With a new year comes the responsibilities of tax filing.

Tax filing can often feel complicated due to the lengthy forms and procedures involved. Whether you are working with a tax professional or handling it by yourself, figuring out the exact amount owed to the IRS can take some time.

You may not completely grasp what deductions are being made from your paycheck and the reasons behind them, which can also vary based on your location and employment.

This article serves as an overview: explaining what income tax is, how it functions, how to compute it, and which states do not impose it.

What is Income Tax?

Income tax is a charge that governments apply to earnings generated by individuals and businesses within their area.

Income tax can be federal as well as state-based. However, not every state levies an income tax. In states that do, residents are required to file income tax returns annually to determine their liabilities.

The aim of income tax is to fund public services and governmental responsibilities while providing essential goods for the population. For example, personal income taxes contribute to funding Social Security, schools, and infrastructure like roads.

Types of Income Tax

Individual income tax, commonly referred to as personal income tax, is applied to a person’s wages, salary, and other income sources. This tax is usually imposed by the state. Depending on specific circumstances, there may be various exemptions, deductions, or credits that allow for certain individuals to reduce or eliminate their tax burden.

Business income tax is imposed on businesses, including corporations, small enterprises, and self-employed individuals. These entities, along with their owners or shareholders, must report their business revenue and then deduct operational and capital expenses. The result is classified as the “taxable business income.”

Which States Do Not Impose Income Tax?

There are eight states that do not levy an income tax:

• Alaska
• Florida
• Nevada
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

New Hampshire does not have a state income tax; however, residents are subject to a 5% tax on earnings derived from interest and dividends.

What Percentage of My Income is Taxed?

The tax percentage applied to your income is determined by your individual situation: your income level and your filing status. Simply put, the higher your earnings, the greater the taxes you will be required to pay.

How to Calculate Income Tax?

To compute your income tax, start by summing up all forms of taxable income earned within the tax year. Next, determine your adjusted gross income. Finally, subtract any deductions you qualify for from this adjusted gross income.