USA Income tax

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Last Updated: Wednesday, 15 April 2026 11:03
Published: Thursday, 31 March 2022 23:44
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Income Tax in USA:

There are 2 type of income tax you have to pay in USA.

  • Federal Income Tax: This is a tax that is levied by the central (federal) govt on individual income to all it's residents. You have to file a federal tax return to pay for taxes.
  • State Income tax: This is a tax levied by the respective states on the income of the residents of it's state. This is on top of the federal income tax. State income tax is highest in California at around 14%. It averages around 5%. It's progressive tax, same as federal tax, where marginal tax rate is lower at lower income, and keeps going higher for higher income. This is a good link showing state income tax for all states:
    • Link => https://www.tax-rates.org/taxtables/income-tax-by-state
    • Texas, Florida, Washington, Nevada, Wyoming and Alaska have no state income tax. But they make up for it by levying higher property tax or sales tax. That's still better.
    • You have to file separate tax return for state income to your respective state. This doubles the burden.

We won't talk about state income tax anymore below. Just Federal taxes below.

Federal Income tax:

Tax foundation is a non profit org which has lots of tax related details: https://taxfoundation.org/

Here's the tax history in USA: https://www.investopedia.com/articles/tax/10/concise-history-tax-changes.asp

Historical tax rates: https://taxfoundation.org/data/all/federal/historical-income-tax-rates-brackets/

Here's the summarized timeline of Federal Income tax. USA became independent in 1776, and the constitution initially written forbade any direct taxes not levied in proportion to each state's population. Some taxes were still levied from time to time, but The Supreme Court declared a flat tax contained in the 1894 Wilson-Gorman Tariff Act unconstitutional in 1895. The 16th amendment was introduced in 1913 to pave the way to an income tax by removing the proportional to population clause, and this is the time when "Federal Income tax" was officially enacted in 1913. Many of the taxes we pay today were created in the 1920s and 1930s, including the estate tax, gift tax, and Social Security taxes. "Social Security Act of 1935" was passed and started SS tax collection in 1937. In 1920's less than 1% of Americans were paying taxes, but by 1945, 43 Million Americans were paying taxes, with top rates of 94%. Alternative Minimum Tax (AMT) came into existence in 1978. Ronald Reagan, a Republican, became US president in 1981. He drove a lot of tax reforms, and his economic reforms came to be known as "Reaganomics". In years from 1981 thru 1986,There were major changes via "The Economic Recovery Act of 1981". In 1986, another tax reform act lowered the top rate from 50 to 28%, cutting corporate taxes from 50% to 35%. All of this resulted in nearly 1M Americans becoming millionaires for the first time. under President Bush, tax laws were again changed in 2001 resulting in tax cuts and increase in tax credits. The former President Bush tax cuts expired in 2010.

TCJA (2018-2025): The big change in tax laws came in 2017 via The Tax Cuts and Jobs Act of 2017 (TCJA). TCJA  is a congressional revenue act of the United States signed into law by President Donald Trump which amended the Internal Revenue Code of 1986. TCJA is a temporary change in tax laws applicable for returns filed in 2018 through 2025. The TCJA eliminated or restricted many itemized deductions.  In net, it was a wash for a middle class family of 4. 

Few highlights from this bill:

  • SALT (State and local taxes) deduction reduction - Prior to TCJA, all taxes paid as property tax, higher of state income tax and sales tax paid, were allowed to be deducted entirely. However, TCJA limited deduction to only $10K. In expensive states, property taxes themselves were over $20K for a single home and state sales tax accounted for additional $5K, but now all of that couldn't be taken for deduction (only limited to $10K in total). For local taxes (i.e sales tax) paid, either you can collect all your receipts and add up to get total sales tax paid, or you can use this calculator from IRS, which shows what local taxes you can claim without providing any proof. Usually this is easier, as this allowed me to take ~$3K in state local tax deduction, which was anymore more than what I would have paid in local taxes. See under deductions section below for more details.
  • Doubled std deduction and elimination of personal/dependent exemption - Std Ded was almost doubled for all taxpayers, i,e   TCJA increased the standard deduction from $6,500 to $12,000 for individual filers, from $13,000 to $24,000 for joint returns or MFJ (Married filing jointly), while also eliminating personal and dependent exemptions. Before 2018, personal exemptions of ~$4K per dependent (i.e 16K personal exemption for a family of 4) was allowed, but now with that gone, additional std ded replaced that. The net effect of such a higher std deduction was that for most folks, itemizing no longer yielded less tax, as itemized deductions couldn't get over the amount of std deduction, so 90% of folks just took std deduction (compared to avg of 70% who took std deduction before 2018).
  • Tax rates reduced - Tax rates were reduced for all slabs, and indexed for inflation as was done for all prior years. Highest tax rates for MFJ were reduced to 37% for income above $600K, while prior to TCJA, highest tax rate of 40% was applied on income over $480K. 
  • increased Child Tax Credit (CTC) - increased the child tax credit from $1K to $2K for qualified taxpayers. 
  • Additional senior deduction - additional deduction for taxpayers 65 and older (age as of 31st Dec of the tax year). It's $2K for individuals, and $1.6K for each person over age 65 when married filing jointly (MFJ). There is no income limit for claiming this, so anyone over age 65 can claim this.
  • Charitable Deduction expanded to non-itemizers  (2021-2022)  - For a brief time for 2-3 yrs (2020-2022), temporary tax break allowed you to get ded for charity donation, even when taking std ded. This charity ded was for upto $300/$600 (for single/MFJ) on top of std ded. This temporary relief expired in 2023 tax yr. 
  • Qualified residence interest deduction - This set the limit on Mortgage Interest Deduction for home acquisition debt. The threshold of debt for which you can deduct interest is set to $750K for all except Married filing separately. This limit used to be $1M and is granfathered for houses bought before that. This limit was made permanent in OBBB (see next section)

 

OBBB (2025-2028): The big change in tax laws came in 2025 via The One Big Beautiful Bill of 2025 (OBBB), also known as the Working Families Tax Cut, signed on July 4, 2025. OBBB stopped most of the tax laws enacted via TCJA from automatically going back to what they were in 2017, while making some additional changes. Those laws from TCJA were set to expire in 2025, but they were either extended or made permanent via OBBB.  Many of these additional changes were effective for 2025 too (even though most of the times tax laws passed within a year are effective next year, but this tax law was an exception). So, most folks got a bigger refund in 2025, than what they would have gotten if OBBB wasn't applied to 2025.

More details here => https://www.hrblock.com/tax-center/irs/tax-law-and-policy/one-big-beautiful-bill-taxes/

Few highlights from this bill:

  • increased state and local tax (SALT) itemized deduction (2025 through 2029) - increased to $40,000 for 2025 and adjusted annually thereafter for 2026 through 2029. This is a huge change, as this will make it more likely that people can itemize deductions and still get over the std deduction amt, especially for folks living in wealthy states with expensive homes. There's an income limit though for MAGI over $250K/$500K, where it's reduced gradually until it gets to $10K in ded. Both ded and MAGI limit are adjusted annually by 1% to account for inflation. For a typical $750K in debt at 5% interest, and 3% property tax, you are looking at total itemized deduction of $37.5K+$22.5K+$4K=$64K which exceeds the std ded by ~$32K.
  • Increase in the std deduction and exemption/tax rates made permanent- increases the 2025 Standard Deduction to $15,750 for Single, $23,625 for Head of Household, and $31,500 for Married Filing Jointly filers. This included additional $750/$1500 (for individual/MFJ) for 2025, as without this, the std ded would have been $15K/$30K. These amounts will increase with inflation each year. Elimination of personal/dependent exemption and tax brackets from TCJA was made permanent (as expected anyway)
  • Increased Child Tax Credit (2025 and beyond) - increased from $2K to $2.2K for qualified taxpayers. Also, this was made permanent and indexed for inflation starting from 2026. Dependent credit of $500 introduced in TCJA was made permanent.
  • Additional senior deduction (2025 through 2028) - This is on top of senior deduction that was added in TCJA. An additional $6K per person deduction for taxpayers 65 and older with phaseout for MAGI over $75K/$150K (for single/MFJ). Senior deduction form TCJA was extended until 2028 (?Not sure extended until when). So, this additional deduction along with std deduction and earlier senior deduction from TCJA made total ded for seniors to be $23,750/$46,700 (single/MFJ) if both seniors are eligible. NOTE: All senior ded are per person, so if only one person is > 65, then only $6K additional ded, even though MFJ.
  • Charitable Deduction expanded to non-itemizers  (2026 and beyond)  - Prior to OBBB, if you wanted to get ded for charity donation, you needed to itemize. This law allows ppl taking std ded to also take this charity ded for upto $1K/$2K (for single/MFJ) on top of std ded. This was permanently added for all future years. 
  • Misc: Many misc items added for tax break 
    • no tax on tips/overtime - deduction allowed upto a certain MAGI. As if anyone was paying tax on those tips anyway.
    • 1099-NEC and 1099-MISC reporting threshold increase (2026 and beyond) => This threshold has always been $600, but starting from 2026, it's increased to $2K and will be ndexed for inflation.
    • Trump savings accounts for children - Trump accounts are a new type of IRA for children, where govt deposits $1K  in a Trump account set up for an eligible child born between January 1, 2025, and December 31, 2028 . 
  •  -

Link with TCJA and OBBB changes => https://www.kiplinger.com/taxes/what-is-the-tcja

NOTE: Tax slabs and deductions go up every year based on inflation. They don't require any tax law changes. Tax laws which have to be authorized by Congress  have been changing every few years, and generally change tax rates or deductions allowed.

IRS (Internal Revenue Service) is the government body supposed to collect taxes. You can find all the tax forms, guidelines and all the tax rules on this website. If you ever have a doubt about any tax related stuff, you can call them using the phone number on their website. They will note down your question and someone will get back to you in couple of days with an answer. You should note down the ID of the IRS person, and the data and the time you talked to him, in case there is a dispute later on.

Tax rates for each year: This link is for tax rates for 2024. At the bottom of the page, there are links for previous year's tax rates, deductions, etc. Or you can replace the year in the link to go that year's tax rates.

Tax Return Breakdown:

Firstly, Filing federal taxes in USA are pretty simple compared to taxes in India, if you maintain a simple return. And the taxes are lot lower here in USA than what most people tell you. You pay about 15% in taxes on salary of around $100K as of 2009 !! For year 2022, the same analysis still holds true where you pay 15% tax on salary of around $150K. I've updated tax laws as per the latest updates.

Let's say you are employed here in USA with a company and make $W (or the money that's reported as your salary on pay-stub. This is also the amount reported on your W-2). The company would deduct taxes (estimated taxes based on information you give them) and hand you the remaining money. Actual taxes are calculated when you file the tax return. If you had overpaid taxes, you get a refund.

Tax Free Contributions/deductions:

There are few contributions that you are allowed to make, which lowers your taxable income. Basically these contributions are taken directly out of your paycheck, and you pay $0 tax on it. These are the tax free deductions that you are allowed to make:

  1. Health insurance Premium: If you are in USA, most of the employers pay for your health insurance premium. Health insurance for a family runs at around $15,000/year (for a decent health insurance plan, see in health section for more details), but the employer picks up about 80% of the tab. So, your share of health insurance premium is only 20% or about $3000/yr. This money thankfully is deducted from your income before you pay any taxes. That means your effective taxable income is lower by that amount.
  2. Health Savings Account (HSA): This is a new type of account that is allowed under the High Deductible Health plan. This money is deducted from your income before you pay any taxes.
  3. AD&D Coverage: Next if you signed for any AD&D coverage (which basically covers you and your family incase of an accident, this is different than life insurance), the premium that you paid for AD&D coverage is also deducted from your income before you pay any taxes.
  4. Flexible spending health (FSA): FSA accounts are additional accounts for Dental/Vision plans that you can setup at your employer. This is totally optional. The money that you put in this account is once again deducted from your income before you pay any taxes.

For all above Health Insurance Plans and Accounts, look in the "Health Insurance section". So, to summarize:

  • Your Salary = $W
    • Health Insurance Premium paid by you = $A
    • HSA money contributed by you and deducted from your salary = $B
    • AD&D Premium paid by you = $C
    • FSA money contributed by you and deducted from your salary = $D
  • So, your taxable income ($TI) = $W - $A - $B - $C - $D

This taxable income is what is reported as medicare wages (item 5 on W-2). Now start's your taxes on this taxable income $TI.

SS and Medicare taxes:

These are taxes that everyone pays irrespective of their income. These are automatically deducted out of your paycheck, so you don't need to file for them in your Federal income tax return. Look under "social security benefits" section for more details on these.

  • Social Security taxes: Firstly you have to pay Social Security taxes on your taxable income. It's 6.2% of your salary. It's applied only on the first $110K of your salary (for year 2009). So, the maximum Social Security taxes that you can pay is $7K or so. Remember that social security taxes are actually 12.4%, but these are divided equally between the employer and the employee. So, if your employed, your employer pays the other 6.2% of your salary to the IRS. Note, that if you were self employed, you would have to pay the total 12.4% tax out of your own pocket. So, govt penalizes for being self employed !! The amount of $TI that is subject to SSN tax is reported as social security wages (item 3 on 2009 W-2). This is equal to max of $TI and $110K. Every year, the limit on which SS tax is applied goes up so that 6% of eligible taxpayers pay the maximum SS tax. As of 2022, the max SS tax is $147K
  • Medicare Taxes: Next you have to pay Medicare taxes on your taxable income. It's 1.45% of your salary. There's no upper limit on this (unlike social security taxes), so you have to pay this tax on all of your taxable income. Once again like the social security taxes, Medicare taxes are 2.9%, but these are divided equally between the employer and the employee. So, if your employed, your employer pays the other 1.45% of your salary to the IRS. Note, that if you were self employed, you would have to pay the total 2.9% tax out of your own pocket. Again this is like a penalty for being self employed !! The amount of $TI that is subject to Medicare tax is reported as medicare wages (item 5 on 2009 W-2). This is equal to $TI.
    • UPDATE 2013: Two additional Medicare taxes were added via the Affordable Care Act (ACA) in 2013. First was the "Additional medicare tax" of 0.9% which was levied on W2 wages of > $200K for individuals and > $250K for married filing jointly. This was only levied on employee and NOT the employer. The second was the the net investment income tax, also known as the “unearned income Medicare contribution surtax,” which is an additional 3.8% tax applied to net investment income above $250K (for married filing jointly) . Like the additional Medicare tax, there is no employer-paid portion.

Remember that there's nothing you can do to lower your social security and the medicare taxes. These are taken out of your salary directly, and you are not supposed to be concerned about these when you file your federal taxes or state taxes. No deduction, credits, etc applies to these taxes.However, if somehow (because of job change, etc) you paid more than the max amount required in SSN taxes, you can claim a refund when filing taxes.

So, your salary after paying these taxes is:

  • Effective salary = $TI - 0.062*$TI (max of around $7K for yr 2009, or $9K for 2022) - 0.0145*$TI.
    • If you are making less than $110K, your effective salary is = 0.9235*$TI.
    • If you are making more than $110K, your effective salary is = 0.9855*$TI - $(max_ss_tax).

401K Retirement Contributions:

If you contribute any money in 401K retirement plan, you don't have to pay any federal taxes on that amount of money. Effectively, your salary is lowered by that amount before you pay any federal taxes. Look in the 401K section to see how much you should be contributing to your 401K. There's a yearly limit on how much can you contribute to 401K. As of 2022, the limit is about $20K per year.

So, your new effective salary subject to federal taxes is ($W0) = $TI - 401K_contribution.

This effective salary ($W0) is what is reported as your wages on W-2 (item 1 on W-2). This is also what you report as your wages on federal income tax return (item 7 on form 1040 in year 2009 tax forms).

NOTE: We pay SS and Medicare taxes on the 401K retirement contribution. The only tax we get sparred from is the Federal income tax. So, 401K contribution is not treated the same way as other contributions like your HSA/FSA contribution. Many folks are misguided that they pay no taxes on your 401K contribution, which isn't true. You always pay SSN+Medicare taxes on 401K contributions.

AGI and Taxes:

Now with all these contributions out of way, we came to effective salary. This effective salary $W0 is what is subject to federal and state taxes. This is the place where you can save a lot by taking advantage of tax breaks. Let's start with your AGI:

On top of $W0 (item 1 on W-2 form) being reported above, you may also have other income ($OI). This other income might be interest income from fixed deposits, income from stocks, dividends from stocks, real estate rental income or any other income from any source. Now all of this other income ($OI) is added to $W0 to get your Adjusted gross income (AGI).

  • $AGI = $W0 + $OI

Remember this AGI is the most important number on your income tax return. This AGI decides entirely what federal taxes you are going to pay. All the statistics on IRS website or elsewhere are based on this AGI number. There's also MAGI (Modified AGI) which adds some deductions back to determine eligibility for certain tax credits, ded and retirement contributions. Most of the tax credits, deductions, etc are based on MAGI, so you want to keep this number low. If your AGI is > $400K (as of 2022 for married filing jointly), you may lose a lot of freebies allowed by the tax laws :(. So, try to keep AGI below 400K, or Wages and other income to less than half a million dollars.

NOTE: You pay social security and Medicare taxes only on your wages (Box 1, 3 or 5 of your W-2), and NOT on any other income ($OI) which is interest income, stock or home sale profit etc. For interest income, many banks/brokerage choose to report bonus income, referral, credit card rewards, etc as Miscellaneous income while others choose to report it as plain interest income or not report at all. That has tax consequences. Head to "Bank Account" section under Finance for more details.

HSA contribution: One other item that affects AGI is your HSA (health savings account). It's indicated as $B above. With the Obama Healthcare reform in 2013, more and more employers switching to High deductible healthcare plan (HDHP). As of 2022, most of the employees have switched to HDHP plans. Look in health insurance section for more details. The money that you and your employer contribute towards an HSA is reported on box 12 of W-2 form, with a code W. The employer portion of this amount (usually $1K for family HDHP) is not included in your wages, and as such you never paid any tax on that amount. However, the employee portion of this amount is included in your wages and is going to be taxed, so you'll have to include this amount in your tax return, in order to claim deduction for your share of contribution to HSA. Entering this amount on your tax form, reduces your AGI by an equivalent amount. So, final AGI = above AGI - HSA contribution by employee. SS and Medicare taxes aren't levied on this HSA contribution, it's just the federal taxes that get confusing.

Estimated Federal taxes are calculated on AGI and what you get in hand is after deducting these estimated federal taxes from AGI. These are called taxes withheld at source.

Now, when you file your yearly income tax return, you can calculate your total taxes. Depending on whether your actual taxes calculated are more or less than the taxes withheld, you may owe money to IRS or get a refund from IRS. Let's walk through the federal tax calculation process starting with AGI:

Deductions:

Deductions are the provision in ta law, which allow you to reduce your taxable income by a given amount, so that you don't have to pay any federal income tax on that amount. This is to help 95% of the people in bringing down their taxes. Deductions are applied before calculating Federal income taxes. Below are the most common deductions that almost everyone is eligible for.

  1. Standard Deduction: You are entitled for a standard deduction of $SD ( for year 2009). This standard deduction basically means that you don't pay any federal taxes on this amount of money, and you can subtract this amount from your AGI.
    • Year 2009: SD is approx $5700 for single filers and $11,400 for married filing jointly
    • Year 2018-2025: As per TCJA of 2017, SD has been doubled. For year 2022, SD is approx $12950 for single filers and $25,900 for married filing jointly
    • Year 2026 onwards: As per new OBBB tax law , many changes have been made permanent. All of these changes apply from tax year 2026 and beyond, so 2025 taxes still follow the TCJA rules. Few of such changes applicable from 2026 are as below:
  2. Itemized deductions: In case you don't want to take standard deduction, you have an alternate choice of taking "itemized deduction". Itemized deduction allows you to add deductions allowed by tax laws, and come up with total deduction amount. If your "itemized deduction" amount comes out to be more than "standard deduction" amount, then you should take itemized deduction. However, "itemized deduction" carry more scrutiny by IRS, so I usually go with standard deduction if the 2 amounts are close to each other. Some of the deductions that can be itemized are:
    • Year 2018-2025: As per TCJA of 2017, itemized deductions were greatly reduced. In parallel, std deduction amount was raised. Effectively, this made itemizing deductions a less appealing choice for most of the tax payers in the bottom 90% taxpayers. Biggest items for itemizing are:
    • Year 2026 onwards: As per new OBBB tax law , increased SALT limit allowed item ded to be beneficial for folks with large property taxes. See in OBBB section above.
    • Years except above: Itemized deductions allowed were more generous, and so a,lot of people opted for this.
    • Common deductions allowed under "itemizing" are:
      1. Mortgage Interest: If you own your house, and pay mortgage on it, then you can deduct the interest payment portion of it. However, it's limited to $1M or $750K (see above under TCJA) 
      2. Property tax: If you paid property tax for your house, you can deduct it here. Most states have property tax of around 1% of the value of house, but states with no state income tax, have property tax as high as 3.5% of the value of the house. This can easily get to $20K-$30K in property taxes. Before TCJA of 2017, all of the property tax was deductible, but now,it's subject to a max amount of $10K, even if you paid more than that.
        • Year 2008: There was one year in 2008 where you could have claimed a deduction of $1000 for property taxes paid on your home in the year 2008 (if you own a home and you paid over $1000 in property taxes. If you paid less than $1000 in property taxes, you can deduct only up to the amount of taxes paid). This was allowed for people filing standard deduction, so everyone got some tax saving. This was to help taxpayers mired in the financial depression of 2008-2009.
      3. Charity contribution: You are allowed to deduct charity contributions up to a limit. No receipts are needed.
        1. For 2026 tax year onwards, as per new tax law "one big beautiful bill", charity contributions for first 0.5% of your AGI are excluded from deduction. Basically, you are better off filing as std deduction for charity contributions. You get most of the benefit. See above under std deduction. 
      4. State income tax: If you paid state income tax, you can deduct that amount here
      5. State sales tax: There is a calculator on IRS site that allows you to claim a "standard sales tax" deduction based on the state you live in. You can use this amount, or you can use your own amount that you spent on buying things. It's better to stick with "standard sales tax" amount, as that is very generous, and you don't need any receipts for that.
  3. Personal Exemption: You are also entitled for a Personal exemption and one additional exemption for each of the dependents (For years before 2018 and after 2025). Each exemption was approx $3650 as of 2009. If you are married filing jointly, you get exemption of 2*$3650 = $7300 (one for you and one for your wife). Your children, parents and almost anyone qualifies to be your dependent for whom you pay majority of the expenses, and who aren't filing their own tax return, and aren't claimed as dependents on anyone else tax return (as that would imply double exemption for same person, not allowed). So, for a family of 4, it would be $14,600 (for year 2009)
    • Year 2018-2025: As per TCJA of 2017, Personal exemption has been eliminated. If Personal exemption and SD were both same as before the cuts, SD would be about $25900/2, and Personal exemption would be about $4K, so sum of the two for a family of 4 would be about $13K+$4K*4=$29K. So, TCJA resulted in loss of about $3K in tax deductions for a family of 4. However, later we'll see that child credits were doubled, getting us to a breakeven point compared to before TCJA.

The exemptions listed above are always there (with exception of personal exemption from 2018-2025), though their amount varies each year. Any additional deductions are for certain years only, but are listed above for completeness.

So, your taxable income subject to tax after these deductions is ($TIT) = AGI - Std_deduction - Exemption*number of dependents - Any_other_exemptions.

Now, we need to calculate taxes on $TI (taxable Income or item 43 on form 1040 for year 2009). In US, there are marginal tax rates, implying you pay a higher tax rate for higher income. Tax rates start from ~10% for lower income, and goes as high as 40% for higher income. You can look at sample tax rates for 2009 by going to IRS website. Here's a quick summary:

  • you pay 10% on income between $0 and $C1 (For single person $C1 is around $10K, for married person filing jointly $C1 is doubled)
  • you pay 15% on income between $C1 and $C2 (For single person $C2 is around $35K, for married person filing jointly $C2 is doubled)
  • you pay 25% on income between $C2 and $C3 (For single person $C3 is around $85K, for married person filing jointly $C3 is $150K)
  • you pay 28% on income between $C3 and $C4 (For single person $C4 is around $170K, for married person filing jointly $C4 is $220K)
  • you pay 33% on income between $C4 and $C5 (For single person or married filing jointly $C5 is around $370K for both)
  • you pay 35% on income over $C5 (Top tax bracket range is 35%)

As you can see that income threshold for higher taxes are doubled for married people for income < $150K. This is so that people in middle class (those typically making < $250K) don't get penalized for being married, where only 1 spouse is working. However for higher income, married people don't get any advantage.

So, net tax payable ($NT) = tax_rate*$TIT (tax rate will apply different to different portions of your income as it's marginal progressive tax rate)

Credits:

Once you calculate your taxes using the tax rate table, you can now start claiming credits on your tax. Remember, credits are different than deductions. Deductions as mentioned above only lower your taxable income by that amount, so you are only saving on tax that would have paid on that income. Credits in contrast lower your tax bill by the credit amount. For Ex, suppose your net taxable income is $10K, and you are paying tax of $1K (assuming 10% tax rate) on this. If you are allowed to take an additional deduction of $1K, this will lower your taxable income to $9K, and so you will be paying a tax of $900 now (assuming 10% tax rate). That's a savings of $100. Now on the contrary assume that you are allowed to take a credit of $1000. Then, you subtract $1000 from the tax of $1K and you are left with $0 in taxes. So, credits are much more beneficial than deductions.

Few of the credits that are more commonly used. Note these credits vary widely from year to year.

  1. Child Tax credit (CTC): For every child you have, you can take some credit provided the child is under a certain age limit and satisfies certain other requirements. a credit of $1000. This is on top of the personal exemption that you can claim for your child. So, for a person in 15% tax bracket range, this is like a total of around $1500 that you get per child from the government.
    • CTC can only be claimed for dependent kids under the age of 17 as of Dec 31 of that tax year. Dec 31 is chosen as the date for eligibility so that fewer kids qualify. If eligibility was determined as of Jan 1 of that year, than the kids who turn 17 during that calendar year would have all qualified. Tax laws are always designed to favor the taxing authority :)
    • TCJA and later OBBB made CTC permanent and increased it to $2200 per child from 2025 onwards and indexed it to inflation.
  2. Earned Income Credit, Make work Pay credit, Education credit, etc ...

So, final tax payable ($FT) = $NT - all_credits

 

 

Taxes on Dependent's income:

The IRS recognizes only two categories of dependents — qualifying children and qualifying relatives. Each comes with different income rules and this is where many taxpayers get tripped up.

  • qualifying children: A qualifying child is usually your son, daughter, sibling or similar relative who is under age 19 or 24 if they are a full-time student. There is no age limit if the child is permanently and totally disabled.
  • qualifying relatives: A qualifying relative typically includes older children who no longer meet the age test, parents, grandparents, other relatives, or even a domestic partner who lives with you. Their income needs to be < certain threshold to be included as dependent (for year 2025, a qualifying relative must have a gross income of less than $5,200).

Both categories require that you provide more than half of the person’s total financial support and they meet residency, citizenship and filing rules. Then you include them as dependents and can include their income on your own tax return. Or they may have to file their own tax return, depending on their income, while still being a dependent on someone else's return. However, if they file return as dependents of someone else, they don't get full deductions. 

Qualifying children are more common where teenagers start making part time money, and taxes need to be paid on those. Kid's income may be unearned (i.e income from dividend, interest and capital gains only) or earned (income from a job with a W-2 issued). Under IRS, anyone < 18 years, (or < 24 if students) is considered a kid. It's generally better to include your kid's income in your tax return, so that your kid doesn't have to file his own tax return. Data below is as of 2024.

  • Unearned income: If kid has low amount of unearned income only, he/she doesn't need to file separate tax return. It can all be included in parent's return. It's generally taxed at lower rate too. 1st $1350 is taxed at 0%, and next $1350 is taxed at 10%, and anything > $2700 is taxed at parent's marginal tax rate. This tax is called "Kiddie Tax", and it was added to prevent parents from shifting their investment to their kids account to get lower tax rate. Now with Kiddie tax, only upto $2700 can be taxed at lower rate. Parents can include this unearned income on their own tax return, as long as total unearned income < certain threshold (it's $13000 for year 2024). 
  • Earned income: If kids have earned income (W-2 wages), they are required to file their own return. Those W-2 wages can't be included on parent's return. Now there are 2 choices => If income is low, and very little federal tax is deducted, then kid can just ditch filing tax. But if your kid wants to get tax refunded back to him, then the kid has to file his separate return. It's advisable to file tax return, so that kids get into habit of filing tax returns. Here, full deduction for "single filing" is applied even though the person is a dependent.  is taxed at lower rates below certain threshold.  This means a child must file if their wages exceed $14,600, or if their earned income plus $450.
  • Mix of earned and unearned income: This needs a separate tax return, just as in "earned income" case above. This is again subject to same rules, but gets more complicated. IRS doesn't want to give full deduction for unearned income, else parents will gift money to kids, and have 0% tax on unearned income from this money. The standard deduction allowed is "earned income +$450". Thus only $450 of unearned income will get taxed at 0%. Earned income will get deduction upto the std deduction allowed. Unearned income will get taxed at regular rates.

 

 

Final Taxes:

Year 2009:

So, let's take an example of a person making $110K, married filing jointly and having 2 kids, and filing taxes for year 2009. We chose $110K, since for any salary upto $110K, a tax filer is able to get advantage of most of the credits/deductions, and still falls under 15% tax bracket. His final tax is as follows:

  • Taxable wage for Social security and Medicare = $110K - $3K (health insurance premium) - $1K (FSA contribution) = $106K. This is your AGI.
  • SS and Medicare tax (collectively known as FICA tax) = $106K*0.0765 = $8.1K.
  • If you are enrolled in HDHP instead of regular co-pay plan, then you can deduct your HSA contribution, to lower down your AGI. So, if you contributed let's say $5K in HSA, your AGI will be $101K. Note, that you have to pay SSN and medicare tax on this HSA contribution of $5K. Look in health insurance section for details about HSA.

Taxable wage for Federal Tax = $106K - $12K (401K contribution of $7K + HSA contribution of $5K) = $94K
Federal taxable wage after deductions = $94K - $12K (standard deduction) - $14K ($3.5K *4 as 4 dependents) = $68K

Federal Tax = $9.6K (approx based on 15% tax rate on $68K)
Credits = $2K for two kids
Net tax to be paid = $9.6K - $2K = $7.6K

State Tax = varies depending on state

So, net tax = $7.3K (SS/Medicare) + $7.6K (regular) = $14.9K (assuming no state tax)
As a percentage of your income, your net tax is less than 15% on your total wage (for a married couple with 2 children for year 2009). That's a pretty low tax rate on a salary of $110K.

Year 2022:

So, let's take an example of a person making $150K, married filing jointly and having 2 kids, and filing taxes for year 2022. We chose $150K for 2 reasons: Firstly a salary of $110K in 2009 would  easily be $150, since for any salary up to $110K, a tax filer is able to get advantage of most of the credits/deductions, and still falls under 15% tax bracket. His final tax is as follows:

  • Taxable wage for Social security and Medicare = $110K - $3K (health insurance premium) - $1K (FSA contribution) = $106K. This is your AGI.
  • SS and Medicare tax (collectively known as FICA tax) = $106K*0.0765 = $8.1K.
  • If you are enrolled in HDHP instead of regular co-pay plan, then you can deduct your HSA contribution, to lower down your AGI. So, if you contributed let's say $5K in HSA, your AGI will be $101K. Note, that you have to pay SSN and medicare tax on this HSA contribution of $5K. Look in health insurance section for details about HSA.

Taxable wage for Federal Tax = $106K - $12K (401K contribution of $7K + HSA contribution of $5K) = $94K
Federal taxable wage after deductions = $94K - $12K (standard deduction) - $14K ($3.5K *4 as 4 dependents) = $68K

Federal Tax = $9.6K (approx based on tax rate on $68K)
Credits = $2K for two kids
Net tax to be paid = $9.6K - $2K = $7.6K

State Tax = varies depending on state

So, net tax = $7.3K + $7.6K = $14.9K (assuming no state tax)
As a percentage of your income, your net tax is less than 15% on your total wage (for a married couple with 2 children for year 2009). That's a pretty low tax rate on a salary of $110K.