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By April 15 of each year, Americans typically must file their tax returns with the Internal Revenue Service (IRS). As the name suggests, income tax requires individuals and businesses to pay a percentage of their earnings or profits from the previous calendar year to the government.

Figuring out the right amount to pay can take some time. When you or your tax preparer fills out your tax forms, you’ll find out if you’ve overpaid your taxes, meaning you’re entitled to a refund, or if you’ve underpaid, which means you’ll owe money to the government.

There are different types of income tax, but the most common one people have to file is federal, which is done through the IRS, a bureau within the U.S. Treasury Department. Depending on where you live, you may also have to pay state or local income taxes.

Here are key things to know about income tax, including how it works, how to determine what you owe, and possible ways to reduce your taxable income and save on taxes.

What Are Income Taxes?

Income taxes are taxes that are collected by the government on income (aka money) earned by individuals and businesses. This can include salaries, tips, commissions, bonuses, investment income, interest earned, and other sources. Income tax can be assessed by a federal, state, and/or local government. Some Americans may only pay federal taxes; others may be liable for taxes at a federal, state, and local level.

Once collected, taxes are typically used to fund a wide array of public services, programs, and government operations at the national and local level.

How Does Income Tax Work?

The amount of income tax you pay depends on how much money you’ve earned in the past year as well as your filing status (e.g., single, married filing jointly, etc.), along with other factors. First, a bit more about what counts as taxable money:

•   Income that’s taxable includes your earnings from work, interest earned on savings accounts, and money made from investments or rental properties.

•   Certain forms of income may not have to be reported on your tax return. Some examples of income that may be nontaxable include child support payments, financial gifts, alimony, and employer-provided health insurance.

The U.S. tax system is progressive, which means the greater your income, generally the higher your overall tax rate. The idea behind a progressive system is that people who earn more are typically able to pay more in taxes.

Currently, there are seven tax brackets, ranging from 10% to 37%. Each bracket corresponds to specific income thresholds and are adjusted each year for inflation.

Tax season revolves around filing income tax returns each spring. Some details:

•   The typical deadline is April 15, though if that date falls on a weekend or holiday, the date will be moved to the next business day.

•   Those who are self-employed may pay quarterly estimated taxes.

•   You must file your federal income tax return with the IRS, by mail or electronically. In order to file, you must have all the necessary year-end income documents, including those from your employers and financial institutions.

•   The IRS recommends taxpayers file electronically, since it can take six weeks or more to process a paper return. Electronic files move much more quickly through the system.

When you fill out your tax return and file it with the IRS, you’ll find out if you’ve underpaid and still owe any taxes or if you’ve paid too much and are entitled to a refund. Salaried workers must complete an IRS Form W-4 to help their employer withhold the correct amount of federal income tax from their paychecks. This form can be changed to help correct for too much or too little taxes withheld during the previous year.

Brief History of How Income Taxes Came to Be

Now that you know what income tax is, here’s a quick look at how it came into being in America. The first federal income tax came about in 1861 as a way to finance the Civil War effort. A year later, Congress passed the Internal Revenue Act which created the Bureau of Internal Revenue, which eventually evolved into today’s IRS. But income tax didn’t have substantial support after the Civil War and was repealed in 1872.

Federal income tax made a short comeback in 1894, but the next year it was ruled unconstitutional by the Supreme Court. This verdict was based on the grounds it was a direct tax and not apportioned among the states on the basis of population.

In 1909, the 16th amendment to the Constitution was introduced, which would give the government the power to collect taxes without allocating the burden among the states in line with population. It was passed by Congress then, but it still needed to be ratified by 36 states. Ratification of the 16th amendment finally happened in 1913, giving Congress the legal right to impose a federal income tax. This laid the foundation for the tax system as it’s known today.

What Are the Different Types of Income Taxes?

Income taxes are primarily categorized based on who pays them (individuals or corporations) and the source of the income, such as wages, investments, or business profits. Here are some common types of income tax:

•   Individual or personal income tax. This type of tax is imposed on salaries, wages, investment earnings, or any other forms of taxable income a person or household earns. Thanks to deductions, tax credits, and exemptions, most people don’t end up paying taxes on all their income.

•   Business or corporate income tax. This kind of tax is based on business profits, minus the costs involved in doing business. According to the IRS, all businesses except partnerships must file an annual income tax return.

•   State and local income tax. Depending on where you live and work, you may have to pay state and local taxes. Currently, nine states (Alaska, Florida, Nevada, South Dakota, Texas, Tennessee, Washington, Wyoming, and New Hampshire) don’t have a state income tax. Some local governments impose a local income tax on people who live or work in a specific city, town, county, municipality, or school district. Both state and local taxes help pay for a wide range of services like roads, schools , and law enforcement. State and local taxes are generally much lower than federal income tax.

How Do I Know How Much I Owe in Income Taxes?

In order to figure out how much income tax you may owe, here are some steps:

•  You’ll want to know your filing status which will determine which tax bracket you fall under. The five filing status choices are single, married filing jointly, married filing separately, head of household, and qualifying widow(er) with dependent child.

•  Once you know how you’re going to file, you’ll need to gather up all your documents detailing your earned income, such as your W-2 and 1099 statements. When you have all of the information about how much money you earned, you can total it up, which amounts to your gross income.

•  The next step in knowing how much you owe in taxes is to calculate your adjusted gross income (AGI). You can do this by taking your total gross income from the year and subtracting any “above the line” adjustments, as they’re known, that you are eligible for. A list of adjustments to income can be found on Schedule 1 of Form 1040. They include, up to certain limits, educator expenses, the deductible part of self-employment tax, and student loan interest payments

Once you’ve got your AGI number, you can then subtract any standard or itemized deductions to get your taxable income amount. Itemized deductions may include charitable donations, paid mortgage interest, property taxes, and unreimbursed medical and dental expenses. An alternative to itemized deductions is the standard deduction option. A standard deduction is a set dollar amount based on your filing status. The vast majority of Americans take the standard deduction when filing their federal income taxes. When you have your taxable income number, you can then pinpoint your tax bracket and determine your tax rate.

Recommended: What Are the Common Types of Payroll Deductions?

Ways to Lower Your Taxable Income

You may be able to reduce your taxable income by taking advantage of any pre-tax savings opportunities available to you. Consider these tips:

•  Take advantage of employer-sponsored retirement plans. Contributions to a 401(k) for example, are made with pre-tax dollars, meaning they lower your current taxable income, and you pay taxes later when you withdraw the money in retirement, potentially at a lower tax rate

•  Enroll in a health spending account (HSA) or flexible spending account (FSA) if your company offers them. A health savings account allows pretax contributions to be used for upcoming healthcare costs for employees with high-deductible health insurance plans. If your employer doesn’t offer one, you can open a HSA on your own, provided you meet the eligibility requirements.

With a flexible spending account, you set aside pre-tax dollars from your paycheck to pay for eligible out-of-pocket healthcare or dependent care expenses. This can help you save money on taxes while covering costs like copays, prescriptions, dental, and vision care.

•  Figure out what tax deductions you can claim. To save on taxes, you can claim a variety of deductions that reduce your taxable income. You have two main options: take the standard deduction (a fixed amount based on your filing status) or itemize your deductions if your eligible expenses are greater than the standard amount.

•  Check that your tax withholding is appropriate. If you find that you owe a significant amount in taxes come tax day, or that you’re due a large refund, you may need to adjust your W-4 form. While a refund may seem like good news, it essentially means you’re giving the government an interest-free loan throughout the year. It’s also a good idea to update your W-4 form if you have a major life change, such as the birth of a child, marriage, divorce, or a significant pay raise.

Recommended: 7 Steps to Prepare for Tax Season

Tips for Filing Income Taxes Correctly

Avoiding mistakes when filing your tax return can help prevent you from missing out on a bigger refund than you claimed or triggering a tax audit by the IRS.

Here are some suggestions on how to fill out your tax return when filing whether you’ve done it before or are doing your taxes for the first time:

•  Gather all of your pertinent paperwork and make sure you’re not missing tax forms. You’ll need a W-2 form from each employer, other earning and interest statements, and receipts for any expenses you’re itemizing on your return. Any income and investment interest forms should be mailed or sent electronically to you in January. If you haven’t received them in the mail, you can typically find and download these documents online through your bank, mortgage provider, or payroll company. If you still haven’t received your tax statements or can’t find them online, call the necessary people to get your documents as soon as possible.

•  When filling out your return, make sure your basic information is accurate, such as your name, Social Security number, and filing status. The IRS will also be double-checking your numbers against your tax statement documentation.

•  Take care when disclosing your income. Report your financial information exactly as it’s reported to the IRS on forms such as your W-2 and 1099s.

•  Sign your tax return. According to the IRS, an unsigned tax return is invalid. If you’re married and filing jointly, in most cases both spouses must sign the form. Filing electronically can help taxpayers avoid submitting an unsigned form by using a digital signature.

•  Consider using a tax preparation software program or having a professional tax preparer do your return. Online software is often fairly straightforward if your situation is pretty simple. However, if your tax return is more involved and complicated, it may be worth it to hire a tax professional. An experienced tax preparer can help ensure your tax return will be filed correctly and on time.

•  Try not to put off filing your taxes until the last minute or you run the risk of missing the tax filing deadline.

•  You can file for a tax extension of six months, but know that any taxes owed are still due on time; it’s the return that can be filed later.

The Takeaway

Income taxes are a way for the government to collect revenue from citizens and businesses. Besides paying federal income taxes, you may need to also pay state and local taxes. There are ways you may be able to lower your taxable income, and doing so may result in paying less in taxes or getting a bigger refund. Knowing how to file correctly and on time can help maintain your financial well-being.

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FAQ

Can I lower my income taxes?

Yes, you may be able to lower your income taxes by reducing your taxable income. You can do this by taking advantage of pre-tax savings opportunities, such as contributing to an employer-sponsored retirement plan (like a 401(k)), or enrolling in a Health Savings Account (HSA) or Flexible Spending Account (FSA). You can also lower your taxable income by claiming deductions. This could be the standard deduction or, if your eligible expenses are high enough, by itemizing deductions like mortgage interest or charitable donations.

How can I determine how much income tax I’m required to pay?

To determine how much income tax you owe, you first need to establish your filing status (e.g., single, married filing jointly) and gather all income documents like W-2s and 1099s to calculate your gross income. Next, you calculate your adjusted gross income (AGI) by subtracting eligible “above the line” adjustments. Finally, subtract either the standard deduction or your itemized deductions from your AGI to find your taxable income. This taxable income amount determines your tax bracket and your resulting tax liability.

Does income tax improve your money management?

Yes, understanding income tax can significantly improve your money management. By learning how tax brackets and deductions work, you can make informed decisions about your withholding (using Form W-4) to ensure you are not giving the government an interest-free loan through a large refund. In addition, taking advantage of pre-tax savings, like 401(k) and HSA contributions, is a key money management strategy that directly lowers your taxable income, helping you save money and invest for the future.

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SOBNK-Q425-058

The Consumer Price Index (CPI) is a monthly measure of how the aggregate costs of consumer goods and services in the United States are changing. Economists use CPI to help them understand whether the economy is in a period of inflation or deflation, and individuals can use it to get a sense of where prices might be headed.

What Is the Consumer Price Index (CPI)?

The CPI measures the change of the weighted-average prices paid by urban consumers for select goods and services, according to the Bureau of Labor Statistics (BLS). In other words, the metric tracks the rise and fall of prices over a given period of time.

Definition and Significance

As mentioned, “CPI” is short for Consumer Price Index, and it’s an often-cited economic indicator.

The BLS produces indexes that cover two populations: CPI-U covers all urban consumers, representing more than 90% of the population. And CPI-W represents urban wage earners and clerical workers, representing approximately 30% of the population. The CPI excludes people who live in rural areas, the military, and imprisoned people.

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How the CPI Works

The CPI tracks prices for a basket of goods and services people commonly buy in eight major categories, including:

•   Food and beverage

•   Recreation

•   Apparel

•   Transportation

•   Housing

•   Medical care

•   Education and communication

•   Various services

CPI Formulas

Each month, the BLS contacts retailers, service providers, and rental spaces across the country gathering prices for about 80,000 items. It uses this data to calculate CPI using the following formula:

CPI = Cost of the Market Basket in a Given Year/Cost of the Market Basket in the Base Year.

The result is multiplied by 100 to express CPI as a percentage. The BLS uses the years 1982-1984 as its base year. It set the index level during this period at 100.

Annual CPI Calculation

Here’s an example of the annual CPI calculation, and comparing two different years to get a gist of the differences.

Imagine the cost of a hypothetical basket of goods in 1984.

When you total the price of these goods you get $79. Using the CPI formula above you take $79/$79 x 100 = 100%. This is where the 1984 base rate of 100 comes from.

Now let’s consider the same basket of goods in 2025.

When you total the prices of these goods you get $216. Now, when you plug this into the CPI formula you get $216/$79 x 100 = 273%. You can now tell that from 1984 to 2025 prices for this particular basket of goods have risen by 173%.

Diverse Categories Within CPI

The CPI tracks more than 200 categories of items, and within each category it samples hundreds of specific items at various businesses which serve to represent the thousands of items available to consumers. In addition to these categories, CPI includes government-charged user fees like water, sewage, tolls, and auto registration fees.

It also factors in taxes associated with the price of goods such as sales tax and excise tax. However, it does not include Social Security taxes or income taxes that aren’t directly related to the purchasing of goods and services.

The CPI also does not include the purchase of investments, like stocks and bonds.

The Consumer Price Index (CPI) in Practice

The CPI can be used in a variety of ways, but perhaps most prominently, in economic policy.

Usage in Economic Policy

The CPI is the most common way to measure inflation, the economic trend of rising prices over time, or deflation, the trend of falling prices. The federal government, or the Federal Reserve, more specifically, sets a target inflation rate of 2% annually, and the CPI can help the government understand whether or not its monetary policy is effective in meeting this target.

The Federal Reserve’s Utilization

The Federal Reserve may look at the CPI to gauge whether or not to raise interest rates, which may cool or heat up the economy, accordingly, by increasing the cost of borrowing. As borrowing costs go up, demand for goods or services tends to fall, lowering prices, and putting downward pressure on the CPI.

Implications for Other Government Agencies

Economists also use CPI as a measure of cost of living, the amount of money you need to cover basic expenses, such as housing, food, and health care. This is important because the government may make cost-of-living adjustments to programs such as Social Security benefits. As the cost of living rises, benefit amounts may be adjusted higher to keep up with the rising costs of goods.

Employers may also look at the cost of living to help them set competitive salaries and determine when to raise wages for employees.

CPI’s Influence on Market Sectors

The CPI can also have an influence on market sectors, like the housing markets, financial markets, and even labor markets. As noted, a lot of it is top-down — depending on how the Federal Reserve reads the CPI and decides to change interest rates, if at all.

Raising rates can temper demand in the housing market, as a mortgage can become more expensive. It can also slow down sales for all sorts of businesses, which is reflected in earnings reports and finally, in the stock market. That can then spill into the labor market, and potentially raise unemployment as companies look to cut costs.

All told, the CPI’s influence can run deep in an economy.

CPI Versus Other Economic Indicators

The CPI is only one of many economic indicators, as mentioned. Others include unemployment, and the Producer Price Index (PPI).

CPI vs Unemployment: Understanding the Relationship

As noted, there tends to be a relationship between the CPI and unemployment rate, as the Fed targets 2% inflation, and full employment. As such, it can decide to make changes to monetary policy to try and restore balance or at least get closer to its goals.

CPI vs PPI (Producer Price Index)

The Producer Price Index or PPI measures the average change over time in the selling prices received by domestic producers of goods and services. In simpler terms, this metric measures wholesale prices for the sectors of the economy that produce goods. Like the CPI, the PPI can help analysts estimate inflation, as higher prices will show up on the wholesale level first before they get passed on to consumers at the retail level.

Analyzing and Critiquing the CPI Methodology

The CPI is a useful measure in many ways, but it does have some limitations.

First, it doesn’t apply to all populations in the United States. CPI considers urban populations alone, so it is not necessarily representative of the costs for those who live outside of those areas.

Also, the CPI calculation does not take into account all of the goods and services available to consumers or new technologies not yet considered consumer staples. What’s more, the metric does not provide any contact into what’s causing prices to move up and down, such as social or environmental trends.

CPI’s Broader Impact and Usage

CPI reports are typically issued monthly by the BLS, and are available to anyone who wants to access them online. They give a broad breakdown of the previous month, and compare price changes year-over-year, and month-over-month.

Breaking Down the Monthly CPI Report

The standard CPI report has an introduction that discusses the changes over the previous month, followed by a table that outlines changes in specific price categories over the past year and several months. It further breaks down food, energy, and “all items less food and energy,” providing additional insight for each category.

Anticipating the Next CPI Report

The BLS publishes the date and time of the upcoming CPI report on its website, typically the second week of the month, at 8:30am ET.

Contemporary Relevance of CPI

In recent years, many people have kept a closely-trained eye on the CPI and CPI reports, after prices rose dramatically due to the pandemic in 2020. While there were a variety of reasons as to why prices increased, that bout of inflation — the first serious case of inflation since the 1980s — caught many people off guard, and strained consumers’ budgets. Though it has moderated in the years since, the cost of living has remained a contentious issue in the U.S.

It also led to the Fed increasing interest rates. Inflation, or the increase in the CPI over the past couple of years, peaked at more than 9% during the summer of 2022, and as of late 2025, was back down to around 3%.

Educational Resources and Further Reading on CPI

There are numerous resources and places to learn more about the CPI, especially after all the attention it has garnered in recent years.

Learning More About CPI

A simple internet search will net a cornucopia of results, loaded with information and insight into the CPI. You’re also likely to find opinion pieces and other media discussing the CPI’s shortcomings or strengths — it can be a good idea to consider everything, and formulate your own opinion.

But in terms of learning more about the CPI itself, the BLS publishes a handbook discussing the concepts and methods it uses, which can also be helpful if you’re hoping to bolster your CPI IQ.

CPI-Related Statistics and Where to Find Them

The BLS publishes the CPI, and a whole host of data and statistics related to it. With that in mind, it can be a great place to start when hunting down CPI-related data. There are multiple other sources that utilize the BLS’ data to compile charts, graphs, and more, but typically, it’s all sourced back to the BLS.

The Takeaway

Rising inflation decreases the value of individuals’ cash savings over time. Investing in stocks, bonds and other investments that offer inflation-beating returns may help consumers protect the value of their savings. Understanding CPI, and how it’s moving, can help you devise a strategy for your investment portfolio.

The CPI can be a deep topic, especially when you consider how it intersects and relates to other elements of the economy, such as unemployment and interest rates. And again, the more an investor understands about the underlying machinations of the economy, the more knowledge they’ll have to power their decisions in the market.

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FAQ

What does CPI stand for?

CPI is an acronym that stands for “consumer price index,” and is a monthly measure of how the aggregate cost of goods and services changes over time.

What produces or calculates the CPI?

The CPI is calculated by the Bureau of Labor Statistics (BLS), a government agency. The BLS actually produces several CPI indexes, such as the CPI-U (Consumer Price Index for All Urban Consumers) and CPI-W (Consumer Price Index for Urban Wage Earners and Clerical W, among others.

What categories of goods or services are included in the CPI calculation?

The BLS tracks food and beverage, recreation, apparel, transportation, housing, medical care, education and communication, and other various service costs when compiling the CPI.

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