How Federal Income Tax Works
The United States federal income tax is a pay-as-you-go system. Tax is paid during the year as income is earned, not in one lump sum in April. For most employees that happens automatically: the employer withholds tax from each paycheck. For freelancers and independent contractors, nobody withholds anything, so they must pay for themselves during the year. Either way, the tax return filed on Form 1040 is the final settlement, working out whether the amounts already paid were too much or too little.
The system in one paragraph
Your employer withholds federal income tax from a W-2 paycheck using the Form W-4 you filled in. If you are paid on a 1099 as an independent contractor, nothing is withheld and you normally pay in quarterly instalments with Form 1040-ES. At the end of the year, gross income is reduced to adjusted gross income (AGI), then to taxable income after the standard or itemized deduction, the marginal tax brackets are applied, and the result is compared with what you already paid. The difference is your refund or the amount you owe.
Pay as you go
Federal income tax is collected as income is earned. Employees pay through withholding on every paycheck, and people with income that has no withholding, such as self-employment income, pay through estimated tax payments during the year. The return is not the moment tax is first paid. It is the moment the year's tax is finally calculated and compared with what was already paid.
This is why a new job, a pay rise, a second job, or a move from employment to freelancing can all change the result. The amount withheld during the year follows the information the payer has, and when that information is out of date, the settlement at filing time is where the difference shows up.
W-2 employees: withholding and Form W-4
If you are an employee, your employer gives you a Form W-2 each year and must furnish it by 31 January. The employer withholds federal income tax from each paycheck based on the Form W-4 you completed. The W-4 was redesigned in 2020 and no longer uses withholding allowances, so it now works from your filing status, dependents, and any extra amounts you ask to be withheld.
The employer also withholds your 7.65% share of FICA tax, made up of 6.2% for Social Security and 1.45% for Medicare, and pays a matching 7.65% itself. In rare cases, a flat 24% backup withholding applies to certain investment income. If your W-4 is wrong for your situation, for example after marriage or a second job, the withholding can be too low or too high all year, which is why the IRS provides a Tax Withholding Estimator to check it.
1099 workers: nothing is withheld
Independent contractors and freelancers are usually paid on a 1099, and the payer does not withhold income tax or FICA. The worker owes the full 15.3% self-employment tax, 12.4% for Social Security and 2.9% for Medicare, on 92.35% of net self-employment earnings, plus income tax on the same earnings. One-half of the self-employment tax is deductible from income on Schedule 1 of Form 1040.
Self-employment tax is owed when net self-employment earnings are $400 or more for the year. Because nothing is withheld, these workers normally make quarterly estimated tax payments using Form 1040-ES. For 2026 the Social Security wage base is $184,500, up from $176,100 in 2025, so the 12.4% Social Security portion stops above that amount, while the 2.9% Medicare portion has no cap.
From gross income to taxable income
The return follows a chain. Gross income is all the income received. Adjusted gross income (AGI) is gross income minus certain adjustments, such as one-half of self-employment tax. Taxable income is AGI minus the standard deduction or the itemized deductions on Schedule A, whichever is larger. The tax brackets then apply to taxable income, not to gross pay, so the standard deduction alone removes a large part of most people's income from tax entirely.
For tax year 2026 the standard deduction is $16,100 for single filers, $32,200 for married couples filing jointly, and $24,150 for heads of household. Those figures, and the bracket thresholds, come from IRS Revenue Procedure 2025-32, announced in IRS news release IR-2025-103 on 9 October 2025. The full brackets are explained in the 2026 tax brackets guide, and the choice between the standard deduction and itemizing is covered in the standard deduction vs itemizing guide.
The return settles the year
Form 1040 adds up the tax on taxable income, subtracts any credits, and compares the result with everything already paid: withholding from W-2 jobs, estimated payments, and refundable credits. If more was paid than the tax owed, the difference comes back as a refund. If less was paid, the balance is due with the return. A refund is not a bonus from the government. It is your own money coming back because you paid too much during the year, as the refund guide explains.
The practical lesson is simple. Employees should check that their W-4 still matches their life, and 1099 workers should set aside tax from every payment and pay it quarterly. The system works smoothly when the money paid during the year is close to the tax finally owed, and it produces surprises when it is not.
Sources: Internal Revenue Service, IR-2025-103 and Revenue Procedure 2025-32 (tax year 2026 inflation adjustments), https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2026-including-amendments-from-the-one-big-beautiful-bill; IRS withholding guidance; Social Security Administration wage base announcement, 24 October 2025.