A Beginner’s Guide to How Income Taxes Work

Governments need money to maintain roads, fund schools and manage many other citizen needs. They primarily fund these activities by collecting tax payments from individuals and businesses. Most people contribute by paying taxes on their income every year.

So, how do taxes work? To get you started, here are some basic facts to know about taxes, including why and how they’re collected, tips for filing your paperwork with the IRS and your state and what options you have if you end up owing any money.

Understanding income tax basics

If you work for someone else, your employer will automatically deduct taxes from your paycheck based on which of the tax brackets you're in. This is called tax withholding. Most will pay part of your Social Security and Medicare taxes.

How much you’ll pay in income taxes depends in large part on what income you earn and how many dependents you claim.  

If you’re self-employed, you’ll need to pay estimated taxes yourself. You can find information on federal income tax rates, how to pay your taxes and more in the IRS article Self-Employment Tax and at the IRS’ Self-Employed Individuals Tax Center.

At the beginning of each year, if you’ve reached a specific income threshold or are eligible for a tax refund, you’ll need to file an income tax return for the previous year.

In most cases, you’ll need to file 2 tax returns—one with the federal government and one for your state. You’ll need to fill out the forms to see if you owe tax or are due a refund. These forms come with step-by-step instructions regarding how to fill out and calculate what you owe.

If you have a balance due, you’ll need to pay what you owe. (There also may be an underpayment penalty, depending on the amount.) If you can’t pay the full total of what you owe right away, the IRS may allow you to pay down your debt with a monthly payment plan.

If you had more money withheld than necessary or if you paid too much in estimated taxes, then you should be eligible for a refund. You can have the money sent to your bank directly or mailed to you as a debit card or paper check, or have the IRS apply the money toward your tax bill for next year.

What you should know about filing a federal income tax return

The filing deadline for your federal income tax return is usually April 15. But if April 15 is on a holiday or on a weekend, then the filing deadline for your tax return will be the next business day.

You can ask for an extension to file your tax return later using IRS Form 4868. Tax filing extension requests must be submitted by or before April 15. The extension only covers filing the paperwork. You’ll still need to pay at least 90% of what you owe. 

Your request can be filed electronically using tax preparation software or by a tax professional. Then, your new deadline to file your tax return will be Oct. 15.

If you don’t file your tax forms by the deadline, you may have to pay a late filing penalty. Interest will accumulate on any unpaid or underpaid tax balance.

What you’ll need to start your tax paperwork

What you’ll need to file your taxes depends on whether you itemize deductions. Here are some of the most common items:

• Social Security numbers (SSN). You’ll need to accurately list the Social Security numbers for yourself, your spouse and other dependents you’re claiming.
• Bank account information. If you’re expecting a refund and want it to go directly to your bank account, you’ll need the bank’s federal tax ID number, its routing number and your bank account number.
• W-2 form(s). This shows your wages, salary and tips for the filing tax year.
• Form 1099. This form reports income such as self-employment income or interest earned.
• Form 1040. This is the form people use to file their annual income tax return.
• Government-issued photo ID (like a driver’s license). If you plan to use a tax preparation professional or an in-person service at the IRS, you’ll need to prove your identity.
• Documentation. If you plan to itemize, you’ll need things like canceled checks, receipts and bills to support your itemized deductions. A complete list is available on the IRS website. If you own or are buying a home, you’ll also need Form 1098 to list mortgage expenses and the real estate taxes you paid. If you paid for childcare, you’ll need that information, too.

Itemizing deductions vs. taking the standard deduction

The standard deduction is a flat amount you can deduct from your taxable income to lower your tax bill. The amount depends on your filing status (married, single, married filing separately, married filing jointly, head of household or surviving spouse), your age and other relevant factors.

If you choose to itemize, you’re allowed to subtract certain approved expenses to lower your income, which then lowers how much money you pay in taxes. Generally, it makes sense to itemize if the total of your deductible expenses is more than the standard deduction. 

Here’s a list of some IRS-approved deductions:

• state and local income taxes
• sales taxes
• real property taxes
• personal property taxes
• mortgage interest
• disaster losses
• gifts to charities
• certain medical and dental expenses

For more information on deductions, see the Instructions for Schedule A.

Options for preparing your income tax return

Depending on your situation, there are several options available to tax filers. We encourage you to speak with a tax advisor to choose the best method for you.

Use tax preparation software

These digital programs are relatively inexpensive, provide step-by-step instructions and make calculations for you automatically. You can buy them online and at many department and electronics stores.

Hire a tax professional

Many certified public accountants, tax attorneys and tax preparation services can use the information you provide to prepare your tax return for you.

Explore free IRS services

The IRS offers 2 other free services. The Volunteer Income Tax Assistance program (VITA) offers free tax preparation for people with disabilities, limited-English speakers and those who generally earn less than the current cap. For people 60 years old and older, the IRS offers Tax Counseling for the Elderly (TCE). You can use the VITA Locator Tool or call 800-906-9887 to find the nearest VITA or TCE center.

How to file your federal income tax return

Once you’ve finished filling out your individual income tax return and signed and dated it, you’ll need to file it with the IRS. Here are several options.

Electronic filing (e-filing)

The quickest, most secure way to file your tax return is electronically through IRS-approved software or a tax professional. E-filing ensures faster processing and quicker refunds.

IRS Free File

You can file your return electronically using IRS Free File if your adjusted gross income is below the current cap. According to the IRS, the IRS Free File Program uses online programs tax preparation companies provide for free.

Paper filing

If you prefer, you can fill out a paper tax return and mail it to the IRS. Fill out the forms you need, make 2 copies (one for the IRS and one for your files) and mail one to the IRS. The instruction booklet will tell you where to mail your return, or you can get the information from the IRS online. Keep in mind that the IRS says processing mailed-in returns may take much longer than filing electronically. That means your tax refund payment could be delayed as well.

What to do if you owe taxes

If you didn’t have enough money withheld from your paycheck during the year, then you likely owe a tax payment to the government now. Here are some tips on how to settle your tax bill.

Make an online payment

You can make secure online payments directly through the IRS website using credit or debit cards, via an electronic funds withdrawal or using the Electronic Federal Tax Payment System (EFTPS). You may end up paying additional interest if you use a credit card to pay your tax bill.

Send a check or money order

You can mail a check or money order payable to the U.S. Department of the Treasury, along with your payment voucher (Form 1040-V), if required.

What to do if you can’t pay your balance

If you can’t pay off your tax debt all at once, you have a few options. Gather all your financial information (like mortgage statements, lease agreements, car loans, utilities and pay stubs) and call the IRS as soon as possible at 800-829-1040.

Here are some options and scenarios that can help if you can’t pay your balance:

• Pay a portion of your bill to start. It’s a good idea to pay as much as you can—even if it’s not the whole amount. Paying even a partial amount will reduce penalties and the amount of interest you’ll pay.
• Apply for a payment plan. If you apply for a payment plan online, the IRS will notify you right away if your plan is approved. The IRS offers payment plan options depending on how much you owe and how long it will take to pay the debt.
• Explore an offer in compromise (OIC). If you can show that paying your tax debt in full would cause financial hardship, you might be eligible for an “offer in compromise.” If approved, the IRS will agree to settle for less than what you owe. Not everyone will qualify.
• Get a temporary delay of collection. If the IRS determines that you’re facing financial hardship and can’t afford to make any payments, they may temporarily delay their tax collection efforts. This won’t get rid of your tax debt, but it will suspend collection actions for a bit.
• Visit an IRS Taxpayer Assistance Center. These centers are available if you want in-person help with questions, adjustments, letters, notices and payment plans if you owe taxes and can’t pay the full amount. To find the center closest to you and to make an appointment, visit the Taxpayer Assistance Center Office Locator page. You can also get help with questions by calling 800-829-1040.

What you should know about filing a state income tax return

Most states and some localities collect income taxes and require you to file a tax return. However, if you file an itemized federal return, you may be entitled to deduct the state and local taxes you paid.

States that don’t have income taxes

*New Hampshire and Tennessee don’t tax wages, but they do tax some investment and dividend income.

States that do have income taxes

Each state may have different requirements, guidelines, forms, tax reforms and rate changes. Check with your state’s tax authority for the most current rates and rules that may affect your state tax return. Many state tax returns can only be filed electronically. You can find your state’s requirements using the resources from this list: skip this list of states

If you owe a tax balance and can’t pay, contact your state’s tax authority as soon as possible to work out an arrangement.

Find helpful tax resources at Navy Federal Credit Union

Our Tax Center has important resources to help you file taxes this year and ensure you receive the benefits you’re entitled to. Navy Federal stands ready to serve you this tax season and throughout the year.