Federal Income Tax Guide

What Is Federal Income Tax?

The U.S. federal income tax is a tax levied by the Internal Revenue Service (IRS) on the annual earnings of individuals, corporations, trusts, and other legal entities. Federal income taxes apply to all forms of earnings that make up a taxpayer's taxable income, including wages, salaries, commissions, bonuses, tips, investment income, and certain types of unearned income.

In the U.S., federal income tax rates for individuals are progressive, meaning that as taxable income increases, so does the tax rate. Federal income tax rates range from 10% to 37% and kick in at specific income thresholds. The income ranges the rates apply to are called tax brackets. Income that falls within each bracket is taxed at the corresponding rate.

The federal corporate tax rate is a flat 21% (reduced from 35% by the Tax Cuts and Jobs Act, passed into law at the end of 2017).

How Federal Income Tax Works

Tax is collected from individuals and corporations by the city, state, or country where they reside or operate. When the tax collected is credited to the country's government, it is referred to as a federal tax.

Governments use the money collected through federal taxes to pay for the growth and upkeep of the country. Some look at federal tax as “rent” charged to live in a country or the fee to use the resources provided by a country. When you pay tax to the U.S. government, you’re in effect investing in your economy, as the government uses the funds to do the following:

• Build, repair, and maintain infrastructure
• Fund the pensions and benefits of government workers
• Fund Social Security programs
• Fund major health programs, including Medicare, Medicaid, CHIP, and marketplace subsidies
• Fund "safety net" programs to assist lower-income households
• Fund defense and international security programs
• Improve sectors such as education, health, agriculture, utilities, and public transportation
• Embark on new feats such as space exploration
• Provide emergency disaster relief

The largest source of revenue for the federal government comes from the income of its residents. In 2020, the IRS collected nearly $3.5 trillion in receipts, of which individuals, estates, and trusts contributed $1.87 trillion. Meanwhile, business income taxes accounted for about $264 billion.

Special Considerations

Workers receive their earnings either as net income (NI), also known as take-home pay, or gross income (or gross pay). Net income is the total amount received after taxes, benefits, and voluntary contributions are deducted from the paycheck. When taxes are withheld, it means the company or payer has paid the tax to the government on the worker’s behalf. Gross income includes the total amount of income, and the worker must pay the government what is owed.

The amount your employer withholds for taxes depends on how much you earn and the information you gave your employer on Form W-4. All money earned, whether as a wage, salary, cash gift from an employer, business income, tips, gambling income, bonuses, or unemployment compensation, constitutes income for federal tax purposes.

Federal Income Tax Brackets

The federal income tax is built on a progressive tax system, where higher income earners are taxed at higher rates. The table below shows the tax brackets and rates for 2021:

For 2022, the same tax rates apply, but the income brackets increase slightly:

The marginal tax rate is the additional tax paid for every extra (or "next") dollar of income. For example, a 10% marginal tax rate means that 10 cents of every next dollar earned will be taken as tax.

An individual who is unmarried and earns $80,000 annually falls into the 22% marginal tax bracket. This means the taxpayer would be responsible for $13,223 in taxes (for 2021), the breakdown for which is illustrated in the chart below.

However, note that while the marginal rate is 22%, the effective tax rate is 16.5%. This figure is arrived at by dividing the total tax bill ($13,223) by income ($80,000) and multiplying by 100. The effective tax rate is the actual rate the individual ends up paying in taxes to the government.

State Income Tax vs. Federal Income Tax

It is important to distinguish between the general notion of income tax and federal income tax. In the U.S., governments at the state level may also levy income taxes in addition to federal income taxes.

Not all states have state-level income taxes. Currently, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming don’t have an income tax. New Hampshire taxes dividends and interest income only, but the state will completely phase out these taxes by 2027.