Calculating Your Income After Deductions for Taxes
Learn how your total income is methodically lowered by deductions to arrive at the specific figure used to calculate your final tax bill.
Understanding your income after deductions is necessary for managing personal finances. The amount of money you bring home is not the same figure the Internal Revenue Service (IRS) uses to calculate your tax bill. Instead, your total earnings are reduced through specific deductions to determine the amount you are actually taxed on.
Determining Adjusted Gross Income (AGI)
The starting point for any tax calculation is your gross income, which encompasses all income you receive from every source. This includes your wages reported on a Form W-2, income from self-employment, taxable interest, and dividends. From this total, you calculate your Adjusted Gross Income (AGI) by subtracting “above-the-line” deductions listed on Schedule 1 of Form 1040. AGI serves as a baseline for determining your eligibility for many other tax deductions and credits.
One of the most common above-the-line deductions is for contributions to a traditional Individual Retirement Arrangement (IRA). For 2025, you can contribute and potentially deduct up to $7,000, or $8,000 if you are age 50 or older. This deduction might be limited if you or your spouse are covered by a workplace retirement plan and your income exceeds certain levels.
Another deduction is for student loan interest paid during the year. Taxpayers can deduct up to $2,500 of interest paid on qualifying student loans. This benefit is subject to income limitations and begins to phase out for single filers with a modified AGI between $85,000 and $100,000 ($170,000 and $200,000 for joint filers). Contributions to a Health Savings Account (HSA) also reduce gross income, with 2025 limits at $4,300 for self-only coverage and $8,550 for family coverage, plus a $1,000 catch-up for those 55 and older.
Calculating Taxable Income
After determining your AGI, the next step is to find your taxable income by subtracting either the standard deduction or your total itemized deductions. You should choose the option that results in a larger deduction. Most taxpayers use the standard deduction, as the amounts were increased by the Tax Cuts and Jobs Act.
The standard deduction is a fixed dollar amount that varies by filing status, age, and whether you are blind. For 2025, the standard deduction for single filers is $15,000, for married couples filing jointly it is $30,000, and for heads of household, it is $22,500. Taxpayers who are age 65 or older or are blind can claim an additional standard deduction amount.
As an alternative, you can itemize deductions on Schedule A of Form 1040. This is beneficial if the total of your deductible expenses exceeds your standard deduction. Common itemized deductions include home mortgage interest, state and local taxes (SALT), and charitable contributions. The deduction for state and local taxes is capped at $10,000 per household, and medical expenses can be deducted only to the extent they exceed 7.5% of your AGI.
The Qualified Business Income (QBI) deduction allows eligible owners of pass-through businesses to deduct up to 20% of their qualified business income. This deduction, also known as the Section 199A deduction, is taken after your AGI is calculated and is available whether you itemize or take the standard deduction. For 2025, the full deduction is generally available to those with taxable income below $197,300 for single filers and $394,600 for joint filers.
The Role of Taxable Income in Your Tax Liability
Your taxable income is the final figure used to compute your actual tax liability. The U.S. employs a progressive tax system with tax brackets, meaning higher portions of your income are taxed at progressively higher rates. For 2025, the federal income tax rates are:
- 10%
- 12%
- 22%
- 24%
- 32%
- 35%
- 37%
The tax brackets are applied to your taxable income in a marginal way. For example, a single filer in 2025 will have the first portion of their income up to $11,925 taxed at 10%, the next portion up to $48,475 taxed at 12%, and so on. This calculation determines your initial tax liability before the application of any tax credits.
It is necessary to distinguish between tax deductions and tax credits. While deductions reduce your taxable income, tax credits provide a dollar-for-dollar reduction of the final tax you owe. For instance, a $1,000 deduction for someone in the 22% tax bracket saves them $220 in tax, whereas a $1,000 tax credit reduces their tax bill by the full $1,000. Credits can be nonrefundable, reducing your tax liability only to zero, or refundable, allowing you to receive the excess amount back as a refund.