The Federal Income Tax: How Are You Taxed?
The federal personal income tax, administered by the Internal Revenue Service (IRS), is the largest source of revenue for the U.S. federal government. Nearly all working Americans are required to file a tax return with the IRS each year. Additionally, most people pay taxes throughout the year in the form of payroll taxes withheld from their paychecks.
Income taxes in the U.S. are calculated based on tax rates ranging from 10% to 37%. Taxpayers can lower their tax burden by claiming deductions and credits.
Federal Income Tax: W-2 Employees
W-2 employees receive W-2 tax forms from their employers, which report the annual salary paid during a specific tax year and the payroll taxes withheld. Employers withhold money from employee earnings to pay for taxes, including Social Security tax, income tax, Medicare tax, and other state income taxes.
Both employers and employees share the responsibility for Federal Insurance Contribution Act (FICA) taxes, which fund Social Security and Medicare programs. The total FICA rate is 15.3% of an employee’s wages, split equally between the employer and employee.
Federal Income Tax: 1099 Employees
Independent contractors, or 1099 employees, do not have federal tax deducted from their pay. They are responsible for their own federal payroll taxes, also known as self-employment tax. Unlike W-2 employees, 1099 workers must pay the entire 15.3% FICA tax themselves.
Employers are required to send 1099 forms to workers who are paid more than $600 during a tax year.
Calculating the Federal Income Tax Rate
The U.S. has a progressive income tax system, meaning higher tax rates apply to higher income levels. These are called marginal tax rates, which only apply to income within specific ranges or brackets. The following table shows the tax brackets for the 2023 tax year, for taxes due in early 2024:
| Taxable Income | Rate |
|---|---|
| $0 – $11,000 | 10% |
| $11,000 – $44,725 | 12% |
| $44,725 – $95,375 | 22% |
| $95,375 – $182,100 | 24% |
| $182,100 – $231,250 | 32% |
| $231,250 – $578,125 | 35% |
| $578,125+ | 37% |
Brackets vary based on filing status: single, married filing jointly, married filing separately, or head of household. For example, a single filer earning $50,000 would have a top marginal tax rate of 22%. However, this rate applies only to income within that bracket, resulting in an effective tax rate of about 12.7%.
Calculating Taxable Income Using Exemptions and Deductions
Federal tax rates apply only to taxable income, which is lower than total or gross income. To calculate taxable income:
- Adjust Gross Income: Make adjustments from gross income to arrive at adjusted gross income (AGI).
- Subtract Deductions: Subtract either itemized deductions or the standard deduction to determine taxable income.
The following table shows the standard deductions for the 2023 tax year:
| Filing Status | Standard Deduction Amount |
|---|---|
| Single | $13,850 |
| Married, Filing Jointly | $27,700 |
| Married, Filing Separately | $13,850 |
| Head of Household | $20,800 |
Itemized deductions may include state and local taxes, mortgage interest, charitable contributions, and medical expenses exceeding 7.5% of AGI.
How to Calculate Federal Tax Credits
Tax credits differ from deductions as they reduce tax liability directly rather than taxable income. Common tax credits include:
- Earned Income Tax Credit (EITC): Refundable, up to $7,830 for 2024 for taxpayers with three or more children.
- Child and Dependent Care Credit: Nonrefundable, up to $3,000 for one child or $6,000 for two or more children.
- Adoption Credit: Nonrefundable, equal to certain adoption expenses.
- American Opportunity Tax Credit: Partially refundable, up to $2,500 per year for qualified education expenses.
Calculating Your Tax Refund
A tax refund depends on the amount of taxes paid during the year versus the tax liability. If taxes paid exceed the liability, the difference is refunded. Refundable tax credits can also result in a refund even if no taxes are owed.
Paying Your Taxes
If you owe taxes, file on time to avoid penalties. If you can’t pay the full amount, the IRS may offer payment options, such as short-term extensions or installment plans. Paying via check or IRS Direct Pay is typically the cheapest method, though credit card payments are also an option with a fee.
State and Local Income Taxes
Many states and some cities and counties have their own income taxes, requiring separate state tax returns. Rules and rates vary by state, so check state-specific tax pages for details.
Understanding the intricacies of federal income tax can help you navigate your financial responsibilities and maximize potential savings through deductions and credits. Consulting with a financial advisor can provide personalized guidance to align your tax strategy with your overall financial goals.