how does income tax really work?

Feb 28

How Does Income Tax Work? (And Why You’re Probably Paying Less Than You Think)

If you’ve ever looked at your paycheck and wondered why a chunk of your money disappears before it even hits your bank account—welcome to the world of income tax. It’s something you’ll be dealing with for the rest of your life, so let’s break it down in a way that actually makes sense.

What Is Income Tax?

Simply put, federal income tax is money you pay to the government based on how much you earn. This money funds things like roads, schools, and national defense. The more you make, the more you pay—but not in the way most people think.

Progressive Tax System: You Don't Lose Half Your Paycheck

In the U.S., we use a progressive tax system, which means higher income is taxed at higher rates—but only the extra income, not all of it.

Here’s what that means:

You don’t pay the same tax rate on every dollar you make. Instead, your income is divided into different tax brackets, each with its own rate.
Only the portion of your income that falls into a higher bracket gets taxed at that rate.
This applies to only to federal income tax, but also some states including California, Minnesota, and Vermont, as well as the District of Columbia.

**Example: How Much Do You Actually Pay?**

Let’s say in 2024, the tax brackets are:

10% on income up to $11,000
12% on income from $11,001 – $44,725
22% on income from $44,726 – $95,375

Now, imagine you make $50,000. You might think, "Oh no, I’m in the 22% tax bracket, so I lose 22% of my income!" But that’s NOT how it works.

Here’s the real breakdown:

The first $11,000 is taxed at 10% → $1,100
The next $33,725 ($44,725 - $11,000) is taxed at 12% → $4,047
The last $5,275 ($50,000 - $44,725) is taxed at 22% → $1,160

Total tax paid? $6,307
Your effective tax rate (what you actually pay) is 12.6%, not 22%!

Tax Deductions & Credits: Lowering What You Owe

Luckily, there are ways to lower your taxable income:

Deductions: Things like student loan interest, 401(k) contributions, and mortgage interest reduce the amount of income the government can tax.
Credits: These directly reduce your tax bill, like the Child Tax Credit or education credits for college students.

The Teenagetraders Takeaway

Your entire income isn’t taxed at the highest bracket—you pay different rates on different portions.
Tax deductions and credits can save you money.
Understanding taxes now can help you legally pay less in the future.

Now, knowing this, do you think taxes are fair? Should they be lower, higher, or completely different? Let’s discuss! 💰📊