The federal income tax is a schedular, progressive tax on income above statutory thresholds. Understanding the structure in outline — brackets, deductions, credits, effective versus marginal — is a working competence. Everything the household can influence follows from the structure.
- 01Distinguish gross income, adjusted gross income, and taxable income.
- 02Compute effective and marginal tax rates from a return.
- 03Explain how a deduction differs from a credit.
The waterfall
Gross income minus above-the-line adjustments equals adjusted gross income (AGI). AGI minus the greater of the standard deduction or itemized deductions equals taxable income. Taxable income runs through the bracket table to produce the tax. Credits reduce the tax; deductions reduce the income the tax is computed on.
The brackets
The federal income tax is progressive: income in each bracket is taxed at that bracket's rate. Marginal rate is the rate applied to the next dollar earned. Effective rate is the total tax divided by taxable income. Most decisions — retirement contribution, charitable giving, tax-loss harvesting — depend on the marginal rate, not the effective.
Deductions versus credits
A $1,000 deduction saves $220 in tax at a 22% marginal rate. A $1,000 credit saves $1,000 in tax at any rate. Credits are more valuable than deductions per dollar; households should exhaust available credits before pursuing marginal deductions.
- Waterfall: gross → AGI → taxable → tax → credits.
- Deductions reduce income. Credits reduce tax.
- Most decisions turn on the marginal rate.