debt, etc.)

However, many types of income are not considered taxable by the IRS, including:

• Gifts
• Inheritances
• Life insurance payouts
• Child support payments
• Welfare and SSI
• Certain scholarships and grants

You can often save money on your taxes by ensuring you follow the guidelines for gift tax in the United States.

There are several ways that you can legally reduce your federal income tax liability, including:

• Taking the standard deduction. If you do not itemize your deductions, you may choose to deduct a set amount of income from your total taxable income. This effectively lowers your taxable income and, thus, the amount of tax owed. It ultimately may place more of your income into a lower tax bracket.
• Itemizing your deductions. In some cases, you can deduct eligible expenses from your total taxable income. This can potentially lower your liability more than taking the standard deduction would. This method is most beneficial for those with significant deductible expenses in a given year.
• Claiming tax credits. If you are eligible for tax credits, you can directly reduce your tax bill dollar-for-dollar. Examples of credits include the Child Tax Credit, Earned Income Tax Credit, and education credits.

Learn more about taxes and how taxation works with Raisin's Tax Guides.

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.