Last month, the IRS announced its Increases in federal income tax brackets in 2025 as well as increases in standard deductions. Federal income tax brackets refer to the tax you pay to the federal government. This tax is a percentage of your income in which you fall into particular strata called tax brackets based on your annual income. As your income increases, you may fall into a high tax bracket, meaning the percentage of your income you owe to the federal government increases.

The difference between federal income tax and state income tax

All Americans, regardless of where you live, must pay federal income tax if you earn an annual income large enough to fall into the top federal tax bracket and above. This also includes all Americans domiciled in a foreign country or Americans who live in the United States but are employed by an international employer. Ultimately, if you’re American and working, you owe federal income tax. The federal income tax rate is progressive, meaning the more money you earn, the higher the percentage of your income you owe.

State income tax however varies depending on where you live. State income tax contributes to the operation and financing of each relative state. Some states are similar to the federal income tax system in which a progressive system is used while others employ a flat rate. A flat tax rate means that no matter how much you earn, you will be taxed at the same rate. This is good news for people who are starting to earn more money and don’t want to pay more of their income in taxes.

Some states do not have a state tax. These states include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. This is why some of these states are home to large numbers of retirees. New Hampshire does not have an income tax, but will tax individuals on income from interest and dividends and not on income from wages and salaries. However, this measure will be gradually phased out by 2025.

Important changes to federal income tax brackets in 2018

In 2018, the Tax Cuts and Jobs Act (TCJA) was adopted. This legislation significantly changed the structure of federal income tax brackets. It was the biggest overhaul of the tax code in three decades and created a single corporate tax rate of 21%. However, most of the benefits provided in the legislation will expire in 2025.

The law retained the seven income tax brackets, but changed the interest rates. The maximum rate went from 39.6% to 37%, while the 33% bracket fell to 32%, the 28% bracket to 24%, the 25% bracket to 22% and the 15% bracket at 12%. The lowest bracket remained at 10% and that of 35% remained unchanged. This structure remained the same for the 2025 federal income tax brackets.

Changes to tax brackets for 2025 to keep up with inflation

Every year the IRS announces changes to the seven tranche thresholds in order to keep pace with inflation. This is done to ensure that “media shifting” does not occur.

“Bracket overshooting occurs when inflation, rather than real increases in income, pushes people into higher income tax brackets or reduces the value they receive from credits and deductions,” explains Alex Durante, economist at the Tax Foundation.