How Income Tax Works: Calculating and Filing Your Return

Income tax is a levy governments impose on the financial income of individuals and businesses to fund public services like infrastructure, national defense, and social programs. In the United States, the Internal Revenue Service (IRS) manages the tax system, establishing the rules for reporting income and calculating taxes. Individuals and businesses are legally required to file an annual income tax return to report their earnings and determine their tax liability, which can be reduced by various deductions and credits.

Determining Your Filing Requirement

Whether an individual must file a federal income tax return depends on gross income, filing status, and age. Gross income includes all income received that is not tax-exempt. The income threshold that triggers a filing requirement is tied to a taxpayer’s filing status and age.

There are five filing statuses:

• Single
• Married Filing Jointly
• Married Filing Separately
• Head of Household
• Qualifying Surviving Spouse

For the 2024 tax year, a single individual under age 65 must file if gross income is at least $14,600. This threshold increases for those 65 or older. For married couples filing a joint return, the threshold is $29,200 if both spouses are under 65.

The Head of Household status is for unmarried individuals who pay more than half of the household expenses for a qualifying person, with a 2024 gross income threshold of $21,900 for those under 65. The threshold for a Qualifying Surviving Spouse is the same as for Married Filing Jointly. If married but filing separately, a return must be filed if gross income is at least $5.

Certain circumstances require filing a tax return even if income thresholds are not met. An individual with net earnings from self-employment of $400 or more must file. Other situations include receiving distributions from a health savings account (HSA) or owing special taxes. Filing may also be advantageous to receive a refund of withheld income tax or to claim certain tax credits.

Calculating Your Taxable Income

The process begins with your gross income, which encompasses all income from any source. Common examples include wages, salaries, tips, interest from bank accounts, dividends from stock investments, and income from self-employment.

From your gross income, you subtract “above-the-line” deductions, known as adjustments to income. These adjustments are available even if you do not itemize deductions. Examples of these adjustments include contributions to a traditional Individual Retirement Arrangement (IRA), student loan interest paid, and certain contributions to health savings accounts. The result is your Adjusted Gross Income (AGI).

After arriving at your AGI, you subtract deductions to further reduce your income subject to tax. Taxpayers choose between taking the standard deduction or itemizing deductions. The standard deduction is a fixed dollar amount based on your filing status, age, and whether you or your spouse are blind. For the 2025 tax year, the standard deduction for a single individual is $15,000, and for married couples filing jointly, it is $30,000.

Itemized deductions are specific expenses reported on Schedule A of Form 1040. Common itemized deductions include state and local taxes (SALT), capped at $10,000 per household, mortgage interest, and charitable contributions. Medical and dental expenses that exceed 7.5% of your AGI can also be itemized. You should choose the option—standard or itemized—that results in a larger deduction.

Applying Tax Rates and Credits

After calculating your taxable income, you apply the federal income tax rates to determine your initial tax liability. The United States uses a progressive tax system with marginal tax rates, meaning as your income increases, it is taxed at progressively higher rates. For the 2025 tax year, there are seven tax brackets:

• 10%
• 12%
• 22%
• 24%
• 32%
• 35%
• 37%

It is a common misconception that all of a person’s income is taxed at their highest bracket. Instead, different portions of your income fall into different brackets. For example, for the 2025 tax year, a single filer would pay 10% on taxable income up to $11,925, then 12% on the portion of income between $11,926 and $48,475, and so on.

After calculating your tax, you can reduce the amount you owe by applying tax credits. A tax credit is a dollar-for-dollar reduction of your tax liability. Tax credits are categorized as either nonrefundable or refundable. A nonrefundable credit can reduce your tax liability to zero, but you do not receive any of the excess as a refund.

A refundable credit can result in a refund if the credit amount is greater than your tax liability. For example, if you owe $1,000 in taxes and qualify for a $1,500 refundable credit, you would receive a $500 refund. Significant credits include the Child Tax Credit, which for the 2025 tax year has a refundable portion up to $1,700 per child. Other credits are the Earned Income Tax Credit (EITC) and education credits like the American Opportunity Tax Credit.

Required Information and Documentation for Your Tax Return

The information required to complete your return includes the full name, date of birth, and Social Security number (SSN) for yourself, your spouse, and any dependents. This information is entered on Form 1040, the standard U.S. Individual Income Tax Return.

You will also need a collection of income-reporting documents. The most common is Form W-2, which you receive from each employer. Other income forms include Form 1099-INT for interest income, Form 1099-DIV for dividends, and Form 1099-NEC for income earned as an independent contractor.

If you plan to itemize deductions or claim certain credits, you will need supporting documentation. For example, to claim the mortgage interest deduction, you will need Form 1098 from your lender. For charitable contributions, you should have receipts or bank records as proof of your donations.

How to File Your Return and Pay Taxes

You have several options for filing your completed tax return with the IRS. The most common method is to e-file through tax preparation software or with a tax professional. Other options include:

• Using the IRS Free File program if your AGI is below a certain threshold.
• Using the Direct File option in certain states for simple returns.
• Mailing a paper return to the IRS address found in the Form 1040 instructions.

If you have a balance due, you can pay the taxes you owe. You can authorize a direct debit from your bank account, use a debit or credit card through an IRS payment processor, or mail a check or money order to the “U.S. Treasury” with Form 1040-V. Note that payment processors may charge a fee.

After filing, you should receive a confirmation that the IRS has accepted your return. If you are due a refund, most are issued within 21 days for e-filed returns with direct deposit, while paper-filed returns take longer. You can track your refund’s status using the “Where’s My Refund?” tool on the IRS website.