Personal Income Tax: Overview

The government collects income tax from U.S. residents each year through the Internal Revenue Service (IRS). Personal income tax revenues help the federal government fund such things as road construction, national defense, and the welfare system. If employed, an individual's employer will withhold income taxes. Because self-employed individuals do not have taxes withheld, they will generally pay estimated taxes throughout the year.

This is an overview of issues related to filing tax returns and paying federal income taxes. See FindLaw's Income Tax Basics and Filing Taxes sections for additional articles and resources.

Personal Income Tax

When most people think of taxes, they think of the federal income tax U.S. citizens and residents must pay on their income each April 15. The income tax is an important source of revenue for the federal government, and the IRC lists the laws that taxpayers and the government must follow.

For the purposes of the income tax, income usually includes any wages, tips, commissions, dividends, alimony, capital gains, unemployment benefits, retirement distributions, and Social Security benefits received during the tax year.

How Tax Rates Are Determined

Not all income is taxed at the same rate. The U.S. has a progressive tax system. That means each level of income is taxed at a progressively higher rate. 

For example, let's say you earned $60,000 in 2023. If you are single and those earnings are treated as ordinary income, the first $11,000 is taxed at 10%, the amount between $11,001 and $44,725 is taxed at 12%, and the amount from $44,725 to $60,000 is taxed at 22%. So, while someone who earns $60,000 is in the 22% tax bracket, the income tax rate they actually pay on all of their income is a little more than 13%.

In addition to basing the amount of tax you pay on the amount of income you earn, the tax code uses your filing status to determine your tax rate. That means the tax bracket will depend on whether you are single, a married couple filing a joint return, married and filing separate returns, a widow or widower, or a head of household. In general, a head of household is an individual with a qualifying child or dependent.

Types of Income

The U.S. tax system divides most individual income into two categories: ordinary income and capital gains. Ordinary income includes most compensation, including wages, income from a business you own, and retirement benefits. Capital gains are the profits you earn on the sale of any asset you have held for longer than one year, while assets held for less than one year are treated as ordinary income. 

It usually benefits taxpayers to get as much of their income as possible classified as capital gains because the capital gains tax rate is lower than the rate on ordinary income.

Tax Deductions and Credits

Tax deductions are amounts that can be subtracted from your income to reduce your tax liability. Taxpayers have the option of claiming the standard deduction or itemizing, depending on which benefits their financial situation more. Most individual taxpayers claim the standard deduction that was added to the tax code by the Tax Cuts and Jobs Act of 2017. 

The tax reform replaced what was known as the personal exemption with the standard deduction, which is the same amount for all taxpayers in the same situations. For example, in 2023, the personal exemption for a single taxpayer was $13,850. Thus, a single taxpayer who earned $60,000 in 2023 would only pay tax on $46,150 of that amount.

If you have deductible expenses greater than the standard deduction, you can claim itemized deductions. That allows you to deduct such things as real estate taxes, state income taxes, and contributions to tax-exempt organizations. Some items, such as student loan interest and contributions to IRAs, are often referred to as deductions but are actually adjustments to income that can be claimed, regardless of whether you claim the standard deduction or itemize.

Tax credits are similar to deductions, but instead of reducing your income, they reduce the tax you would owe on your income. Thus, if you owe $1,000 in taxes and can claim a $500 tax credit, your tax bill would be reduced to $500.

Why Tax Laws Matter

Tax laws provide guidance to both taxpayers and the government. The IRC was enacted by Congress and is regularly updated to address problems in the code, help some types of taxpayers, and prevent other taxpayers from taking advantage of the system. Since the IRC can't possibly address every tax situation, the IRS provides rules and regulations that apply tax law to specific tax situations.

Tax laws also address the punishments the IRS can impose on individuals who don't follow the tax laws and regulations. They dictate the methods the IRS can use to collect, which types of penalties it can impose, and how large they can be. Additionally, the IRC outlines your rights as a taxpayer when you are dealing with the IRS. Those rights are listed in the Taxpayer Bill of Rights, which puts all of the taxpayer rights in one tax code section.

Filing a Personal Income Tax Return FAQ

Here are the answers to common questions related to filing a personal income tax return:

Q: What Income Is Subject to Income Tax?

Individuals must pay taxes on their adjusted gross income, which usually includes wages, salaries, tips, commissions, business income, rents, dividends, alimony, capital gains, distributions from traditional IRAs, unemployment benefits, and Social Security benefits.

Q: How Is My Income Tax Calculated?

The federal income tax system is not based on a flat tax where everyone pays a single rate. Your personal income tax rate is determined by the amount of income you earned during the tax year. The IRS has individual income tax brackets ranging from 10% to 37%. The percentage you pay increases with each income threshold you reach.

Q: What Is My Filing Status?

The IRS takes your personal family situation into account when it calculates how much tax you owe. Your filing status can be single, married filing jointly, married filing separately, head of household, and qualifying widower. If you are married, you are allowed to file a joint return together that essentially doubles the tax benefits you receive, but you are not required to file jointly. For example, for married couples, the 2023 standard deduction is $27,700, which is double the $13,850 standard deduction for individual filers. If you are not married but have a child or a dependent, you may file as head of household and receive greater benefits than an individual but fewer than a married couple. The 2023 standard deduction was $20,800 for those filing as head of household.

Q: What Kinds of Deductions Can I Take?

Tax deductions are adjustments to an individual's taxable income that usually further a government tax policy, like promoting home ownership or college education. For every dollar of deductions an individual has, the amount of income the government levies taxes on decreases by a dollar. A taxpayer can take the standard deduction or claim itemized deductions. Common deductions include student loan interest, college tuition, medical and dental costs, mortgage points, mortgage interest, property taxes, state income taxes, charitable contributions, and home office expenses.

Q: What About the Personal Exemption?

Until 2017, the federal tax code provided for a personal exemption. However, the 2017 Tax Cuts and Jobs Act did away with the personal exemption and replaced it with the much larger standard deduction. Some states, like New Hampshire, still provide a personal exemption from the income tax.

Q: What Are Tax Credits?

Tax credits reduce an individual's tax liability dollar for dollar. For every dollar of tax credits that an individual has, the dollar amount of the taxes that they must pay goes down by a dollar. Every year new tax credits become available, but common credits include the earned income tax credit, first-time homebuyer credit, child and dependent care credit, adoption credit, Hope and Lifetime Learning credit, credit for the elderly and disabled, and retirement savings contributions credit.

Q: Does My Business Pay Income Tax?

The short answer is yes. However, the specifics of how your business is taxed depend on how it is organized. Most small businesses are organized as partnerships, S corporations, or sole proprietorships where the business's net income is simply treated as personal income to you and your partners (if it is a partnership). However, businesses organized as C corporations are subject to the corporate income tax on the income it earns.

Q: Can I Obtain an Extension if I Can't File My Tax Return by April 15?

If a taxpayer is unable to file a return on time, the taxpayer can request an automatic extension by filing IRS Form 4868. Along with filing the tax form, it is necessary to pay all the tax liability or the estimated income tax due. The extension to file does not extend the time to pay.

Q: What Happens if I Don't File a Tax Return?

Federal tax law requires you to file an income tax return each year. If you fail to do so, the IRS can seek criminal charges against you if they discover the nonpayment within six years. That six-year period only applies to criminal charges because there is no statute of limitations for collecting any taxes you owe from a year when you did not file a return. In addition, failing to file a tax return by the deadline can result in:

• The assessment of penalties and interest on the tax debt
• The filing of a substitute return for the taxpayer by the IRS
• The IRS beginning collection activities after assessing the tax debt, including levying wages and bank accounts and placing a lien on real property

Q: Do I Have to File a Tax Return if I Live in Another Country?

A U.S. citizen earning income abroad still must file a tax return and pay taxes to the U.S. government, even if they are a nonresident. If qualified for the foreign earned income exclusion, the taxpayer may exclude foreign income up to $107,600 (for 2020). The taxpayer may also qualify for the foreign housing exclusion and deduction. In some countries, the taxpayer may also have to pay income taxes in the country they reside in.

Q: What Types of Activities May Trigger an Audit by the IRS?

It is difficult to completely audit-proof a tax return, but some taxpayer activities may stand out. For instance, the IRS may scrutinize the tax information of a self-employed person more than an employed taxpayer because there is more opportunity to hide income and claim personal expenses as business expenses.

Q: What About State Income Taxes?

Most states have some form of income tax but generally impose the tax at a lower rate than the federal government. The seven states that don't have an income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Many states also have a sales tax, and some have a statewide property tax.

Paying Personal Income Tax FAQ

Here are the answers to common questions related to paying personal income tax:

Q: Can I Pay My Tax Debt in an Installment Plan?

A taxpayer that is unable to pay their tax debt by the deadline may work out an installment agreement with the IRS. An installment agreement allows payment of the debt in installments, but interest and penalties will apply. To qualify, the taxpayer must be current on their tax return filings.

Q: Can I Settle My Tax Debt With the IRS?

In some cases, the IRS will agree to settle a tax debt for less than what the taxpayer owes. Requests to settle debts are called "offers in compromise" (OICs). If the debtor can pay the full tax liability in an installment plan or by another method, the IRS will most likely deny a settlement request. The IRS may accept a request based on three reasons:

• Doubt about the tax liability
• Doubt that the tax debt is collectible
• If collecting the tax liability would create an economic hardship or an exceptional circumstance that makes it unfair

Can I Settle My Tax Debt With the IRS?

In most circumstances, tax liability survives bankruptcy. In Chapter 13, the debtor will have to pay the debt in full in a repayment plan. The debtor will most likely continue to owe the debt at the conclusion of a Chapter 7 bankruptcy. However, a taxpayer may discharge tax liability in Chapter 7 upon the fulfillment of certain conditions.

Still Have Questions? Reach Out to an Attorney

If you have questions about personal income tax and how it will affect you, you may want to contact a local tax attorney for help. Tax attorneys have a deep understanding of tax law and have made a career out of helping people with their tax problems.