Opening the book…
- Determine gross, adjusted gross, and taxable income.
- Apply deductions and credits to basic income tax calculations.
- Compute FICA tax and income tax.
Before the start of the American Civil War in \(1861,\) most of the country’s revenue came from tariffs on trade and excise taxes. However, this fell far short of the high cost of the war. Because of this, the federal government enacted the nation’s first income tax with the Revenue Act of \(1861,\) which created the Internal Revenue Service as we know it today.
No one likes paying income tax, but it is a reality of life. In this section, we will learn about Form \(1040,\) the U.S. Individual Income Tax Return, and ways to prepare for tax time.
The U.S. tax code may change from year to year. Because of this, this section includes examples of how taxes, deductions, and exemptions might be computed. The types of income, deductions, and exemptions that are used in the examples are used in the current tax code.
Income Tax Terminology
Your income drives how much you pay in taxes. The more you earn, the more you are likely to pay. But your income alone is not the full story. When you add all the money you earn from your job, freelance work, interest from savings, and other sources, you have your gross income. If you are an employee, your income from your job will be reported on a W-\(2,\) which is sent to you by your employer. Income from freelance work will be reported on a \(1099\)-MISC form, and is sent by the company that paid you. Income from interest is reported on a \(1099\) -INT form and comes from the entity that paid the interest.
Before you determine how much you owe in taxes, you will make certain adjustments to that gross income. You will deduct or subtract some of the income from the gross income. That’s your adjusted gross income or AGI. That is still not what you are taxed on. Next, you need to apply exemptions to your income. These are pieces of income that the government does not tax. After that is done, you reach your taxable income. We will look at each of these parts of the taxable income.
"Tax withholding" refers to the portion of an employee’s wages that an employer deducts and sends directly to the government as partial payment of the employee’s income tax. It serves as a way to pay income taxes gradually over the course of the year rather than all at once when you file your return. You can find federal income tax withholding on your Form W-2.
Money given as a gift may be taxed if the gift amount is high enough. If you win \($50,000\) in the lottery, that money is taxed as income. If you give a family member a large cash gift, the gift will be subject to tax if it exceeds the federally set limits.
You will notice that your paycheck already has taxes taken out. Your employer will withhold some of your income, sending it directly to the federal, state, and local governments. It is an estimate of how much you will owe in income tax. Ultimately, it reduces the amount you will pay when your taxes are due. If they withhold too much income, you will receive the excess withheld as a refund.
Here are the U.S. states that do not have a state income tax as of \(2025\): Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming
Gross income (GI) refers to the total earnings an individual or business receives before any deductions or taxes are taken out. Gross income includes wages, salaries, bonuses, rental income, tips, investment income, unemployment compensation, profit from business, and game-show winnings.
Adjusted Gross Income (AGI) is your gross income minus certain allowable deductions, known as adjustments. Some of the adjustments include student loan interest, contributions to a traditional IRA, contributions to a health savings account (HSA), alimony paid, educator expenses, tuition, and fees.
\begin{align*}
\text{Adjusted Gross Income (AGI)}=\text{Gross Income}-\text{adjustment}
\end{align*}
A deduction is an amount you can subtract from your adjusted gross income (AGI) to reduce the amount of income that's subject to tax. Deductions help lower your taxable income, which can decrease the amount of tax you owe. There are two types of deductions:
Standard Deduction: A fixed amount set by the IRS based on your filing status (e.g., single, married, filing jointly).
Itemized Deduction: If your deductible expenses are higher than the standard deduction, you can itemize. Common itemized deductions include: Mortgage interest that you paid, charitable contributions if you made any, medical bills over a threshold, medical insurance under certain circumstances, and property taxes. If you add all these up, and they are all legal deductions, the sum is subtracted from your gross adjusted gross income.
During calculation, you have to use only one deduction, whichever is higher, NOT BOTH.
Taxable income (TI) is the portion of your income that is subject to income tax after all deductions (standard or itemized) and adjustments (like those used to calculate AGI) have been subtracted from your gross income.
\begin{align*}
\text{Taxable Income}=\text{AGI}-\text{Deduction}
\end{align*}
Remember that your AGI is not your taxable income.
Example \(\PageIndex{2}\): Find GI, AGI, and TI
Puspa and Sami were calculating their taxes for \(2022.\) Their income for that year was \($176,815.\) They contributed \($7,900\) to tax-deferred retirement plans. They also have a rental income of \($19,800\) for a home they rent and \($18,200\) for profits from a small business. They have the following deduction: mortgage interest payments of \($15,600.\) State and local taxes deduction of \($7,400.\) And charitable contribution amount of \($10,200.\) The standard deduction for a married couple filing jointly is \($25,900.\)
\(1.\) What is their gross income?
\(2.\) What is their adjusted gross income?
\(3.\) What is their taxable income?
- Answer
-
\(1.\) \(\text{Adjusted Gross Income (AGI)}= $176,815+ $19,800+$18,200=$214,815 \)
\(2.\) Here, \($7,900\) to a tax-deferred retirement account is the adjustment. So
\begin{align*}
\text{Adjusted Gross Income (AGI)}&=\text{Gross Income}-\text{adjustment}\\&=$214,815 - $7,900\\&=$206,915
\end{align*}\(3.\) Since itemized deduction = \($15,600+ $7,400+ $10,200 =$33,200\;\) is more than the standard deduction, we must subtract the itemized deduction to find taxable income.
\begin{align*}
\text{Taxable Income}&=AGI-\text{deduction}\\&=$206,915- $33,200\\&= $173,715
\end{align*}Note: For deductions, always find both options (itemize and standard) and use the higher one. If you subtract the higher deduction, your taxable income will be less. That’s what all taxpayers want.
Tax Credits
Another piece of the tax puzzle is tax credits. This is money subtracted from the tax you owe.
Tax credits are very different from deductions or exemptions. Deductions and exemptions are taken away from your gross income before the tax you owe is calculated. A tax credit is subtracted, dollar for dollar, from your tax bill. Once the tax you owe is calculated, subtract any tax credits from that calculated tax.
Some of the tax credits are refundable. This means that if subtracting them from your tax results in a negative number, you receive a tax refund. For more details, see this article about tax credits(opens in new window).
| Refundable Tax Credit | Non-Refundable Tax Credit |
|---|---|
|
|
The federal government has imposed income limits and restrictions on those eligible to receive tax credits because the value of these credits is so high. Here is a partial list of tax credits that you might qualify for:
- Earned income credit is a refundable tax credit for low- to moderate-income workers and ranges from \( $632\) to \( $7,830\) depending on dependents and income. This is refundable.
- The American Opportunity Credit is a tax credit available to parents with children enrolled at least half-time in college and pursuing a degree. This credit is worth \( $2,500\) per student for the first \( 4\) years of undergraduate school, subject to income limits. This is a refundable tax credit.
- The lifetime learning credit is a credit equal to \(20\%\) of educational expenses, up to \( $2,000\) per year, subject to income limits. There is no cap on how many years you can apply this credit to. This is a nonrefundable tax credit.
- The child tax credit is worth \( $2,000\) per child under the age of \( 17\) if that child lives at home for at least half the year, subject to income limits. This is a refundable tax credit.
- The Child and Dependent Care Tax Credit was designed to help pay for child care while the parent is working. The amount of the credit is dependent on your income. However, the maximum amount that can be received is, in \( 2026,\) \( $3,000\) for one eligible person, or \( $6,000\;\) for two or more qualifying people. A dependent qualifies if they are a child under \( 13\) years old, a spouse who is unable to care for themselves, or some other qualifying person. This is a refundable tax credit.
- The premium tax credit was created by the Affordable Care Act and is received by many people throughout the year. In essence, it is a health insurance premium subsidy. The amount of the credit is based on your income and the price of health insurance in your area. This is a refundable tax credit.
Example \(\PageIndex{3}\): Apply a Tax Credit
\(1.\) Kaitlyn has calculated the tax she owes to be \( $5,200.\;\) However, she receives an earned income tax credit of \( $1,715.\) How much does Kaitlyn owe after applying the earned income tax credit?
\(2.\) Chanajah calculated their tax owed, which came to \($4,300.\) They have an earned income tax credit of \($2,190,\) a child tax credit of \($2,000,\) and a child and dependent care tax credit of \($4,000.\) How much tax does Chanajah owe, or how much will they get in a refund?
- Answer
-
\(1.\) The amount of taxes Katilyn owes is her calculated tax of \( $5,200\) minus the credit she receives. The amount she owes in taxes is
\begin{align*}
$ 5,200 − $1,715 = $3,485
\end{align*}\(2.\) Adding Chanajah’s tax credits together, we find their total to be \($8,190.\) That is more than the tax they owe, which was \($4,300.\) Each of those credits is refundable, which means they will receive a refund. Subtracting the credits from the tax owed yields
\begin{align*}
$ 4,300 − $ 8,190 = − $3,890
\end{align*}This is negative, so it represents a refund of \($3,890.\)
-
Deduction: Lowers how much of your income is taxable.
Example: If you make \($60,000\) and have a \($5,000\) deduction, you now only pay taxes on \($55,000.\) -
Tax credit: Lowers your actual tax bill, dollar for dollar.
Example: If you owe \($5,000\) in taxes and you have a \($1,000\) credit, you only owe \($4,000.\)
Big difference:
- A deduction reduces the amount of income taxed.
- A credit directly reduces how much tax you owe.
Example \(\PageIndex{4}\): Tax Credit or Deduction
Assume a student earns \($40,000\) in income for the year, and their tax rate is a flat \(12%\).
- How much will his tax bill be reduced if he makes a \($2000\) contribution to charity?
- How much will his tax bill be reduced if he qualifies for a \($2,000\) tax credit?
- Answer
-
If you itemize your deduction, the \($2000\) contribution to the charity reduces your taxable income by \($2000.\) Since you are in \(12\% \) tax bracket, your tax bill will be reduced by \($2000\times 0.12=$240.\;\), but if you use the standard deduction (when your itemized deduction is less than the standard deduction), your tax bill is reduced by nothing.
- Answer
-
Whether you use itemize or standard deduction, your tax bill is reduced by \($2000.\)
Computing FICA Taxes
FICA stands for the Federal Insurance Contributions Act of \(1935.\) FICA taxes are used solely to fund Social Security and Medicare and are separate from federal income tax.
FICA taxes are the taxes taken out of your paycheck to fund Social Security and Medicare.
Social Security helps people when they retire, become disabled, or die (their family can sometimes get benefits).
Medicare helps mainly older people \((65+)\) with health insurance.
| Employee's Rates | Self-Employed Rates1 |
|---|---|
|
|
FICA taxes include Social Security and Medicare. The Social Security tax applies to the first \($147,000\) of income, while the Medicare tax applies to all income.
It amounts to \(7.65\%\) of your gross pay, which is withheld from your paycheck automatically. Your employer is required to match the \(7.65\%\) amount. Of the \(7.65\%\), \(6.2\%\) goes to Social Security (SSI), and \(1.45\%\) goes to Medicare.
As of \(2022,\) SSI tax only applies to the first \($147,000\) of earnings. Any gross income above that is not taxed for Social Security. This limit changes every year.
Medicare tax, on the other hand, applies to the entirety of your gross income.
Example \(\PageIndex{5}\): Computed FICA Taxes
\(1.\) McKenzi earned \($2,700\) in gross income, before taxes, in a given \(2\)-week period. How much does she owe in FICA taxes, and how much of that is for SSI?
\(2.\) Suppose you earn \($50,000\) from your own business in \(2022.\) How much do you owe in FICA taxes, and how much of that is for SSI?
\(3.\) Renard earned \($195,000\;\) in wages for the year as an employee. How much in SSI taxes does Renard owe for the year? What are the total FICA taxes?
- Answer
-
\(1.\) The FICA tax is \(7.65\%\) of her gross earnings. \(7.65\%\) of her \($2,700\) is \($206.55.\;\) Also, the SSI is \(6.2\%\) of her income, which is \(0.062\times$2700=$167.40\)
\(2.\) The FICA tax is \(15.3\%\times $50,000 =$7,650.\) SSI is \(12.4\%\times $50,000 = $6,200.\)
\(3.\) Since Renard earned more than the taxable limit of \($147,000,\) he only pays the \(6.2\%\;\) SSI tax on \($147,000.\) This comes to \($9,114=0.062\times$147,000.\)
\begin{align*}
\text{FICA Tax}&=7.65\% \; \text{of} \; $147,000+1.45\% \; \text{of} \; ($195,000-$147,000)\\
&= 0.0765\times $147,000+0.0145\times $48,000\\&=$11,941.50
\end{align*}
Calculating Your Income Tax
Your income tax bill and your income tax rate are based on your taxable income. The tax system in the United States is progressive, meaning that the tax rates are marginal, so the higher your taxable income, the higher the tax rate you will pay.
Taxable income is broken into brackets, or ranges of income. Each bracket has a different tax rate. The tax brackets and rates for single filers as of \(2022\) are given below:
| Marginal Tax Rate | For Single Filers | For Married Individuals Filing Joint Returns | For Heads of Households |
|---|---|---|---|
| \(10\%\) | \($0-$10,275\) | \($0-$20,550\) | \($0 -$14,650\) |
| \(12\%\) | \($10,275-$41,775\) | \($20,550-$83,550\) | \($14,650 -$55,900\) |
| \(22\% \) | \($41,775-$89,075\) | \($83,550-$178,150\) | \($55,900-$89,050\) |
| \(24\% \) | \($89,075-$170,050\) | \($178,150-$340,100\) | \($89,050-$170,050\) |
| \(32\% \) | \($170,050-$215,950\) | \($340,100-$431,900\) | \($170,050-$215,950\) |
| \(35\% \) | \($215,950-$539,900\) | \($431,900-$647,850\) | \($215,950 -$539,900\) |
| \(37\% \) | \($539,900\;\) or more | \($647,850\;\) or more | \($539,900\;\) or more |
| Standard Deduction | \(\mathbf{$12,950}\) | \(\mathbf{$25,900}\) | \(\mathbf{$19,400}\) |
So if your taxable income is \($76,500\), you are in \(22\%\) tax bracket? Why? (See above Table
Since that person's taxable income \(\$76,500\) falls in the single filer column in a \(22\%\) marginal rate row. We call the person whose taxable income falls in the \(22\%\) tax bracket. So that person needs to pay \(10\%,\) \(12\%,\) and \(22\%\) of his portion of the taxable income as shown in the following comic diagram.
Tax brackets are progressive. Your income is divided into ranges, and each range is taxed at its own tax rate. Only the income within a bracket is taxed at that bracket's rate.
The following calculation shows how to calculate the tax bill of the above single filer. That person's taxable income is in \(22\%\) tax bracket,
| Marginal Tax Rate | Taxable income that applies to the given marginal tax rate | Tax calculation |
|---|---|---|
| \(10\%\) | \($10,275-$0=$10,275\) | \(0.10\times $10,275=$1,027.50\) |
| \(12\% \) | \($41,775-$10,275=$31,500\) | \(0.12\times $31,500=$3,780\) |
| \(22\% \) | \($76,500- $41,775 =$34,725\) | \(0.22\times $34,275=$7,639.50\) |
So the total tax bill will be
\begin{align*}
$1,027.50+$3,780+$7,639.50=$12,447
\end{align*}
There are various tax brackets, and the rates may change from one year to the next. The income limits may also change. For all examples going forward, we will use the single filer tax brackets, even if those brackets are not appropriate (e.g., married or head of household filers).
Example \(\PageIndex{6}\): Income Tax on Taxable Income
Use the \(2022\) Marginal Tax Rate Table to find the federal tax bill. Faith has a taxable income of \($103,650 \), and she is single.
- Answer
- \begin{aligned}
0.10\times $10,275+ 0.12\times ($51,775-$10,275) + 0.22\times ($89,075- $41,775 + 0.24\times ($103,650 - $89,075 ) =$18,711.50
\nonumber\end{aligned} - Faith's taxable income falls in the marginal tax bracket of \(24\%.\;\) So she needs to pay \(10\%,\) \(12\%,\) \(22\%,\) and \(24\%\) of her portion of the taxable income as shown in the following table.
Marginal Tax Rate for Taxpayer Marginal Tax Rate Taxable income that applies to the given marginal tax rate Tax calculation \(10\%\) \($10,275-$0=$10,275\) \(0.10\times $10,275=$1,027.50\) \(12\% \) \($41,775-$10,275=$31,500\) \(0.12\times $31,500=$3,780\) \(22\% \) \($89,075- $41,775 =$47,300\) \(0.22\times $47,300=$10,406\) \(24\% \) \($103,650 - $89,075 =$14,575\) \(0.24\times 14,575=$3,498\) - So Faith tax bill is
- \begin{align*}
$1,027.50+$3,780+$10,406+$3,498 =$18,711.50
\end{align*}
Remember that your employer will estimate how much tax you will owe and withhold it from your paychecks. This means you may have already paid some, if not all, and more of the income tax you owe.
If the total taxes owed after tax credit (if there is one) is more than the tax withholding (in W-2), the taxpayer is due a refund, and if the total taxes owed after tax credit (if there is one) is less than the tax withholding (in W-2), the taxpayer owes taxes.
Example \(\PageIndex{7}\): Finding Income Tax Owed
Emmanuel is preparing his taxes for the year \(2022.\) His filing status is married jointly. His and his wife's income that is in W-2 for the year was \($95,250 \ \) He also has income from some freelance artwork he did, amounting to \($7,500,\) which is shown in the form \(1099.\) Emmanuel also deposited \($4,500\) into a tax-deferred retirement plan. He paid \($7,920\) in mortgage interest for the year and \($3,740\) in property taxes. He also qualified for \($4,000\) in child tax credits. Based on this information, how much tax does Emmanuel owe, or how much does he get in a refund?
- Answer
-
We need to know Emmanuel’s taxable income, based on gross income, deductions, and exemptions.
His gross income is the amount from his W-2 and his \(1099\)-MISC. Adding these gives a
\begin{align*}
\text{Gross income} = 95,250+$7,500=$102,750
\end{align*}\($7,500\;\) is his adjustment because it is deposited in the tax-deferred retirement plan. So
\begin{align*}
\text{Adjusted Gross Income (AGI)}&=\text{Gross Income}-\text{adjustment}\\&=$102,750 - $4,500\\&=$98,250
\end{align*}The amount \($7,920\) for mortgage interest, \($3,740\) for property taxes are itemized deduction.
\begin{align*}
\text{Itemize Deduction } &= $7,920 + $3,740\\&=$11,660
\end{align*}From the \(2022\) tax table, his standard deduction (for a married couple) is \($25,900,\) which is more than the itemized deduction. So we need to use the standard deduction to find the taxable income.
\begin{align*}
\text{Taxable Income}&=$98,250-\text{deduction} \\&= $98,250- $25,900\\&= $72,350
\end{align*}His taxable income belongs to the \(12\%\) marginal tax bracket.Marginal Tax Rate Marginal Tax Rate Taxable income that applies to the given marginal tax rate Tax calculation \(10\%\) \($20,550-$0=$20,550\) \(0.10\times $20,550=$2,055\) \(12\% \) \($72,350-$20,550=$51,800\) \(0.12\times $51,800=$6,216\) Total tax computation \($2,055+$6,216 =$8,271\)
Once his taxes are computed, he subtracts his tax credits. His only tax credit is \($4,000.\) The total he owes in taxes is
\begin{align*}
\text{Total tax owe } = $8,271- $4,000=$4,271
\end{align*}So Emmanuel owe \($4,271 \) tax.
Example \(\PageIndex{88}\): Refund or Tax Owe?
The Halls are a married couple with two children. Their total adjusted gross income is \($181,770.\) They have following itemize deductions:
\begin{aligned}
&$9050\;\;\text{in property taxes}\\
&$9850\;\;\text{in charitable contributions}\\
&$910\;\; \text{in childcare expenses}\\
\end{aligned}
In addition, they are eligible for a \($2000\) tax credit for each child. (For this problem, treat this credit as non-refundable.) Round all answers in this problem to the nearest cent, if necessary. To complete this problem, you will need to refer to the \(2020\) tax table.
| Rate | Single | Married Filing Jointly |
|---|---|---|
| \(10\%\) | \($0-$9,875\) | \($0-$19,750\) |
| \(12\%\) | \($9,875-$40,125\) | \($19,750-$80,250\) |
| \(22\%\) | \($40,125-$85,525\) | \($80,250-$171,050\) |
| \(24\%\) | \($85,525-$163,300\) | \($171,050-$326,600\) |
| \(32\%\) | \($163,300 - $207,350\) | \($326,600-$414,700\) |
| \(35\%\) | \($207,350- $518,400\) | \($414,700-$622,050\) |
| \(37\%\) | \($518,400\) or more | \($622,050\) or more |
| Single | Married Filing Jointly |
|---|---|
| \($12,400\) | \($24,800\) |
\(1.\) If they itemize their deductions, how much will the Hall' total deduction be?
\(2.\) Should they itemize their deductions or use the standard deduction?
\(3.\) What is the Hall' taxable income for \(2020?\)
\(4.\) Calculate the Hall' total taxes owed, before tax credits.
\(5.\) Calculate the Hall' total taxes owed, after tax credits.
\(6.\) They have prepaid \($22,253\) over the course of the year through withholding. Do the Hall owe taxes, or are they due a refund? How much do they owe, or what refund are they due?
- Answer
-
\(1.\) Itemize deduction: \($9,050+$9,850+$9,100=$28,000\)
\(2.\) They should use itemize deduction of \($28,000\;\) since it is more then standard deduction \($24,800.\)
\(3.\) Taxable income is
\begin{align*}
\text{Taxable income}&=\text{AGI}-\text{deduction}\\&=$181,770 - $28,000 \\&=$153,770
\end{align*}\(4.\) The Hall's taxable income belongs to the tax bracket of \(22\%.\)
Marginal Tax calculation Marginal Tax Rate Taxable income that applies to the given marginal tax rate Tax calculation \(10\%\) \($19,750-$0=$19,750\) \(0.10\times $19,750=$1,975\) \(12\% \) \($80,250-$19,750=$60,500\) \(0.12\times $60,500=$7,260\) \(22\% \) \($153,770- $80,250=$73,520\) \(0.22\times $73,520=$16,174.40\) Calculate the Hall' total taxes owed, before tax credits, is \($1,975+$7,260+$16,174.40 =$25,409.40\)
\(5.\) Once his taxes are computed, he subtracts his tax credits. His only tax credit is \($4,000.\)
Because \(2\times$2000\), since for each child, the child tax credit is \($2,000.\)
\begin{align*}
\text{Total tax after tax credit } &= $25,409.40 - $4,000\\&=$21,409.40
\end{align*}\(6.\) They have prepaid \($22,253\) over the course of the year through withholding. That means they are already more than they are liable to. So they will get a refund of \($22,253-21,409.40 = $843.60\)
This page titled 4.6: Income Tax and FICA Taxes was last modified on Wed, 28 Oct 2026 13:46:20 GMT and is shared under a CC BY 4.0 license and was authored, remixed, and/or curated by Cheban Acharya via source content that was edited to the style and standards of the LibreTexts platform.
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