Latest Facts and News
- The IRS has announced tax inflation adjustments for the 2024 tax year
- Standard deduction for married couples filing jointly rises to $29,200 for 2024
- New tax brackets and rates have been set for 2024, affecting taxpayers across income levels
- The IRS collected over $4.9 trillion in gross taxes in fiscal year 2022
Federal taxes touch every aspect of our lives, from the paycheck you take home to the daily services you use. But what does federal tax really mean, and how does it affect you personally? Understanding it can help you make better financial decisions and stay ahead.
In this blog post, we’ll break down what is a federal tax in simple terms. You’ll learn how it works, its impact on your finances, and why it’s essential to understand it.
Let’s dive in.
What Is a Federal Tax?
Federal tax is the amount the U.S. government collects from individuals, businesses, and other entities to fund its operations and public programs. These taxes help pay for national defense, healthcare, and education. The Internal Revenue Service (IRS) is responsible for managing federal taxes.
After learning what is a federal tax, let us examine its different forms.
Types of Federal Taxes
There are several types of federal taxes, each serving a different purpose. Below is a comparison table outlining various federal tax types, their purposes, and who pays them.
| Tax Type | Purpose | Who Pays |
| Income Tax | Funds general government operations | Individuals and businesses |
| Payroll Tax | Supports Social Security and Medicare programs | Employees and employers |
| Estate Tax | Taxes large inheritances | Estates above a certain value |
| Excise Tax | Levied on specific goods (e.g., fuel, tobacco) | Consumers (indirectly) |
Income tax is the largest source of federal revenue, followed by payroll taxes.
What Is Included in Federal Income Tax?
Federal income tax applies to the money you earn and some types of unearned income. Without these elements, it is impossible to comprehend what is a federal tax. Here is what is included in federal income tax:
- Earnings from Work
- Wages and salaries
- Commissions and bonuses
- Tips.
- Other Income Sources
- Investment income, such as dividends and interest.
- Certain types of unearned income.
These are the main components of federal income tax. It covers a wide range of earnings to ensure everyone contributes fairly.
Taxable Income Sources
Taxable income includes money you earn during the tax year from various sources. Here’s a simple breakdown of common taxable income sources:
1. Employee Compensation
- Salaries and wages
- Tips
- Bonuses
- Fees paid by your employer
Your employer reports this on your W-2 form.
2. Business and Investment Income
- Rental income from properties you own
- Income from partnerships
- Earnings from S corporations (for shareholders)
3. Other Sources
- Bartering is the value of goods or services exchanged
- Digital currencies are income from the sale, exchange, or investment of cryptocurrencies
- Royalties like income from intellectual property or natural resources
Remember, even non-traditional income like childcare services or fringe benefits may be taxable. Always check the IRS website for the most up-to-date information on what’s taxable.
Tax Deductions and Credits
Tax deductions and credits are essential for reducing federal income tax liability. While both can save you money, they work in different ways.
Deductions lower your taxable income, reducing the income subject to tax. On the other hand, credits directly reduce the amount of tax you owe, often providing a more significant benefit.
Below is a detailed breakdown of tax deductions and credits to ensure nothing is missed:
1. Tax Deductions
Tax deductions help reduce your taxable income, which can lower the amount of taxes you owe. There are different types of deductions available, each with specific benefits.
- Standard Deduction: This is a fixed amount that reduces your taxable income. The amount varies based on your filing status. For example, in 2024, the standard deduction is $14,400 for single filers and $29,200 for married couples filing jointly.
- Itemized Deductions: These deductions allow you to deduct specific eligible expenses instead of taking the standard deduction. Common expenses include:
- Charitable donations
- Mortgage interest
- Medical expenses
Itemizing can be beneficial if these expenses exceed the standard deduction
- Other Deductions: Some deductions are separate from the standard or itemized options, like:
- Contributions to retirement accounts (such as IRAs)
- Certain educational expenses
Deductions are a great way to reduce your taxable income, potentially lowering your tax liability and saving you money.
2. Tax Credits
Tax credits are designed to help taxpayers lower their tax bills or even receive refunds. They come in two main types, each with specific benefits.
- Refundable Tax Credits: These credits reduce your tax bill to $0 and pay you the remaining amount as a refund. For example, if you owe $750 in taxes and have a $1,000 refundable credit, you’ll get a $250 refund.
- Nonrefundable Tax Credits: These credits can reduce your tax bill to $0 but won’t pay out any extra as a refund. One of them is the adoption tax credit.
Who Benefits from Tax Credits?
- Parents: Credits like the Child Tax Credit and Child and Dependent Care Credit.
- Low-Income Earners: Earned Income Tax Credit.
- Students: American Opportunity Tax Credit and Lifetime Learning Credit.
Tax credits are a simple yet powerful tool to reduce taxes and sometimes even get money back.
Understanding Federal Tax Brackets
The federal income tax system in the United States uses a progressive tax structure with seven tax brackets. Here are the tax brackets for both 2024 and 2025:
2024 Tax Brackets and Rates
| 2024 Tax Rate | Single Filers | Married Filing Jointly | Married Filing Separately | Heads of Households |
| 10% | Up to $11,600 | Up to $23,200 | Up to $11,600 | Up to $16,550 |
| 12% | $11,601 to $47,150 | $23,201 to $94,300 | $11,601 to $47,150 | $16,551 to $63,100 |
| 22% | $47,151 to $100,525 | $94,301 to $201,050 | $47,151 to $100,525 | $63,101 to $100,500 |
| 24% | $100,526 to $191,950 | $201,051 to $383,900 | $100,526 to $191,950 | $100,501 to $191,950 |
| 32% | $191,951 to $243,725 | $383,901 to $487,450 | $191,951 to $243,725 | $191,951 to $243,700 |
| 35% | $243,726 to $609,350 | $487,451 to $731,200 | $243,726 to $365,600 | $243,701 to $609,350 |
| 37% | Over $609,350 | Over $731,200 | Over $365,600 | Over $609,350 |
2025 Tax Brackets and Rates
| 2025 Tax Rate | Single Filers | Married Filing Jointly | Married Filing Separately | Heads of Households |
| 10% | Up to $11,925 | Up to $23,850 | Up to $11,925 | Up to $17,000 |
| 12% | $11,925 to $48,475 | $23,850 to $96,950 | $11,925 to $48,475 | $17,000 to $64,850 |
| 22% | $48,475 to $103,350 | $96,950 to $206,700 | $48,475 to $103,350 | $64,850 to $103,350 |
| 24% | $103,350 to $197,300 | $206,700 to $394,600 | $103,350 to $197,300 | $103,350 to $197,300 |
| 32% | $197,300 to $250,525 | $394,600 to $501,050 | $182,101 to $231,250 | $197,300 to $250,500 |
| 35% | $250,525 to $626,350 | $501,050 to $751,600 | $231,250 to $626,350 | $250,500 to $626,350 |
| 37% | Over $626,350 | Over $751,600 | Over $626,350 | Over $626,350 |
Marginal vs. Effective Tax Rates
Marginal and effective tax rates are two important concepts in understanding a federal tax and how taxes work. While they are related, they measure different aspects of your tax responsibility.
- Marginal Tax Rate: This is the tax rate applied to the last dollar you earn. Tax brackets split income into different levels, taxing each at a specific rate. Higher income levels are taxed at higher rates. The marginal tax rate helps you understand how much tax you’ll owe on any additional income.
- Effective Tax Rate: This is the average percentage of your total income that goes to taxes. It’s calculated by dividing your total tax bill by your total income. Unlike the marginal tax rate, the effective tax rate shows what you actually pay on average, across all tax brackets, and is typically lower than your marginal rate.
Marginal Tax Rate Example
You can calculate the tax owed using the IRS tax brackets and taxable income (income after deductions).
For example, two siblings filing jointly with taxable income of $215,000 in 2024. Based on the tax brackets, their highest marginal tax rate is 24%. However, only a small portion of their income is taxed at this rate. Most of their income falls into lower brackets, such as 22%, 12%, and 10%.
The breakdown is as follows:
| Rate | Taxable Income | Tax Owed |
| 10% | $23,200 | $2,320 |
| 12% | $71,100 | $8,532 |
| 22% | $106,750 | $23,485 |
| 24% | $13,950 | $3,348 |
In total, the siblings owe $37,685 in federal income taxes. While their highest (marginal) tax rate is 24%, their effective tax rate—the average rate paid on total income—is 17.5%.
Effective Tax Rate Example
Now consider a scenario with a head of household filer earning $85,000 in taxable income for 2024. According to the tax brackets, their last dollar of income falls into the 22% marginal tax bracket.
After completing their Form 1040, they calculate a total tax liability of $12,000. Dividing their total tax by their taxable income gives: $12,000 ÷ $85,000 = 14%
This 14% is their effective tax rate, representing the average portion of income paid in taxes. Though their marginal rate is 22%, their effective rate reflects the blended impact of all tax brackets they fall into.
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How Federal Taxes Are Collected?
The IRS has a structured process for collecting unfilled and unpaid federal taxes, ensuring taxpayers are informed and provided with options to resolve their obligations. When you know what is a federal tax, you already know that the IRS will come to collect if any is unpaid.
- Receiving the Initial Bill
- The collection process begins when the IRS sends a notice or letter of bill for unpaid taxes. This happens if the entire tax amount is unpaid when filing your return.
- The process continues until the tax is fully paid or the IRS can no longer legally collect it.
- Issuing the First Notice
- The IRS sends a letter outlining the amount owed, including penalties and interest.
- This letter demands full payment and explains the consequences of non-payment.
- Accruing Penalties and Interest
- Unpaid taxes are subject to daily compound interest and monthly late payment penalties.
- Acting quickly reduces additional charges.
- Offering Payment Options
The IRS provides several ways to resolve the debt:
- Payments spread over 180 days for balances under $100,000 as a short-term payment plan. Installment agreement payments over a longer period. A user fee applies, with discounts for eligible low-income taxpayers.
- Settlement for less than the full amount owed with an offer in compromise, subject to strict eligibility requirements.
- Delaying Collection for Financial Hardship
- Accounts may be marked as Currently Not Collectible if financial hardship prevents payment.
- While collection actions are paused, interest and penalties continue to accrue.
- Escalating Collection Actions
If no payment arrangements are made, the IRS may take further actions:
- A legal claim on property to secure the debt. Liens affect credit and must be resolved by paying the balance in full.
- The IRS can seize wages, bank accounts, property, or future refunds to satisfy the debt.
- Providing Taxpayer Protections
- The IRS follows strict rules to ensure fairness during the collection process.
- Taxpayers can refer to resources like the Taxpayer Bill of Rights or Publication 594 to understand their rights.
- Resolving the Debt
- Contacting the IRS is essential to resolving unpaid taxes. Payment arrangements can prevent further actions.
- The IRS encourages proactive communication to settle debts voluntarily.
Knowing the IRS collection process highlights the importance of staying ahead on your tax payments. Let’s explore how to pay your federal taxes to avoid penalties and collection actions.
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How to Pay Federal Income Tax?
You must pay federal income tax as you earn or receive income during the year. This is done through withholding or estimated tax payments.
- Tax Withholding: If you’re an employee, your employer deducts income tax from your paycheck and sends it to the IRS. The amount withheld depends on your earnings and the details on your Form W-4.
- Estimated Taxes: If you’re self-employed or expect to owe $1,000 or more, you need to make estimated tax payments. This applies to business owners, partners, and gig workers.
Paying on time helps you avoid penalties and stay on track with your tax obligations.
Tax Filing and Payment Deadlines
Understanding when to file and pay your taxes is crucial to avoid penalties and stay compliant with IRS requirements. Here’s a clear breakdown of important dates and processes.
- Tax Filing Deadlines
For most taxpayers, filing deadlines depend on whether you follow a calendar year or a fiscal year:
- Calendar Year Filers: The deadline is April 15, 2024 for the 2023 tax year.
- Fiscal Year Filers: File by the 15th day of the fourth month after your fiscal year ends.
- Weekend or Holiday Rule: If the deadline falls on a weekend or legal holiday, it moves to the next business day. Returns are considered on time if mailed and postmarked by the due date.
Need more time? You can request an automatic 6-month extension by submitting Form 4868 before the original deadline. Remember, this extends the time to file, not the time to pay any owed taxes
- Tax Payment Deadlines
If you need to pay estimated taxes, the IRS divides the year into four payment periods, each with specific deadlines:
- January 1 – March 31: Due April 15.
- April 1 – May 31: Due June 15.
- June 1 – August 31: Due September 15.
- September 1 – December 31: Due January 15 of the following year.
Special Situations:
- Fiscal Year Taxpayers: Deadlines differ; see Chapter 2 of Publication 505.
- Farmers and Fishermen: Adjusted schedules are outlined in Chapter 2 of Publication 505.
Payments can be made by mail with Form 1040-ES, online, by phone, or through the IRS2Go app. If the due date falls on a weekend or holiday, payments made on the next business day are considered on time.
Impact of Federal Taxes on Personal Finances
Federal taxes have a significant impact on individual financial planning and budgeting. Understanding what is a federal tax can help you see how these mandatory contributions affect your income, savings, and overall financial health.
Here are some key ways taxes affect personal finances:
- Disposable Income: Taxes directly reduce the amount of income available for spending and saving. Understanding the difference between gross income and after-tax income is necessary for accurate budgeting.
- Investment Decisions: Tax considerations can influence investment choices. For example, individuals may opt for tax-advantaged accounts like IRAs or 401(k)s to reduce their taxable income and save for retirement.
- Deductions and Credits: Tax deductions and credits can affect financial planning strategies. Individuals may make decisions about charitable giving, mortgage interest, or education expenses based on available tax benefits.
- Timing of Income and Expenses: Tax planning often involves strategically timing income and expenses to optimize tax liability. This can impact when individuals choose to realize capital gains or make major purchases.
- Retirement Planning: Tax implications play a significant role in retirement planning. Individuals must consider the tax treatment of different retirement accounts and how withdrawals will be taxed in the future.
- Estate Planning: Federal estate taxes can affect how individuals plan to transfer wealth to their heirs, potentially influencing decisions about gifting and estate structures.
- Business Decisions: For self-employed individuals or small business owners, tax considerations can impact decisions about business structure, equipment purchases, and hiring.
- Housing Decisions: Tax deductions for mortgage interest and property taxes can influence decisions about homeownership and the size of mortgage to take on.
- Education Planning: Tax credits and deductions for education expenses can affect how families save and pay for college.
- Healthcare Spending: Tax-advantaged accounts like Health Savings Accounts (HSAs) can influence how individuals budget for and manage healthcare expenses.
Understanding these tax implications is essential for effective financial planning. It allows individuals to make informed decisions that maximize their after-tax income and wealth accumulation over time.
Tax Planning Strategies
Here are some simple and effective tax planning strategies to help you minimize your federal tax liability legally:
- Invest in Municipal Bonds: Municipal bonds are a great way to earn interest income that is often exempt from federal taxes. These bonds are issued by state or local governments, making them a tax-friendly investment option.
- Aim for Long-Term Capital Gains: When you hold investments like stocks or real estate for more than a year, you qualify for lower long-term capital gains tax rates. This can save you money compared to short-term gains, which are taxed as regular income.
- Start a Business: Starting a business can provide tax benefits. You can deduct business expenses like office supplies, travel, and equipment. Self-employed individuals can also deduct health insurance premiums and contributions to retirement accounts.
- Max Out Retirement Accounts: Contribute as much as possible to tax-advantaged retirement accounts like 401(k)s or IRAs. Contributions to traditional accounts reduce your taxable income now, while Roth accounts grow tax-free for the future.
- Use a Health Savings Account (HSA): If you have a high-deductible health plan, an HSA allows you to save pre-tax money for medical expenses. Contributions are tax-deductible, and withdrawals for qualified expenses are tax-free.
- Claim Tax Credits: Tax credits directly reduce the amount of tax you owe. Look into credits like the Earned Income Tax Credit, Child Tax Credit, or education credits to lower your tax bill significantly.
By using these strategies, you can reduce your federal tax liability while staying within the law.
Conclusion
Federal taxes are a part of everyday life, and knowing how they work can help you make smarter choices with your money. It’s not just about paying your taxes—it’s about using that knowledge to plan better for things like savings, investments, and future goals.
If you’re feeling unsure about how federal taxes affect you or need help with managing your tax situation, talking to a professional at Hopkins CPA Firm can really help. Our experts can guide you, answer your questions, and make sure you’re making the best decisions for your finances.
FAQ's
How often do federal tax rates change?
Federal tax rates can change annually, typically with the release of new tax brackets and adjustments for inflation. The IRS may also update rates due to changes in tax laws. It’s important to stay informed each year to know how these changes might affect your tax situation.
Can I be exempt from paying federal income tax?
Yes, here are five situations where taxpayers may be exempt from paying federal income tax:
- Not-for-Profit Organizations: Religious and educational organizations under section 501(c)(3) are tax-exempt.
- U.S. Citizens Working Abroad: Americans earning up to $126,500 abroad may be exempt.
- Low-Income Taxpayers: Those with income below the standard deduction may not need to file or pay taxes.
- Taxpayers With Deductions: Significant deductions can lower taxable income to zero.
- Taxpayers With Dependents: Families qualifying for credits like EITC or Child Tax Credit may owe no taxes.
How does working in multiple states affect my federal tax obligations?
If you work in multiple states, you may need to file tax returns in each state. Some states have reciprocity agreements, allowing you to avoid paying taxes in the state where you work, but these agreements vary.
Many states also offer tax credits to offset taxes paid to another state. It’s important to check the filing requirements of each state, as you may still need to file to claim credits or refunds. For specific guidance, consider consulting Hopkins CPA Firm.
What happens if I overpay my federal taxes?
If you overpay your federal taxes, the IRS will automatically refund the extra amount. However, if you prefer, you can request that the overpaid amount be applied as a credit toward your taxes for the following year, rather than receiving a refund. This helps reduce your future tax payments.
Are federal tax laws the same for corporations and individuals?
Federal tax laws for individuals and corporations are different.
- Personal Income Tax: Individuals pay personal income tax based on their earnings, and the tax is applied at different rates depending on their income level. The tax is calculated according to a progressive tax system, where higher incomes are taxed at higher rates.
- Corporate Tax: Corporations, on the other hand, pay corporate tax on the income they earn. The tax rate for corporations is fixed and subject to change based on the union budget. Unlike individuals, corporations can deduct business-related expenses, which reduces their taxable income.
So, while both individuals and corporations pay taxes, the rules, tax rates, and deductions differ.
