The Basics of Tax Rates and Deductions on Personal Income

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April 15th (or thereabouts) is a day that many people fear because it marks the due date of income taxes for the previous year’s earnings. Income tax collection is the Federal Government’s largest source of revenue making up over a third of its income. One complaint many taxes payers have is the complexity of the tax laws that govern tax collections. The 1040, which is the standard Federal tax form, comes with a long list of instructions containing many exceptions to the rules of proper income reporting. The 1040EZ form makes the process easier for tax payers who have simple income to report. The complexity of the tax laws makes many people turn to tax professionals for advice on reporting income and paying taxes to the Government.

There are four major considerations when reporting income and paying taxes to the Federal Government. Tax rates, deductions/exemptions, dividends/interest, and capital gains combine to make the process of figuring taxes complicated. This article introduces tax rates and deductions/exemptions to help familiarize the reader with the basics of personal income tax.

Tax Rates

Both corporations and personal income taxes are based on a schedule such that tax rates increase as taxable income increases. The minimum owed can be as low as zero to a maximum of about 40%. The tax rates differ depending on the filer’s situation. For example, there are different tax schedules depending on whether the tax payer is single or married. There are also schedules for people filing their taxes as either married but filing separately and as head of household. These tax rates are also influenced by other factors such as deductions, exemptions, and income from other sources besides wages, salaries, and tips such as dividends, interest, and money received by realizing earlier capital gains.

Of course, individuals with one job and no spouse, children/dependents, deductions, or monies earned from other sources such as investments, find that figuring taxable income is quite simple. These individuals usually qualify for filing with the 1040EZ form which is short and simple to complete.

Tax payers with more complicated situations may find that the cost of professional tax advice actually reduces their tax liability even though the advice costs money. It is really a question of opportunity cost whether to seek advice from a professional or try to figure taxes without any help.

Deductions and Exemptions

Taxable income is defined as a filer’s gross income from all sources minus any legally allowable deductions and exemptions. For example, for each dependent a filer has, a standard amount may be deducted from taxable income. Each year this standard amount increases to account for changes in inflation and other economic conditions.

The most important decision any tax payer must make is whether to take the standard deduction or attempt to itemize deductions. Often, the standard deduction is higher than what could be subtracted from taxable income by itemization. Itemizing deductions can be a tedious task of accurately recording throughout the year such expenses as interest paid, charitable donations, other income tax liabilities (state and local taxes, for example), property taxes due, medical expenditures, and occupational expenses.

For some filers, their taxable income is too high to claim any deductions or exemptions at all. This is in line with the concept of taxes increasing as taxable income increases. In other words, there is a maximum taxable income under which deductions and exemptions can be claimed at all.


The first two of four major personal income tax considerations, tax rates and deductions/exemptions, make up the majority of what makes figuring taxable income difficult for most filers. There are several tax tables used to determine taxes due and one of the most common mistakes filers make is using the wrong table given with the 1040 tax packet.

The choice to either take the standard deduction or itemize deductions can be the most important decision for a tax payer. This decision can significantly reduce a filer’s tax liability when itemizing deductions leads to a larger total deduction than the standard amount. When a tax payer has had a multitude of potential deductions, it may be worth the time to create a mock itemized deduction list to estimate the reduction of taxable income over taking the standard deduction.

As always, consult a profession tax preparer to determine the best method for determining your taxable income.