5.1 Taxes, Net Income, and Budgeting

Individuals pay taxes to federal, state and local governments. The mix and the amounts vary a lot by state; some states have no income tax, for example.

• Income tax: a share of your income. Employers withhold (take out) part of each paycheck and send it to the government. Each year you file a tax return to pay any amount still owed or get a refund if too much was withheld. Self-employed people must send in their own income tax payments.
• Capital gains tax: tax on the profit when you sell an asset, like stock, for more than you paid. It's reported on your income tax return, and gains on assets held more than a year are usually taxed at lower rates than wages.
• Payroll taxes: Social Security and Medicare taxes, withheld from each paycheck. As of 2026 an employee pays 6.2% of wages for Social Security (up to a yearly wage cap, $184,500 in 2026) and 1.45% for Medicare, and the employer pays a matching amount (an extra 0.9% Medicare tax on wages above $200,000 has no employer match) (IRS Topic 751, irs.gov, checked October 2026). Self-employed people and independent contractors pay both halves themselves. Employers also pay unemployment insurance taxes that fund unemployment benefits.
• Property tax: based on the value of property you own, such as a home, land and, in some places, a car. Bills may be paid yearly, twice a year or monthly.
• Sales tax: a percentage of the price of things you buy. The store collects it and sends it to the government.

The amount depends on income, deductions and credits. The U.S. federal income tax (and some state income taxes) is progressive: income is split into brackets, and each higher rate applies only to the dollars inside that bracket. So people with higher incomes pay a larger share of their income in tax, but moving into a higher bracket never shrinks your after-tax income, because only the dollars above the bracket line face the higher rate.

A tax deduction lowers your taxable income. Examples include mortgage interest, contributions to certain retirement accounts, charitable donations, state and local taxes and some medical costs (many have limits and rules). A tax credit cuts the tax you owe dollar for dollar. Examples include the child tax credit, the child and dependent care credit, education credits and credits for certain purchases. A credit is worth more than a deduction of the same size.

• Gross pay: everything you earned in the pay period, from salary (divided into pay periods), hours worked, a contracted amount or another pay scheme.
• Mandatory deductions: required by law and withheld by your employer, mainly income taxes and payroll taxes.
• Voluntary deductions: money you chose to set aside for employer benefits, such as health insurance, health or dependent care savings plans, life insurance, retirement savings and union dues.
• Pretax deductions: some voluntary deductions, like traditional retirement contributions and many health insurance premiums, are taken out before income tax is figured, so they shrink your taxable income. That's a built-in reward for saving.
• Net pay: what's left after every deduction, the amount actually deposited. It can be much smaller than gross pay, so build your budget on net pay.