In the U.S., the federal income tax system is progressive, which means that the rate you pay increases as your income increases. There are different brackets, each with its own tax rate. The IRS updates the income ranges for these brackets annually.
Your filing status is based on your marital status and family situation. It determines your tax rates, standard deduction, and other tax-related factors. The four main statuses are "Single," "Married Filing Separately", "Married Filing Jointly," and "Head of Household."
Income is the money you earn from different sources, including but not limited to, wages, tips, interest, dividends, and rental properties. The IRS categorizes income into different types, such as earned and unearned income, to determine its taxability. See what the IRS defines as taxable and non-taxable income.
Your AGI is your gross income minus specific adjustments. These adjustments can include things like student loan interest, educator expenses, and contributions to certain retirement accounts. AGI can determine your eligibility for several tax credits and deductions.
The standard deduction is a set amount that taxpayers can subtract from their income to reduce their taxable income. This amount varies based on the taxpayer's filing status, such as single, married filing jointly, or head of household. Each year, the IRS updates the standard deduction amount based on inflation. See the standard deduction for tax year 2023.
Instead of taking the standard deduction, taxpayers can choose to itemize their deductions. Itemized deductions include, but are not limited to, expenses like mortgage interest, state and local taxes, and charitable contributions. This is beneficial if your eligible expenses to be itemized exceed your standard deduction.
A tax credit directly reduces the amount of taxes you owe. Examples include the Earned Income Tax Credit (EITC) for low-to-moderate-income workers and the Child Tax Credit for parents. Unlike the 2 types of deductions above, which lower your taxable income, credits reduce your tax liability dollar for dollar.
When you earn wages, your employer withholds a portion of your income for federal, and sometimes state, income taxes. This system ensures that taxpayers pay their taxes throughout the year rather than in one lump sum. At the end of the year, if too much was withheld, you'd receive a refund. On the other hand, if not enough was withheld, you would owe additional taxes.
A tax return is a form (or set of forms) that taxpayers fill out to report their income, deductions, and credits. The most common individual tax return form is IRS Form 1040. After completing and submitting this form and/or other forms, you would either owe the IRS taxes or be due a refund for overpayment of taxes.
If you've paid more in taxes than you owe (through withholding or estimated payments), the IRS will issue a refund for the overpayment. Refunds can be received through direct deposit or a paper check.
An audit is a review of a taxpayer's return to verify that income and deductions are accurate. It doesn't always indicate wrongdoing; sometimes returns are chosen randomly for audit.
***Disclaimer: This article is for informational purposes and is not meant to be financial or legal advice***