Income Tax Basics

How progressive brackets work

Your income is divided into slices. Each slice is taxed at a specific rate. Moving up a bracket only affects the income above the threshold, not everything you earn.

For a single filer in 2026, the brackets look like this (approximate based on IRS updates):

Married filing jointly has roughly double-wide brackets. Other filing statuses have their own tables.

Worked example

A single filer with $100,000 of taxable income (after deductions):

• First $12,400 → 10% → $1,240
• Next $38,000 → 12% → $4,560
• Next $49,600 → 22% → $10,912
• Total federal tax: $16,712

That's an effective rate of 16.7%, even though this taxpayer is "in the 22% bracket." Their marginal rate — what the next dollar earned would pay — is 22%.

The tax formula

Your federal tax is calculated roughly as:

1. Gross income — wages, self-employment, investment income, distributions, etc.
2. Subtract above-the-line deductions (certain IRA contributions, HSA, student loan interest up to limit, half of self-employment tax, etc.).
3. This gives Adjusted Gross Income (AGI).
4. Subtract either the standard deduction ($16,100 single, $32,200 MFJ in 2026) or itemized deductions, whichever is larger.
5. Apply any qualified business income (QBI) deduction.
6. This gives taxable income.
7. Calculate tax using the brackets.
8. Subtract tax credits (child tax credit, dependent care, education credits, etc.) to get tax owed.

AGI matters separately from taxable income — many tax benefits (Roth IRA eligibility, Medicare premium surcharges, ACA subsidies) are based on AGI or MAGI (modified AGI).

Deductions vs credits

Deductions reduce the income that gets taxed. A $1,000 deduction saves you $1,000 × your marginal rate. For someone in the 24% bracket, a $1,000 deduction saves $240 in tax.

Credits directly reduce the tax you owe. A $1,000 credit saves you $1,000 flat, regardless of bracket.

Credits are worth more per dollar than deductions. A few are "refundable" — they can reduce your tax below zero and generate a refund, like the earned income tax credit.

Common deductions

Above-the-line (reduce AGI, available whether or not you itemize):

• Traditional IRA contributions (with phase-outs)
• HSA contributions
• Student loan interest (up to $2,500; phase-outs apply)
• Self-employment tax (half)
• Self-employed retirement plan contributions

Standard vs itemized — you pick one:

• Standard deduction: $16,100 single, $32,200 MFJ in 2026. Most filers use this — it's simpler and often larger than itemized.
• Itemized deductions: state and local taxes (capped at $10,000), mortgage interest (on up to $750k of debt), charitable contributions, large medical expenses, others. Use if your total itemized deductions exceed the standard deduction.

Common credits

• Child tax credit ($2,000/child under 17; partly refundable)
• Earned income tax credit (refundable; phases out with income)
• Dependent care credit (for childcare)
• Education credits (American Opportunity, Lifetime Learning)
• Retirement savings contributions credit (Saver's Credit; for lower incomes)

Beyond federal

Your total tax burden includes:

• FICA — 7.65% up to the Social Security wage base ($184,500 in 2026), plus 1.45% Medicare on all income, plus 0.9% additional Medicare on income above $200k single / $250k MFJ. Self-employed pay double (both halves).
• State income tax — varies from 0% (Texas, Florida, Washington, etc.) to over 13% (California top bracket).
• Local income tax — some cities and counties.

A high-income Californian might pay 37% federal + 13% state + 3% FICA Medicare = 53% marginal rate on earned income, before considering phase-outs and surcharges.

How Horizons uses this

Income-linked expenses in Horizons represent tax liabilities tied to your income level. As income rises or falls, the tax expense adjusts proportionally. The engine handles marginal-bracket math when you enter a combined effective rate, and uses the same logic to compute gross-ups for retirement withdrawals.

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