Income Tax, Tax Brackets and Deductions Explained

By Indeed Editorial Team

Updated February 9, 2021

Published February 4, 2020

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Filing income taxes annually is a certainty for most people. You work; you pay taxes. Your taxes become revenue for the government to provide for the general welfare of the public and sustain effective public services, such as Medicare and Social Security. In this article, we explain what income tax is and the different types of income tax, and we examine what is considered taxable income.

What is income tax?

Income tax is revenue collected by the government from earned wages and used, in turn, for the government to operate. It is calculated individually and based upon your annual earned income. Income tax applies to any person or entity, such as trusts, estates or corporations, that make a profit or earned income. Individual income tax rates are determined according to tax brackets set by the government. The amount of taxable income you have and your filing status will dictate what tax bracket you're in.

Read more: Learn About Being a Tax Preparer

What is a tax bracket?

A tax bracket, or tax band, refers to the percentage you are obligated to pay for each portion of your income. For the United States, these rates are divided into seven brackets, or categories. Lower-income households will pay lower income tax rates based upon earned income minus any income-producing expenses, and higher-income earnings are obligated to pay higher rates. This is a progressive tax system.

Your filing status is also considered when calculating your responsibility. You may file as single, married and filing separately, married and filing jointly, or head of household. Although rates for each status vary, those filing as single will be moved into the higher brackets more quickly, and those filing as head of household will be taxed with more income on a lower bracket before being moved into a higher bracket. Once filing status is determined, wages are broken up into seven different earning categories. Brackets are adjusted each year based upon the Consumer Price Index to account for inflation. The seven tax brackets are:

  1. 10%: $0 to $13,850: Based on your filing status, you may be responsible for paying 10 percent of your income up to $9,700 if filing as single or $13,850 if filing as head of household.

  2. 12%: 9,701 to $52,850: In this bracket, you will pay a 12% fee of earned wages past the first $9,750 if filing as single or $52,850 if you are the head of household.

  3. 22%: $39,476 to $84,200: Those filing as single and those filing as head of household in this bracket will be taxed 22% of any wages earned up to $84,200.

  4. 24%: $84,201 to $160,725: Filers who have earnings beyond $84,200 will have that income subjected to the rate of 24%.

  5. 32%: $160,726 to $204,100: Taxpayers whose earned income surpasses $160,725 will be taxed at 32%, up to $204,100.

  6. 35%: $204,101 to $510,300: Those whose earned income and investment income is higher than $204,100 will be obligated to pay 35%.

  7. 37%: $510,301 or more: Taxpayers who earn $510,301 or more will fall into bracket seven and pay 37% of income beyond $510,300.

Read more: Learn About Being an Accounting Assistant

Types of income tax

There are several different forms of income tax. Some are taken before payment is received, often called "withholding," and others are taken as payment later. Some forms of income tax are:

  • Payroll tax: Employers often withhold a portion of earned income to pay for federal income tax. This process is called withholding. You will often fill this out as part of the hiring process and can indicate a number from zero (if not claiming yourself) and up for each dependent you claim, including yourself.

  • Federal Unemployment tax: This is paid by an employer and increases per number of employees.

  • Federal Insurance Contributions Act tax: FICA is money from your earned income that employers keep to support Medicare and Social Security.

  • Capital gains tax: This is any income earned from stocks, bonds or other investments. This is an obligation charged on any monetary gain you earn when selling assets.

  • Corporate tax: This tax is exclusive for business owners and varies depending on business success. Corporate tax rates range from 15% to 35%.

Deductions

Deductions allow tax-paying residents to reduce the amount of their gross income for specific reasons, thereby reducing the amount of earned and taxable income. Some common deductions that can be claimed are:

  • Work-related educational expenses

  • Charitable contributions

  • Expenses incurred to run a business (in some cases things like internet cost, cell phone use)

  • Educational credit

  • Dental expenses

  • Medical expenses

  • Student loan interest paid

  • Child and dependent care tax credit

Earned income tax credit

The earned income tax credit is a benefit and deduction available to taxpayers with low to moderate incomes. It is to help alleviate the cost of living and improve quality of life. It functions to reduce the amount owed and may qualify some for a tax return. Some of the requirements to qualify are:

  • Have an earned income from working for someone

  • Have an earned income from running a business

  • Be a U.S. citizen or resident for the entire tax year

  • Investment income not exceeding $3,600

  • Meet adjusted gross income caps (which vary)

What qualifies as taxable income?

According to the IRS, income is money, property or services you receive within the taxable year. There are both earned income and unearned income. Earned income is money you receive, usually from an employer, in exchange for work or services offered. Unearned income is money gained from things including but not limited to interest, Social Security payments, alimony or rent collected on property owned.

Related: 20 Side Jobs to Generate Additional Income

The IRS identifies some of the following as taxable income:

  • Salaries, wages and tips earned

  • Disability benefits

  • Freelance earnings and net self-employment

  • Fees paid from jury duty

  • Rental property income

  • Security deposits

  • Winnings from gambling or lottery

  • Awards from contests

  • Benefits from unemployment

  • Capital gains from selling assets

  • Alimony payments

Example scenarios

Let us look at two scenarios to learn more about the tax brackets and taxable income.

  • Example 1: In this first example, Jim is single with no dependents and makes $50,000 a year. Having no pre-tax withdrawals like a 401(k), he can claim the standard deduction and avoid itemizing. Jim's taxable income is $50,000 minus the standard $12,000 deduction which results in $38,000. He lands in the 12% tax bracket, being only $700 away from landing in the 22% bracket. Therefore, his $38,000 taxable income would be taxed at 12%. He owes $4,560 on his earned taxable income. If Jim earned an additional $1,900 from a side business, then $700 of that $1,900 would be taxed at 12% and the remaining $1,200 would be taxed at 22%.

  • Example 2: In this next example, Sally is single, filing as head of household with a taxable income of $51,799. Her first $13,599 is taxed at 10%. From that portion of taxable income, she owes $1,359.90. Her remaining $38,200 is taxed at 12%. From that final portion, she owes $4,584. Collectively, Sally owes $5,943.90. Any additional taxable income she may have earned over $51,799 would put her in a higher tax bracket.

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