What Is Income Tax?

Income tax is a type of tax that is imposed on an individual’s or business’s earned and unearned income.

Key Takeaways

• An income tax is a tax based on a taxpayer’s income after any exemptions, deductions, or adjustments allowed by the tax-imposing jurisdiction’s laws.
• Tax laws vary by jurisdiction, but they generally inform taxpayers of which income is taxable versus non-taxable, any deductions or other benefits, and the income tax rates.
• Whether you need to pay income tax or not depends on your individual situation and the income tax laws where you live or are otherwise required to file a tax return.

How Income Tax Works

An income tax is a type of tax that is imposed on an individual’s or business’s earned and unearned income.

For example, the U.S. imposes a federal income tax on its citizens—both those who live in the U.S. and those who live abroad—as well as on its resident aliens. This income tax generates most of the U.S. government’s revenue.

Generally, the jurisdiction imposing an income tax has laws in place to instruct taxpayers on how to calculate their income-tax owing. Most states have their own income tax codes that impose state-level income taxes, and some cities and counties impose additional local-level income taxes.

For the federal income tax system, this set of laws is known as the Internal Revenue Code. It includes rules pertaining to:

• What kind of income is and is not subject to income tax; for example, wages are generally subject to the federal income tax, but interest on state and local government obligations is generally exempt from the federal income tax.
• Deductions and adjustments that taxpayers can take to reduce their income tax liability; for example, individual taxpayers can take either a standard deduction amount for their filing status, age, and blindness status, or they can itemize their deductions against their income.
• The tax rates for each level of income; for example, there are currently seven individual income tax brackets for federal income tax purposes, ranging from 10% for the lowest levels of income to 37% for the highest levels of income.

Let’s say that a taxpayer is single with no dependents, under the age of 65, and not blind. This individual earns $20,000 per year from their job, has no other forms of income, and takes the $12,950 standard deduction for their situation. This standard deduction amount is subtracted from the taxpayer’s wages to calculate their taxable income of $7,050.

The taxpayer would then use the income tax rates for the year to calculate their income-tax owed. In this case, the taxpayer’s taxable income of $7,050 falls entirely within the 10% income tax bracket, so their federal income tax liability is $705, which is $7,050 multiplied by 10%.

Note

If this taxpayer lives or otherwise has a filing requirement in a state that imposes an income tax, they would have to perform similar calculations based on their state’s tax laws.

Do You Need To Pay Income Tax?

Whether you need to pay income tax depends on the rules for the jurisdiction in which you are subject to an income tax. For example, all U.S. citizens and resident aliens are subject to the income tax rules.

However, you may not have to pay federal income taxes if your standard deduction amount or itemized deduction amount exceeds the amount of money you make. That would reduce your taxable income to $0, which would mean you wouldn’t owe any income tax.

Note

If you had self-employment earnings of $400 or more, you may still be subject to the self-employment tax.

Also, keep in mind that your state—if it has a standard deduction amount at all—may have a lower standard deduction amount than the federal standard deduction amount. That means it’s possible you may owe state income tax but not federal income tax, or vice versa.

Whether or not you need to pay income tax depends on your individual situation and the tax laws imposed by the jurisdictions in which you are subject to the income tax.

How Much Are Income Taxes?

The amount of a taxpayer’s income taxes depends on various factors, such as:

• Amount of income
• Type of income
• Eligibility for any tax deductions or credits
• Tax rates in their jurisdictions
• Other income tax rules

Generally, to calculate your income taxes for a particular jurisdiction, you file a tax return in that jurisdiction. A tax return is a standard form or series of forms issued by the taxing jurisdiction that taxpayers complete to calculate their income tax liability, then file with the jurisdiction. For example, individual taxpayers in the U.S. use Form 1040.

Types of Income Tax

Income taxes are categorized in three ways based on the share of taxpayers’ income that goes toward paying them: progressive, regressive, and proportional.

Frequently Asked Questions (FAQs)

What is the earned income tax credit?

The earned income tax credit is a refundable credit available to moderate-income taxpayers. Because it is a credit, it reduces the amount of tax liability after all income and deductions have been accounted for. Because it is a refundable credit, taxpayers who qualify for it will receive a refund from the IRS even if they do not owe any tax.

What states don't have an income tax?

Seven U.S. states have no income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Wyoming. Two more states, Washington and New Hampshire, do not tax wage or salary income, but do tax some kinds of investment income .

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

1. Congressional Budget Office. "The Federal Budget in Fiscal Year 2021: An Infographic."
2. IRS. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”
3. IRS. "1040 Instructions."
4. IRS. “Topic No. 554 Self-Employment Tax.”
5. IRS. “Fairness in Taxes: Progressive Taxes.”
6. IRS. “Understanding Taxes: Regressive Taxes.”
7. IRS. “Understanding Taxes: Proportional Taxes.”
8. IRS. "Earned Income Tax Credit."
9. Tax Foundation. "State Individual Income Tax Rates and Brackets for 2022."

• About Us
• Privacy Policy
• Editorial Guidelines
• Terms of Service
• Diversity and Inclusion Pledge
• Advertise
• Careers
• Contact
• EU Privacy

We Care About Your Privacy

We and our 100 partners store and/or access information on a device, such as unique IDs in cookies to process personal data. You may accept or manage your choices by clicking below, including your right to object where legitimate interest is used, or at any time in the privacy policy page. These choices will be signaled to our partners and will not affect browsing data.

We and our partners process data to provide:

Store and/or access information on a device. Use limited data to select advertising. Create profiles for personalised advertising. Use profiles to select personalised advertising. Create profiles to personalise content. Use profiles to select personalised content. Measure advertising performance. Measure content performance. Understand audiences through statistics or combinations of data from different sources. Develop and improve services. Use limited data to select content. List of Partners (vendors)