What is income tax and how is it calculated?

Income tax is the tax that corporations and individuals are required to pay each year by federal, state, and local governments on all of their income. Total income can include wages, tips, interest, dividends, unemployment, and pension distributions.

To calculate income tax, you must first determine your taxable income and tax status to see what tax bracket you fall into and what total deductions you qualify for. Once you have calculated how much of your total income is taxable for the year, you can determine the amount of federal and state income taxes you owe.

When you file your IRS Form 1040 at the end of the year, you’ll already have an idea of how much you expect to have to pay in income taxes or if you’re entitled to a refund.

This is how income tax works

Regardless of your immigration status, if you work and earn an income in the United States, you must pay federal income taxes on all of your earnings to the Internal Revenue Service (IRS) each year. Based on guidelines set by the IRS, calculate your taxable income by considering deductions and exemptions. Then see if you’re eligible for tax credits before determining the total amount you owe in taxes.

The government uses these personal income taxes to fund national security, roads, schools, government services, and programs like Social Security.

Calculation of taxable income

Taxable income is the amount you earned during the year that is taxable. It is equal to your gross income or annual income less any deductions and exemptions to which you are entitled. When you fill out your Form 1040 to pay taxes, calculate your taxable income using the total wages, tips, and other compensation listed in box 1 on Form W-2.

To determine taxable income, subtract the deductions and allowances to which you are entitled from your gross annual income.

exceptions

Tax exemptions, such as charitable donations or dependents’ allowances, reduce your taxable income and the amount you owe in taxes. As the standard deduction was increased with the Tax Cuts and Jobs Act 2017, personal allowances were abolished for 2022.

Standard vs. single deductions

When filing your taxes, you can choose to itemize your deductions or take the standard deduction based on your filing status. You only want to list if your qualifying deductions are greater than the standard deduction.

If someone can claim you as a dependent, you can claim a standard deduction of $1,150 or your entire earned income plus $400 — whichever is greater. If this total exceeds the standard deduction for your enrollment status, use the standard deduction listed below instead.

These rates are based on the IRS Revenue Procedure 2021-45.

Source: tax office
2022 standard deduction
login status	deduction amount
single	$12,950
Married filing jointly	$25,900
head of household	$19,400
Register married separately	$12,950

Understanding your federal income tax bracket

Based on your filing status—single, married, filing jointly, married, filing separately, or head of household—and your taxable income, you are placed in a federal tax bracket that determines your tax rate and amount of tax liability.

What is Federal Income Tax Withholding?

Federal income tax withholding is the amount deducted from your paychecks during the year and used for taxes. This number can be found in box 2 of the W-2 form that your employer gives you at the end of each year.

What tax bracket am I in?

Once you have calculated your taxable income, you can view the current federal tax bracket based on your filing status and determine the taxes you owe. Your taxable income is on line 37 of Form 1040.
The seven income tax brackets for 2022 range from 10 percent on incomes of less than $10,275 to 37 percent on incomes of $539,900 or more for single parents. Below is the effective tax rate based on your filing status and taxable income.

Source: tax office
2022 federal income tax brackets and rates
tax rate	single	Married filing jointly	head of household	Register married separately
10%	$0 to $10,275	0 to $28,550	0 to $14,650	$0 to $10,275
12%	$10,275 to $41,775	$20,550 to $83,550	$14,650 to $55,900	$10,275 to $41,775
22%	$41,775 to $89,075	$83,550 to $178,150	$55,900 to $89,050	$41,775 to $89,075
24%	$89,075 to $170,050	$178,150 to $340,100	$89,050 to $170,050	$89,075 to $170,050
32%	$170,050 to $215,950	$340,100 to $431,900	$170,050 to $215,950	$170,050 to $215,950
35%	$215,950 to $539,900	$431,900 to $647,850	$215,950 to $539,900	$215,950 to $323,925
37%	$539,900 or more	$647,850 or more	$539,900 or more	$323,925 or more

State and Local Income Tax

Only nine states in the US — Texas, Florida, Tennessee, Alaska, Nevada, Washington, New Hampshire, Wyoming, and North Dakota — do not levy state income taxes. The other 41 states levy either a flat or a graduated income tax.

Color coded map of the United States showing state tax rates.

tax credits

While deductions reduce your taxable income, tax credits reduce the amount of tax you owe, also known as tax liability. If your tax credits are greater than the taxes you owe, you could be eligible for a refund. Be sure to follow the IRS rules for calculating your tax credit before claiming it on your tax return.

Individuals may qualify for Family and Dependent Loans, Income and Savings Loans, Homeowner Loans, Health Loans, and Education Loans. The child tax credit and dependent care tax credit are among the most common tax credits that individuals are entitled to.

How do I pay taxes or get a refund?

Once you have determined the amount of state and federal income taxes you owe for the year, you have a few options for paying them. If you filed a W-2 form with your current employer, they will deduct a portion of your paychecks for your income taxes throughout the year – this is your withholding tax.

Many people pay slightly more than what they actually owe in income taxes throughout the year. When you file your tax return, calculate how much you actually owe. If you paid too much, you are entitled to a tax refund.

If you didn’t have income taxes deducted from your salary throughout the year, or you owe more than was deducted, you must pay the taxes you owe when you file them with the IRS. Calculating your income tax allows you to estimate how much you will owe in taxes so you can budget throughout the year and follow our tax planning strategies to lower your tax liability and ease the stress of tax season.

Our budgeting app makes it easy to set aside money each month to pay your taxes at the end of the year and even track your refund after you file it.