How income tax is actually calculated

Five steps, in this order

US income tax is computed in a fixed sequence, and almost every misunderstanding comes from skipping a step or doing two out of order. The sequence is: total income, then adjusted gross income, then taxable income, then tax from the brackets, then credits.

Total income is everything you received that the law counts: wages, self-employment profit, interest, dividends, capital gains, rent, taxable retirement distributions. Not gifts, not inheritances, not most life insurance proceeds, and not the return of your own capital when you sell something.

Adjusted gross income is total income minus specific deductions the law lets you take before anything else — half of self-employment tax, deductible retirement contributions, HSA contributions, student loan interest, self-employed health premiums. AGI matters far beyond this calculation because dozens of thresholds elsewhere are measured against it.

Taxable income is AGI minus your deduction: the standard deduction of $16,100 single or $32,200 joint for 2026, or your itemised deductions if they come to more. Then any qualified business income deduction comes off as well.

Tax is the brackets applied to taxable income, slice by slice. Credits then reduce that tax directly — and a credit is worth its full face value where a deduction is worth only your marginal rate on it.

$85,000 worked through, line by line

Start with $85,000 of salary and no other income, single, taking the standard deduction. AGI is $85,000 because there is nothing to adjust. Taxable income is $68,900 — $85,000 minus the $16,100 deduction.

Now the brackets, each applied only to the slice of income inside it: 10.00% on $12,400, which is $1,240; 12.00% on $38,000, which is $4,560; 22.00% on $18,500, which is $4,070. Added together, $9,870 of federal income tax.

Notice what that means. The top rate reached is 22.00%, but the tax is 11.61% of gross income. The marginal rate applies only to the last slice; everything underneath was taxed less. This gap is the single most misunderstood thing in personal tax.

FICA is computed separately and does not use brackets at all: 6.20% for Social Security up to $184,500 of wages and 1.45% for Medicare with no ceiling, both from the first dollar with no deduction. That is $6,503 on this salary.

Then state tax, computed on its own base with its own rates — and in eleven states a city or county tax after that. Total federal tax here is $16,373; what your state adds ranges from nothing to $6,604 depending entirely on where you live.

Deductions and credits are not the same thing

A deduction reduces the income you are taxed on. A credit reduces the tax. At a 22.00% marginal rate, a $1,000 deduction saves $220 and a $1,000 credit saves $1,000 — nearly four times as much, for the same headline number.

The standard deduction is claimed by roughly nine in ten filers because it exceeds what they could itemise. Itemising is worth it when mortgage interest, state and local taxes within the cap, charitable giving and large medical expenses together come to more than $16,100 single or $32,200 joint.

Being 65 or over, or blind, adds $1,650 per condition per person to the standard deduction — $2,050 for someone unmarried. It is claimed by checking a box and is missed surprisingly often.

Credits split into two kinds and the difference decides who benefits. A non-refundable credit reduces tax to zero and stops; a refundable one pays out beyond that. The Child Tax Credit is partly refundable — $2,200 per child with up to $1,700 refundable — and the Earned Income Tax Credit is fully refundable, up to $8,231.

That is why a household with no tax liability should often still file: refundable credits are money arriving rather than a rebate of tax paid, and roughly a fifth of eligible households never claim the EITC because they assumed there was no point.

Why AGI matters far more than it looks

AGI is an intermediate figure that never appears on a payslip, and it quietly controls a large part of the return. Dozens of provisions are measured against it, so reducing AGI can be worth much more than the marginal rate on the reduction.

The phase-outs measured against AGI or a modified version of it include: the Child Tax Credit above $200,000 single, the qualified business income deduction above $201,750, the net investment income tax above $200,000, student loan interest deductibility, IRA deductibility, education credits, and the ACA premium subsidy.

Where two of those overlap, the effective marginal rate on a dollar of income can be far above any bracket. Someone losing a credit at the same time as crossing into a higher bracket faces a combined rate that no tax table shows, which is the honest explanation for why a raise sometimes feels like it did nothing.

The levers that reduce AGI are the above-the-line deductions: traditional retirement contributions, HSA contributions, half of self-employment tax, self-employed health premiums. Unlike itemised deductions they work whether or not you itemise, which is why they are called "above the line".

For anyone near one of those thresholds, a contribution can be worth substantially more than its own tax saving because it also restores something that was phasing out. That compounding is the most valuable and least visible planning available on an ordinary return.

The state calculation is a separate one

States do not simply apply their rate to your federal taxable income. Most start from federal AGI and then make their own adjustments — adding back municipal bond interest, subtracting retirement income, applying their own standard deduction, their own exemptions and their own credits.

The structures differ fundamentally. 9 states tax no wage income at all. 13 apply a single flat rate. 29 run graduated brackets. That means a comparison table showing "top rate" tells you very little about what anyone actually pays.

Watch for the exempt band specifically, because it is where compiled sources fail most often. Ohio and Mississippi both publish what looks like a flat rate but tax nothing below a threshold — treating them as flat from the first dollar overstated an Ohio bill by 43% in the sources we checked.

Then the local layer: eleven states let a city, county or school district levy income tax, and we model 3,672 such jurisdictions across 7 states. The mechanics differ enough that one rate field cannot express them — Pennsylvania and Ohio tax earned income, Maryland taxes state taxable income, Indiana taxes by county of residence on 1 January.

And residency is its own question. Working across a state line generally means the state where the work happens taxes it, with a credit in your home state. That produces two returns and, occasionally, a total higher than either state alone would have charged.

What you owe and what you paid are computed separately

Everything above computes what you owe. Whether you get a refund depends on a completely separate number: what was withheld from your pay during the year, estimated from a table by an employer who does not know your full situation.

The two are almost never equal, and the difference is the refund or the bill. Neither is evidence of an error — the system is a series of estimates settled once a year, and the only question is whether you would rather have had the money earlier.

Which direction it goes is predictable. Under-withholding comes from income the employer cannot see: a second job, a spouse's salary, self-employment, investment income. Over-withholding comes from a mid-year start, a year with unpaid leave, or a W-4 completed defensively and never revisited.

The error that ruins more refund estimates than any other: adding FICA to what was withheld. Boxes 4 and 6 of a W-2 are Social Security and Medicare — $6,503 on this salary — and they are not prepayments of income tax. They never come back.

Correcting a gap is a W-4 change rather than anything done on the return, and it works forward from the date you file it. A shortfall found in June is spread over half a year; the same shortfall found in April is a single payment.

Where these numbers come from, and why that matters

Every federal figure on this page comes from IRS Rev. Proc. 2025-32, § 3.01, Tables 1-4, read off the document rather than off a summary of it. Every state figure comes from that state's own department of revenue publication, one state at a time.

That is not pedantry. When we audited this category we found sites ranking on the first page for "2026 income tax calculator" serving the previous year's numbers — a standard deduction of $15,200 instead of $16,100, and a first bracket ending $475 early. Several linked to the correct IRS page from the same screen.

State data goes stale faster still. Of 37 states checked against their own source, 12 carried a wrong rate, threshold or credit in the compiled sources everyone uses. Georgia cut its rate in May with effect from 1 January, so a table published in April was correct when written and wrong by summer.

So every figure here carries the document it came from and the date it was checked, and where a state has not yet been read off a primary source, the page says so rather than implying it has. "We have not looked" and "it does not exist" are different claims.

The check we would suggest running on any calculator, including this one: find the standard deduction it is using and compare it against the IRS revenue procedure. Two minutes, and it tells you more than any feature list.

Filing status changes the arithmetic before it starts

Status decides your standard deduction and the width of every bracket, so it moves the answer before any of your figures are used. The same $85,000 produces $9,870 of federal income tax filing single and $5,840 filing jointly — a difference of $4,030 on identical income.

Single applies to anyone unmarried on the last day of the year who does not qualify for a better status. Married filing jointly combines both incomes on one return with a deduction of $32,200 and brackets that are twice as wide at the lower end.

Head of household is the one most often missed. It is available to an unmarried person maintaining a home for a qualifying dependant, and it carries a deduction of $24,150 — well above single — with wider brackets to match. People assume it requires a specific family arrangement rather than meeting a defined test.

Married filing separately is usually worse than filing jointly and occasionally necessary: where one spouse has substantial medical expenses subject to an income floor, where there is a reason not to be jointly liable for the other's return, or in some income-driven student loan repayment calculations. It disqualifies you from several credits including the EITC.

Status is determined on 31 December for the whole year. Marrying on the last day of the year means filing as married for all of it, and divorcing on the last day means filing as unmarried for all of it — which makes the timing of either, where it is flexible, a genuine tax decision.

Not all income is taxed the same way

The calculation above treats income as one number, and for a salaried worker it effectively is. Once other kinds of income appear, several run on their own tracks.

Wages are ordinary income and carry FICA. Self-employment profit is ordinary income and carries self-employment tax, which is both halves of FICA at 15.30%. Interest and non-qualified dividends are ordinary income and carry no payroll tax at all.

Long-term capital gains and qualified dividends have their own rate schedule — 0.00%, 15.00% and 20.00% — but they are not taxed in isolation. They stack on top of your ordinary income, so the rate depends on your total taxable income rather than on the gain alone.

Rental income is ordinary income and, unusually, carries no self-employment tax. Retirement distributions from traditional accounts are ordinary income with no FICA; from Roth accounts they are not income at all. Social Security is partly taxable under a rule of its own that depends on everything else you receive.

Some income is not taxed at all: gifts and inheritances received, most life insurance proceeds, municipal bond interest for federal purposes, and the return of your own capital when you sell something. That last one is why only the gain on a sale is taxed, not the proceeds.

When itemising beats the standard deduction

You take whichever is larger, and for roughly nine in ten filers that is the standard deduction. Itemising is worth the effort only when your qualifying expenses exceed $16,100 single or $32,200 joint.

The categories that get people there: mortgage interest on a substantial loan, state and local taxes within the statutory cap, charitable contributions, and medical expenses above a percentage-of-income floor that is high enough to exclude most households in most years.

The state and local tax cap is what pushed most people to the standard deduction. Before it, high-tax-state homeowners routinely itemised; with a cap on the deductible amount, many no longer clear the standard deduction even with a mortgage.

Bunching is the technique that responds to this: concentrating two years of charitable giving into one year to clear the standard deduction that year, and taking the standard deduction the next. A donor-advised fund is the usual vehicle, allowing the deduction in the year of contribution while the giving happens over time.

Note that itemised deductions reduce taxable income, not tax — so they are worth your marginal rate on them. A $20,000 itemised total that exceeds the standard deduction by $3,900 is worth $858 at a 22.00% rate, not $20,000.

What happens when a household has two incomes

Filing jointly combines both incomes into a single calculation. The brackets are wider and the deduction is larger, but neither is unlimited — so two similar incomes combined can reach a higher bracket than either would alone.

Where the joint brackets are exactly twice the single ones, combining is neutral. Where they are not — which is the case in the upper bands federally and in several state systems — the result is a marriage penalty: a couple pays more filing jointly than two single people with the same incomes would have paid separately.

The reverse happens too, and more often. Where one income is much larger than the other, joint filing produces a marriage bonus: the smaller income effectively fills the lower brackets that the larger income had already passed through, and the household pays less than the two would have separately.

The withholding consequence is the practical one. Each employer withholds as though its salary were the only income, applying the standard deduction and the lowest brackets twice over. The household is systematically under-withheld unless Step 2 of the W-4 is completed, and the shortfall is roughly the tax on $16,100 plus a bracket effect.

Filing separately rarely fixes it and usually costs more, because it forfeits several credits and applies narrower brackets. The fix is the W-4, not the filing status.

Five things that are not what they sound like

"Tax bracket" is not "tax rate". It is the rate on your last dollar. On $85,000 the bracket is 22.00% and the tax is 11.61% of income.

"Write-off" is not a refund. A deductible expense reduces taxable income, so a $1,000 business expense saves $220 at a 22.00% rate — not $1,000. Spending money to save tax is only ever worthwhile when you needed the thing.

"Tax-free" usually means "not federally taxed". Municipal bond interest is exempt federally and often taxable by a state other than the issuing one — and it counts toward provisional income for Social Security taxation, so it can raise your tax without being taxed itself.

"Pre-tax" does not mean free of all tax. A traditional 401(k) contribution avoids income tax and not FICA, so 7.65% still applies. An HSA through payroll is the exception that avoids both.

"Refund" is not a payment from the government. It is over-withheld money returning without interest. A larger refund is not a better outcome; it is a larger interest-free loan you made.

Questions

How is income tax calculated step by step?

Total income, then AGI after above-the-line deductions, then taxable income after the standard or itemised deduction, then tax from the brackets slice by slice, then credits subtracted from the tax. On $85,000 single that produces $9,870 of federal income tax on $68,900 of taxable income, plus $6,503 of FICA computed separately.

Does a higher bracket tax all my income at that rate?

No. Brackets are slices: only the dollars inside a bracket are taxed at its rate. On $85,000 the top rate reached is 22.00% but the actual tax is 11.61% of gross, because everything beneath the top slice was taxed at lower rates.

What is the difference between a deduction and a credit?

A deduction reduces the income you are taxed on and is worth your marginal rate on it. A credit reduces the tax itself and is worth its full value. At 22.00%, a $1,000 deduction saves $220 and a $1,000 credit saves $1,000.

What is AGI and why does it matter?

Adjusted gross income is total income minus specific above-the-line deductions. It matters far beyond the tax calculation because dozens of thresholds are measured against it — the Child Tax Credit phase-out, the QBI deduction, the net investment income tax, IRA deductibility and the ACA premium subsidy among them.

Is FICA part of income tax?

No, it is computed separately and behaves differently: flat from the first dollar with no deduction and no brackets, 6.20% for Social Security up to $184,500 and 1.45% for Medicare with no ceiling. On $85,000 that is $6,503, and at low incomes it frequently exceeds income tax.

How do states calculate their tax differently?

Most start from federal AGI and then apply their own adjustments, deduction, rates and credits. Nine states tax no wage income at all, fifteen apply a flat rate and the rest run brackets — and several "flat" states tax nothing below a threshold, which is where compiled sources most often go wrong.