In this guide
Graduating from college and jumping into a new career is an exciting time, with opportunities appearing endless, and the feeling that you’re ready to take on the world. But these opportunities are accompanied by new responsibilities, and it is normal for graduates to feel out of the loop when their first tax season rolls around.
This guide will give you a solid understanding of tax rates, and everything connected to them – as well as set you on a path toward managing your finances with confidence and efficiency.
Chapter 1
What you need to know about tax rates
What is a tax rate?
A tax rate is the percent value (0-100%) at which you are taxed. Taxes are sums that are deducted from the money that you hold or earn. The most prominent place where a tax rate is used is income tax.
To illustrate this concept, we can imagine someone who just earned $50 for a day’s work. Let’s say they have to pay a tax on this amount – at the rate of 10%. 10% of the $50 value is deducted, and our entrepreneur is left with $45. In this case, the $50 would be income (or revenue), and the $45 would be profit.
In the context of tax rates, it is also important to mention brackets. Brackets are like a category or group that you belong to, based on the amount of your income, and they are tied directly to rates. Going back to our example, our worker is still a junior, making $50 a day. Someone more senior, who makes $100 daily, is expected to contribute more than $10, as their tax bracket is higher.
The purpose of tax rates
In very broad terms, tax rates (like taxes themselves) exist so that people in a certain area can live fairly and comfortably. We pay money to a government (federal, state, or local) so that they can take care of our basic societal needs: paving and maintaining roads, keeping streets lighted and safe, providing protections for the most vulnerable groups of the population, and keeping us financially supported in old age.
Rates are intended to be fair: a millionaire can do a lot more to improve life in their community than someone making minimum wage – so more is expected of them. It would be nearly impossible to keep things stable if everyone paid the same sum in taxes – as it would be a financial challenge for a large chunk of the population, and a trivial expense to the highest earners.
How tax rates are calculated
The rates of income tax are set by the federal government and local governments, and differ between individuals and corporations. For example, the federal tax rate for corporations is currently set at 21%, whereas for individuals, it can reach as high as 37% – depending on the brackets.
The rates are set by the U.S. Congress (House + Senate) based on how businesses and individuals are doing, the economic outlook for the next decade, and other factors. The rates become final through legislation passed and signed by the president.
Historically, the rates have fluctuated quite often – especially with the arrival of new presidential administrations. For example, in 2017, the corporate tax rate was cut from 35% to 21%, and the current presidential administration has voiced a desire to bring it up to 28%.
As for calculating your personal rate, you can do this on your own, or use a special calculator. You will only need to fill in details about your taxable income, marital status, and a few other relevant factors, and should receive a result with information about what to expect for your next filing.
Tax rates in 2022/2023
You can find a comprehensive list of federal income tax rates here. Based on these figures, a single adult with a taxable income of $60K would have to pay $8,817 in taxes.
For 2023, the tax rates (between 10% and 37%) will remain as they are, but the corresponding brackets will change. For example, the lowest bracket used to apply to income up to $10,275, but the coming year will make it $11K – and similar changes will apply across the board. This doesn’t necessarily mean that everyone’s salaries have gone up, but rather that inflation is pushing the value of the dollar down.
Who pays these rates?
We have focused heavily on individuals when discussing taxes, but income tax is also paid by corporations, estates, and trusts. So, if you launch a business after graduating, inherit an estate, or are gifted a trust fund, you should definitely look into additional rates that should be paid.
For individuals, the group obligated to pay U.S. federal taxes is citizens and residents of the United States. The situation with citizenship is pretty cut and dry, but there is much more nuance to residency.
Taxes paid by residents
According to the IRS (Internal Revenue Service), which collects federal taxes and administers tax code, a resident of the U.S. must pass one of two tests to qualify for paying federal income tax per the standard rates:
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Green card test
A person has resided in the country throughout the calendar year lawfully with a green card (permanent resident card).
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Substantial presence test
A person has resided in the country for at least 183 days over this year and the previous two (must be at least 31 in the current year).
If you are a foreign citizen that doesn’t meet these requirements, but still holds the right to work, you shouldn’t start jumping for joy just yet. Non-residents still have to pay taxes for something called ECI (effectively connected income) – any money earned in the U.S. – and at the same rates as ordinary citizens.
Exceptions
The U.S. tax code has lots of rules, and plenty of exceptions to them, too. For example, non-residents may have to pay smaller rates or no rates at all if a tax treaty with the relevant conditions is in effect between their native country and the U.S.
When talking about foreign nationals, it’s also important to mention exempt individuals.
The IRS lists the following categories:
- diplomats and full-time workers of international organizations
- teachers, trainees, and students
- professional athletes
There are also situations where no income tax is paid at all, but we’ll get to those interesting arrangements later.
How these funds are collected
Taxes are paid via bank transfer – preferably through a direct government provider. For example, if you are employed at a company, the employer will generally withhold any relevant tax payments from your salary, so the amount you see on the check will be profit – what is left after taxes are deducted. The same employer will probably process the monthly income payment through the EFTPS system. EFTPS (Electronic Federal Tax Payment System) is provided by the government as an easy way to pay federal taxes, track past payments, and schedule automatic payments in the future.
If you are self-employed, you will be responsible for paying a self-employed tax at the rate of 15.3%. This is made up of a 12.4% in contribution to social security, and 2.9% as a medicare contribution. Self-employed people are also responsible for filing all of the relevant forms detailing their work-related expenses.
Getting ready for Tax Day
Tax Day is a day usually around April 15, and serves as the deadline designated by the US government for submitting your tax return. A tax return is essentially a report of financial activity to the IRS, including: income, gains, expenses, and about a dozen other things. The relevant form for people employed at a US company full-time is W-2.
As tax season approaches, you can prepare by digging out your tax return from the previous year and gathering any tax records provided by your employer. The tax year ends on December 31, so these records are usually sent in January. It can also be helpful to double-check these records and make sure the proper amount has been withheld from your wages.
Other items to prepare and keep handy include: your Individual Tax Identification Number (ITIN), receipts/records of charitable contributions, medical expenditures and premiums, loan interest, and various other forms of income.
Filing taxes - general information
The tax return can be sent by mail to the designated local subsidiary of the IRS or submitted online via the Free File system. This system can be accessed on the IRS website or via one of the IRS partners using it.
Filing taxes isn’t always easy – and it intimidates so many people that some hire accountants and other specialists to handle the process for them. At the same time, the government and various supporting organizations have gone to great lengths to make the system as painless and optimized as possible.
The pleasant side of this process is that you often receive refunds for too many taxes paid, due to deductions, charitable contributions, and other recognized factors.
Filing taxes - pro tips
One thing to keep in mind about filing your return is that you can request an extension. Various situations come up that can delay your filing, such as your accountant falling ill or refusing service, documents not arriving in time, and sometimes just underestimating the volume of work required. It’s all fine, as long as you warn the IRS and ask for an extension. You should get a few more months to send the return, but this is not an extension to any outstanding payments.
Another troublesome situation to be aware of is an ITIN number expiring. This can happen if your ITIN is not used in a return for three years – or simply because the middle digits of the ITIN contain a certain value between 90 and 99. Be sure to check the status of your ITIN before filing, and renew it if necessary.
Dangers of lax reporting
Getting in trouble with the IRS is not ideal. The most common issues that crop up are inaccurate reporting of income and contributions, which (depending on the situation) can be attributed to human error and quickly corrected.
However, in some cases, reporting is demonstrably fraudulent or misleading – even tax returns are not sent at all. In the worst cases, the government can easily freeze your assets and arrest you. But before any action is taken against you, you will get some written correspondence from them as an opening to rectify the situation.
If you get any such messages or calls, be sure to cooperate. There’s no need to panic, they should be focused on helping you get things in order.
How a tax rate can go up or down
It is quite common for people to be unhappy with the amount of tax they are paying, and look for ways to reduce it. In a broad sense, you could lobby your representative in Congress to make changes to the rates, but this is hardly a quick solution. The other viable and legal approach remaining is to reduce your taxable income.
First, let’s look at another approach that won’t lower what comes out of your salary, but will still be helpful in retaining more funds for personal use – acquiring tax-free income. Tax-free income refers to funds and assets that you get that are exempt from taxation. The most common ways to do this are by receiving insurance payments (disability, injury, death, etc.), selling a house, receiving a financial gift, and receiving interest from municipal bonds.
As for reducing taxable income, deductions are the answer, and are sometimes even effective enough to take you to a lower bracket. These deductions can come from charitable contributions, medical expenses, paying a mortgage, receiving a child or education credit, or reporting a major theft of possessions.
Tax rates for married couples
Being married in the eyes of the law can have several benefits for a person’s tax rate, but it could also be a penalty. Here’s what we mean:
If a couple files income tax jointly, their incomes are pooled into a single bracket and the total paid ends up being lower than what they would have if they filed separately, then added the amounts together. For example, if one partner had taxable income of $30K and another had $120K, their separate filings added together would equal $25,878.
However, if they file jointly, they would only have to pay $24,234 – a saving of $1,644.
Another notable situation where a shared income can be advantageous is when one of the two partners owns a business that is losing money. The second partner has the opportunity to use this loss as a deduction in a joint filing.
Tax rate for a head of household
Head of household is another interesting status that influences a person’s income tax rate and amount. The status means that you are supporting someone, and the advantages (unsurprisingly) have to do with brackets.
The brackets for the head of household are wider, so a 12% rate that would allow a maximum income of $41,775 is stretched to $55,900 at the same rate for this person. For example, if their income was $55K, they would get savings worth as much as $1,410.
To qualify for this status, you must not be married, pay more than half of household expenses, and care for a child or dependent (e.g. a relative). There is also a greater deduction to income tax for filing as a head of household than for single or married (joint) taxpayers.
Other rated taxes – AMT
AMT is important to mention in a conversation about income taxes, because it often comes into play. It stands for Alternative Minimum Tax and is essentially a secondary tax system whose purpose is to close loopholes in the main income tax system – and collect fees that should be fairly due to the government. AMT mostly targets ultra-wealthy people and asset owners.
AMT works by adding/removing certain deductibles from the payable amount – especially when the taxpayer has exploited them excessively. Unless you quickly find a six-figure job after graduation, you probably won’t have to deal with AMT in the short-term, but it is something to keep an eye on as you become more financially accomplished.
Other notable taxes - FICA
FICA is a tax that runs in parallel with the federal income tax, but has some slight differences. It stands for Federal Insurance Contributions Act, and is withheld monthly from your paycheck – just like the main levy tied to income. FICA deducts a rate of 7.65% from your gross income, with your employer obligated to match it.
FICA is intended to fund two specific government programs – social security and medicare. Social security is a pension and disability program, and medicare is a health insurance program that supports vulnerable populations, such as the elderly and disabled. Medicare covers an estimated 64 million Americans, while social security covers over 170 million workers – with most adults in the country paying contributions or receiving benefits from it.
Tax deductibles and credits
Reading about all these taxes, you might think that they just keep piling on. But you have to understand that taxes can also go down, and this happens all the time. One of the ways is through deductibles – factors that lower your taxable income, which can lower your bracket, or at least lower the amount that you have to pay in this bracket. Deductions are great and pretty easy to achieve, but you still need to pay the base sum of your bracket, along with any the leftover amount.
Tax credits are also popular, because they don’t subtract from your rates or brackets – rather from the final amount that you have to pay. For example, if you had a gross income of $30K with $20K of deductibles, you would still have to pay 10% in the lower bracket ($1K). However, a credit of $20K replacing the deductible would lower the tax due to only $752.
Getting your credit/refund
Tax credits can be applied in one of two ways. If the credit is non-refundable, it will only lower the total income tax owed, and be considered fulfilled if the credit exceeded the owed amount. However, if the credit is refundable, then any amount on the credit remaining (after it has covered your tax liability) should be transferred to your bank account. The same should happen with tax refunds – sums that are paid to the government in excess of what you owe in taxes.
In rare cases, the government may deliver stimulus checks to taxpayers – allowing them to spend the money right away, without worrying about tax liability.
About state tax rates
Now we come to another twist in the tangled fabric of American financial systems – state taxes. As you might know, states can make and enforce their own laws separate from the federal government, and taxes are no exception. Like the federal government, state governments also need funding, and primarily get it from tax paying citizens, residents, and businesses living and operating in their area.
There are as many systems and unique arrangements as there are states, but traditionally, taxpayers have to cover both federal and state taxes to fulfill their financial obligations.
Connection between federal and state tax
States are known to establish dozens of taxes. However, one important distinction to make is that state income tax usually only applies to income earned in the state. For example, if you live in one state and commute to work in another one, you’d normally pay this tax where the work is done.
As for federal income tax, the government only wants to make sure that your wages were earned inside the country. Another peculiarity of state tax is that it’s customarily paid after federal taxes – though state governments have just as much power in withholding part of a paycheck to cover their taxes.
Filing state taxes tends to be quite similar to its federal counterpart, and 20 states even support the FreeFile program as a recommended option matching the unique system in their state. Each state will have their own tax brackets.
Living/working in tax-free states
If you consider how much money some people pay in state income taxes, it becomes easy to see why a state’s tax rate can be a powerful motivator or discouraging factor for living and working in the region. Years and decades of paying several thousand dollars add up to a car, a vacation – even a new home that you miss out on.
At the moment, only eight states in the U.S. do not levy income tax on residents:
- Texas
- Washington
- Florida
- Alaska
- Nevada
- Tennessee
- South Dakota
- Wyoming
The first three states are particularly significant, as they have large territories and powerful economies – attracting various work migrants and even retirees. In Texas alone, the past 10 years brought a population growth reaching almost four million. This is in contrast to California, which has the highest state income tax (13.3%), and a steadily declining population.
Progressive/flat-rate tax systems
One notable feature of the American tax system is that most income taxes are either flat or progressive. Flat tax is exactly like it sounds like – a straight line, constant and unbroken. So everyone pays 5% or 10% or whatever single rate is set by the state – regardless of their wealth and income level. A flat rate is most commonly applied to state income tax, sales tax, payroll tax, and property tax.
The other option – progressive – is what the federal income tax system can be called. It works by applying a higher tax rate with higher income, but not to the point that someone with a very high rate ends up with less profit than someone in a lower bracket. There’s always an incentive to move to a higher bracket – even if you end up a smaller portion of your wages.
There’s a lot of discussion about the fairness and efficiency of both systems, with economists failing to achieve a consensus. A progressive approach is praised for giving more financial opportunities to lower earners, and criticized for scaring away high earners and their businesses to countries with a tax system more favorable to them.
As for flat tax, it’s fair in the aspect that everyone has the same percent of profit to work with, and criticized for overburdening disadvantaged people who have very limited financial flexibility.
So how much will you actually pay?
The best way to get an accurate understanding of your tax payments and remainders will be to use one of the many specialized calculators available online, or consult an accountant who’s knowledgeable in these matters.
In the meantime, you can use public data as a general reference. Let’s take for example the year 2017, which was pretty average from an economic standpoint. That year, taxpayers with income over $200K paid over 58% of collected taxes (federal income). On the other hand, two-thirds of taxpayers in the lowest bracket (<$30K) paid no tax at all.
The amount that someone with a salary between $50K and $100K ended up paying in 2015 was 9.2% (on average), comparable to $5,520 on a salary of $60K.
Another fascinating year to compare is 2021, when the global economy began bouncing back from the pandemic. This year, the percent of (all) households that did not pay any income taxes reached 57%. This was a year when Congress allocated substantial child credit and stimulus checks to support consumers (and by extension, the economy as well).
Standard and itemized deductions
Going back to the topic of deductions (which lower your taxable income), we should point out that they come in two possible forms – standard or itemized. A standard deduction is a helping hand extended by the government to various categories of the population. And the great part is that nearly everyone qualifies for one.
For example, a standard deduction for a single adult makes up $12,550, while a couple filing jointly pays double the amount. As you might imagine, these deductions can work wonders in lowering your bracket.
As for itemized deductions, they are a list of expenses you incurred, including: medical payments, gambling losses, charity contributions, and real estate taxes. It makes sense to itemize your deductions when they exceed the amount of the standard deduction.
Do tax rates apply to tips and commissions?
In regards to tips, they are not taxable in the amount of up to $20/month. However, beyond that, the IRS advises that tips should be recorded and reported. The person receiving the tips should keep a record of them and include them in their next return – while the employer should withhold the amount necessary to cover social security, medicare, and other payroll taxes.
Commissions are reported and taxed differently, depending on your work arrangement. For example, if you are self-employed, they will just be part of your gross income. If commissions are fulfilled as part of your contract with an employer, the work provider can classify them as supplemental wages added to your standard ones, or a separate category of supplemental wages.
Tax rates for gigs or multiple jobs
Gigs are described by the IRS as income earned through providing on-demand services. Most of the time, these are jobs for freelancers and contractors, including: driving/delivery, home improvement work, and temporary services like dog-walking and snow-clearing. If you are working here without a contract, the income will fall under the standard self-employed rules, and you will be responsible for withholding dues yourself.
If there is some kind of formal arrangement with paperwork, the situation with employer/self-employed reporting will be decided based on your specific circumstances. You can contact a CP accountant for clarification. These types of gigs are much easier for the IRS to track and inspect than small jobs paid with cash.
If you opt to work multiple jobs, your gross income will just be added together to get the corresponding tax bracket. Figuring out payroll tax and withheld sums can be a bit complex in these circumstances, so it’s recommended to consult a professional.
Tax rates for international work
After you graduate, you may choose to work in another country, but where does that leave you in the eyes of the U.S. tax system? Well, even if you leave the country and start paying taxes elsewhere, the U.S. system is not done with you, and you still have to file returns and pay taxes on worldwide income. This, as with standard federal income tax, applies to U.S. citizens and residents.
The good news is that only a fraction of such international workers have to pay this tax. Per the Foreign Earned Income Exclusion, you are exempt from paying if your income was below $112K and you are a resident and taxpayer in the new country. Still, the relevant tax return should be sent before Tax Day to the relevant IRS-provided address.
Other terms you should know
As you start working actively with tax forms and communication, you might encounter some new terms, such as:
Ad valorem tax – a fancy term for sales tax
Resident alien – a foreign resident living legally in a country in the long-term
Entity – usually a company, person, or organization
Estate – all things owned by a person: physical and non-physical assets
Indemnification – amount of compensation received to cover damages or losses
Liquidation – the process of dissolving a company
Remuneration – employment benefits provided to an employee for their services.
Correcting any tax mistakes
Even with good preparation, there’s no guarantee that you will get everything right on each year’s tax return. Making a mistake here is certainly scary, but not the end of the world. The IRS has a process in place to update and amend the details you originally sent. All you need to do is fill out and send the form 1040-X ‘Amended U.S. Individual Income Tax Return’.
The 1040-X form allows you to change a broad range of details – starting with your filing status, amount of income, add or remove deductions or credits, and much more. The first thing to keep in mind is that you don’t want to send an inaccurate filing twice, so if you feel lost or unsure about your form, it can help to get some professional assistance.
Another thing to consider is that changes should be made within three years of originally filing, or two years after the day you paid the last tax in that calendar year. A few exceptions exist that prolong these deadlines.
Chapter 2
Bonus info
Other taxes you need to know about
While we’ve covered the biggest and main tax you’ll be dealing with in your first several jobs, there are a few others that you will encounter in work and life:
Payroll tax
A federal tax, whose contributions are split between employees and employers. It’s used by the government to fund social security and medicare.
Sales tax
Applied at the state and county level in 45 states. Brings additional revenue for local government funding.
Capital gains tax
Imposed on the sale of major assets (stock, cars, companies, etc.). Only applies when the sale price is more than the previous purchase price.
Property tax
Imposed on property owners and calculated based on fair market value assessment. Determined at the state level.
Corporate tax
Paid by business owners to the federal government based on their business’s income, sometimes also at a state and local level.
Top tools for filing taxes
We live in a digital age, and filling in paper forms just doesn’t have much charm anymore. Your first few tax filings can be a confusing affair without guidance. Let’s go over a few tools that can help you learn, calculate, audit, and submit your taxes:
Free File
A free tool provided by the IRS. People with an adjusted yearly income of $73K or less only need to answer a few questions, and most of the work is handled by the software. Higher-income earners are advised to download relevant forms and fill them in independently.
Turbotax
A private service for filing simple state and federal taxes, with a free and paid version available.
TaxSlayer
Another filing service with a free version (best for <$100K earners). Provides plenty of customization for joint filing and student programs (loans and credits).
