Step 1: Determine Your Gross Income
The starting point for any tax calculation is gross income — every dollar you received during the tax year from all sources. The IRS defines gross income broadly to include wages and salaries, self-employment income, tips, bonuses, rental income, dividends, capital gains, interest income, alimony (for agreements before 2019), and most other forms of compensation.
If you receive a W-2 from an employer, Box 1 shows your taxable wages. But if you have multiple income streams — say, a salary plus freelance income plus dividend payments — you need to add them all together. Missing even one source of income can create problems when you file.
Some income is explicitly excluded from gross income under the tax code. Gifts, inheritances, life insurance death benefits, and certain employer-provided benefits (like contributions to a health insurance plan) are generally not included. The IRS Publication 525 provides a comprehensive list of taxable and non-taxable income.
Step 2: Subtract Adjustments (Above-the-Line Deductions)
Before you reach Adjusted Gross Income, you can subtract certain "above-the-line" deductions. These are valuable because you can claim them regardless of whether you itemise or take the standard deduction. Common adjustments include:
- Traditional IRA contributions: Up to the annual limit if you meet eligibility criteria
- Student loan interest: Up to $2,500 per year (subject to income phase-outs)
- Educator expenses: Up to $300 for teachers buying classroom supplies
- Self-employment tax: You can deduct half of self-employment tax paid
- Health Savings Account (HSA) contributions
- Alimony payments (for divorce agreements before January 1, 2019)
These adjustments can meaningfully reduce your taxable income, so it's worth reviewing each one carefully before filing.
Step 3: Calculate Your Adjusted Gross Income (AGI)
Your Adjusted Gross Income (AGI) is simply gross income minus the above-the-line adjustments from Step 2. AGI is a critical figure in the tax system because many other calculations — including eligibility for certain credits and the threshold for itemised deductions — are based on it.
For example, you can only deduct medical expenses that exceed 7.5% of your AGI. If your AGI is $80,000, you'd need more than $6,000 in medical expenses before any deduction kicks in. Understanding your AGI therefore has knock-on effects throughout your return.
Step 4: Apply the Standard or Itemised Deduction
After AGI, you subtract either the standard deduction or your itemised deductions — whichever is larger. This gives you your taxable income.
The standard deduction is a flat amount set by the IRS each year, adjusted for inflation. For most taxpayers — especially those without a mortgage or large charitable contributions — the standard deduction exceeds what they'd get by itemising. After the Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction, the percentage of filers who itemise dropped significantly.
Itemised deductions include state and local taxes (SALT, capped at $10,000), mortgage interest on your primary and secondary homes, charitable contributions, and certain casualty losses. If your itemised total exceeds the standard deduction, it makes sense to itemise. Tax software and a qualified preparer can calculate both scenarios for you.
Step 5: Apply the Tax Brackets
This is where many people misunderstand how income tax works. The US federal income tax system is progressive, meaning different portions of your income are taxed at different rates. You do not pay your top (marginal) rate on all your income.
The 2025 federal tax brackets for single filers were:
| Taxable Income | Tax Rate |
|---|---|
| $0 – $11,925 | 10% |
| $11,926 – $48,475 | 12% |
| $48,476 – $103,350 | 22% |
| $103,351 – $197,300 | 24% |
| $197,301 – $250,525 | 32% |
| $250,526 – $626,350 | 35% |
| Over $626,350 | 37% |
Brackets are adjusted annually. Check IRS.gov for the current year's figures.
To calculate the tax owed, you apply each rate only to the income within that bracket's range. If your taxable income is $60,000, you pay 10% on the first $11,925, 12% on the income from $11,926 to $48,475, and 22% only on the remaining $11,525 (from $48,476 to $60,000).
Step 6: Subtract Tax Credits
After calculating your gross tax liability from the brackets, you can reduce it further with tax credits. Unlike deductions (which reduce taxable income), credits directly reduce the tax you owe dollar-for-dollar. A $1,000 credit saves you exactly $1,000 in tax.
Some credits are non-refundable, meaning they can reduce your tax bill to zero but not below. Others are refundable, meaning if the credit exceeds your tax liability, you receive the difference as a refund. The Earned Income Tax Credit (EITC) and the Child Tax Credit (partially refundable) are among the most widely claimed.
Common credits include the Child Tax Credit, Child and Dependent Care Credit, American Opportunity Credit (education), Lifetime Learning Credit, Earned Income Tax Credit, Retirement Savings Contributions Credit (Saver's Credit), and various energy-efficiency credits. Each has eligibility requirements based on income, filing status, and other factors.
Worked Example
Let's put it all together. Suppose you are a single filer in 2025 with the following profile:
- Salary: $85,000
- Freelance income: $5,000
- Traditional IRA contribution: $7,000
- Student loan interest paid: $1,500
Step 1 — Gross Income: $85,000 + $5,000 = $90,000
Step 2 — Above-the-line deductions: $7,000 (IRA) + $1,500 (student loan interest) = $8,500
Step 3 — AGI: $90,000 − $8,500 = $81,500
Step 4 — Standard deduction (2025, single): $81,500 − $15,000 = $66,500 taxable income
Step 5 — Apply brackets:
- 10% on $11,925 = $1,193
- 12% on ($48,475 − $11,925) = 12% × $36,550 = $4,386
- 22% on ($66,500 − $48,475) = 22% × $18,025 = $3,966
- Total federal tax before credits: $9,545
Step 6 — Credits: Suppose you qualify for a $500 Saver's Credit. Your final tax = $9,545 − $500 = $9,045.
Your effective tax rate is $9,045 ÷ $90,000 = 10.05% — significantly lower than the 22% marginal rate. This is the number that represents your actual tax burden.
State Income Tax
Federal income tax is only part of the picture. Most US states also levy an income tax, with rates and structures varying considerably. California has the highest top marginal rate at 13.3%, while Texas, Florida, and several other states have no income tax at all. Some states use a flat rate (e.g., Illinois at 4.95%), while others have progressive brackets similar to the federal system.
State income taxes are calculated separately from federal taxes, typically starting from your federal AGI and making state-specific adjustments. Some states conform closely to federal treatment; others diverge significantly, particularly around retirement income, Social Security benefits, and pass-through business income.
Always check your state's Department of Revenue or equivalent for current rates and rules. The combination of federal and state tax determines your total income tax burden.