Federal Income

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Federal Income Tax: What It Is and How It Works

What is federal income tax?

The U.S. federal income tax is levied by the Internal Revenue Service (IRS) on the annual earnings of individuals, corporations, trusts, and other entities. For individuals it applies to wages, salaries, tips, investment income, certain retirement benefits, and other forms of earned and unearned income. The system is progressive: higher portions of income are taxed at higher rates determined by tax brackets.

Why it matters

Federal income tax is the largest source of revenue for the federal government and funds programs and services such as infrastructure, defense, Social Security, Medicare and Medicaid, education, disaster relief, and more.

Types of taxable income

  • Earned income: wages, salaries, self-employment income, business income, pensions, unemployment benefits, fringe benefits.
  • Unearned (passive) income: interest, dividends, capital gains, royalties, certain cryptocurrency proceeds.

Gross income vs. net income

  • Gross income: all money received from any source unless specifically excluded by law.
  • Net income (take-home pay): what remains after taxes, benefit contributions, and other withholdings. Employer withholding depends on pay and the employee’s Form W-4.

Filing federal income taxes

  • The primary individual tax return is Form 1040 (Form 1040-SR is an option for seniors).
  • Most returns are filed electronically; additional IRS forms apply for special circumstances (investments, itemized deductions, business income, etc.).

How tax brackets work

  • The federal system is progressive with tax rates applied to income ranges (brackets). For 2024 and 2025 the marginal rates are: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
  • Marginal tax rate: the rate applied to the next dollar of income you earn.
  • Effective tax rate: your total tax divided by total income; it is typically lower than your highest marginal rate because lower portions of income are taxed at lower rates.

Tax reductions: deductions vs. credits

  • Tax deductions reduce taxable income. Common options:
  • Standard deduction (set amount by filing status).
    • 2024: $14,400 (single), $29,200 (married filing jointly).
    • 2025: $15,000 (single), $30,000 (married filing jointly).
  • Itemized deductions: mortgage interest, charitable contributions, qualifying medical expenses (subject to limits).

  • Above-the-line deductions: certain retirement contributions (e.g., traditional IRA) and eligible education expenses.

  • Tax credits reduce tax liability dollar for dollar and are generally more valuable than deductions. Examples:

  • Child Tax Credit (maximum $2,000 for 2024 and 2025; refundable portion capped at $1,700).
  • Earned Income Tax Credit (EITC) for low- to moderate-income workers.

  • Education credits (American Opportunity Tax Credit, Lifetime Learning Credit).

  • Refundable vs nonrefundable credits:

  • Nonrefundable credits can reduce tax liability to zero but do not generate a refund beyond that.
  • Refundable credits can reduce liability below zero, producing a refund for the unused portion.

State vs. federal income tax

  • Most states levy their own income tax in addition to federal tax. As of 2024, seven states do not impose a state individual income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming. New Hampshire taxes interest and dividends only and is phasing those out by 2027.

Other federal tax filers

  • Businesses: corporations, partnerships, and other entities have distinct filing rules and may access business-specific credits (General Business Credit, etc.).
  • Nonprofits: tax-exempt organizations file informational returns (e.g., Form 990) to maintain status.
  • International considerations: U.S. residents and certain foreign entities with U.S.-source income must follow special reporting and filing rules.

Common questions

  • Are Social Security benefits taxable? Social Security benefits are included in “combined income” (AGI + nontaxable interest + half of Social Security). If combined income is between $25,000 and $34,000 (single), up to 50% of benefits may be taxable; above $34,000, up to 85% may be taxable.
  • When is federal income tax due? Typically April 15 each year; the date moves to the next business day if it falls on a weekend or holiday. The IRS may extend deadlines in emergencies.
  • What are the current marginal rates? For 2024 and 2025: 10%, 12%, 22%, 24%, 32%, 35%, 37%.

Bottom line

Federal income tax is a progressive system that applies to most forms of individual and entity income. Annual updates to brackets, deduction amounts, and credits affect tax liability, so taxpayers should review current IRS guidance, consider available deductions and credits, and consult a tax professional when needed.

Sources (selected)

Internal Revenue Service; U.S. Department of the Treasury; Social Security Administration.