Income Tax

What is income tax?

Income tax is a government levy on earnings from work, investments, and business activity. It funds public services such as Social Security, defense, education, and infrastructure. Systems vary by country and by state/local jurisdictions; understanding how income tax is calculated and the available deductions and credits helps taxpayers reduce their liability.

Key points

• Income tax applies to individuals and businesses.
• Many systems are progressive: higher incomes face higher marginal rates.
• Taxable income is typically adjusted gross income (AGI) minus the standard deduction or itemized deductions.
• Tax credits reduce tax owed dollar-for-dollar; deductions reduce taxable income.
• Some U.S. states do not impose a state income tax, but may rely on other taxes.

How income tax is collected (U.S. context)

The federal tax authority administers rules for what income is reportable and taxable, plus allowable deductions and credits. Employers often withhold estimated taxes from wages; self-employed taxpayers must make estimated payments. Taxpayers report income and claim deductions/credits on their annual return.

Types of income tax

Individual (personal) income tax

Levied on wages, salaries, investment income, and other individual receipts. Common elements:
* Adjusted Gross Income (AGI): total reportable income after certain adjustments.
* Deductions: either the standard deduction or itemized deductions (mortgage interest, state taxes, charitable contributions, etc.).
* Tax credits: available for specific situations (education, child care, earned income, etc.) and reduce the tax bill directly.

Example: If gross income is $100,000 and allowable deductions total $20,000, taxable income becomes $80,000. If tax owed on that amount is $20,000 and the taxpayer has $4,500 in credits, the final tax due is $15,500.

Business income tax

Businesses pay tax depending on their legal form:
* Corporations are taxed at the corporate level.
* Pass-through entities (sole proprietorships, partnerships, S-corporations) typically pass profits/losses to owners, who report them on personal returns.
Taxable business income is revenue minus allowable operating and capital expenses.

State and local income tax

Most U.S. states impose personal income taxes; however, nine states do not collect state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Absence of a state income tax does not always mean lower overall tax burden—states may offset with higher sales, property, or other taxes.

How much of your income is taxed?

The share of income taxed depends on your total income, filing status (single, married filing jointly, etc.), deductions, and credits. Federal marginal tax rates span multiple brackets; higher income moves you into higher brackets, increasing the marginal rate applied to the top portion of your taxable income.

How to calculate income tax — basic steps

1. Add all sources of taxable income for the year.
2. Apply adjustments to compute AGI.
3. Subtract the standard deduction or itemized deductions to get taxable income.
4. Apply tax rates or brackets to compute gross tax.
5. Subtract tax credits and apply any prepayments/withholdings to determine net tax due or refund.

Practical tips

• Keep good records of income and deductible expenses.
• Use available credits (education, child, energy, earned income) where eligible.
• For self-employed individuals and business owners, track business expenses and understand estimated tax obligations.
• Consider tax-advantaged accounts (retirement, HSA) to reduce taxable income.
• When moving between states, evaluate the full tax picture—income tax, sales tax, property tax, and public services.

Bottom line

Income tax is a primary source of government revenue and affects individuals and businesses differently depending on income, filing status, deductions, credits, and location. Learning the basic calculation steps and available tax benefits helps reduce liability and supports better financial planning.