US Tax System Explained: A Practical Guide for New Arrivals

Relocating to the United States for a new career opportunity is exciting, but the US tax system can feel overwhelming when you first encounter it. If you have just moved (or are about to), understanding how US federal income tax works is essential. Your tax obligations will likely begin as soon as you start earning US income, and the system operates differently from Australia.

This guide walks you step by step through how the US federal income tax system works, how your tax is calculated, and what you should understand before filing your first US tax return. It is intended as a general overview. We strongly recommend seeking advice from a licensed professional to ensure you make thoughtful and informed decisions about your income and investments. That said, we also believe you should have a solid foundational understanding of the system you are operating within. Even a working knowledge of how US tax works can help you make better decisions and ask more informed questions of your accountant or financial adviser.

The Foundation: How the US Calculates Federal Income Tax

At its core, the US tax system follows a structured formula:

All Assessable Income from All Sources

– Adjustments to Income

= Adjusted Gross Income (AGI)

– Standard or Itemised Deductions

– Qualified Business Income (QBI) Deduction (if applicable)

= Taxable Income

× Applicable Tax Rates

= Tentative Tax

+ Additional Taxes

– Tax Credits

– Tax Payments

= Refund or Amount Owed

Let’s break this down in plain English.

Step 1: What Counts as Income in the US Tax System?

Your tax return (Form 1040) begins with gross income. Common sources include:

Employment Income (Form W-2)

Your wages, tips and compensation are reported by your employer on Form W-2.

Importantly:

Pre-tax retirement contributions (such as 401(k) contributions) reduce the income shown in Box 1.
You cannot deduct those contributions again, no “double dipping”.

1099 Forms… strap in, because there’s plenty of them!

Interest Income (Form 1099-INT)

Interest from:

Bank accounts
Certificates of deposit (CDs)
Taxable bonds (including US Treasury securities)

The interest earned inside retirement accounts is generally tax deferred.

Dividends (Form 1099-DIV)

Dividends are divided into two types:

Ordinary dividends (taxed as ordinary income)
Qualified dividends, which may receive preferential long-term capital gains tax rates if certain holding period rules are met (generally 61 days during a 121-day window around the ex-dividend date).

Many index funds distribute a mixture of both.

Retirement Distributions (Form 1099-R)

Distributions from:

Traditional IRAs
401(k)s
403(b)s
457(b)s
Federal Thrift Savings Plan (TSP)

These are typically taxable as ordinary income unless they represent after-tax contributions.

Social Security Benefits

Up to 85% of Social Security benefits may be taxable depending on your total income. The calculation is based on “provisional income,” which includes:

Half of your Social Security benefits
Other taxable income
Certain tax-exempt interest

Capital Gains (Form 1099-B)

When you sell investments in a taxable account:

Short-term gains (held one year or less) are taxed at ordinary income rates.
Long-term gains (held more than one year) receive preferential rates.

Capital losses can offset capital gains. If losses exceed gains, up to USD 3,000 can offset other income annually, with excess carried forward indefinitely.

Step 2: Adjustments to Income – Getting to AGI

After adding all income sources, you subtract certain adjustments to reach Adjusted Gross Income (AGI).

Common adjustments include:

Health Savings Account (HSA) contributions (if not made via payroll)
Deductible traditional IRA contributions
Half of self-employment tax
Self-employed retirement contributions
Self-employed health insurance deduction

AGI is extremely important, many tax benefits and phase-outs are based on it.

Step 3: Standard Deduction vs Itemised Deductions

From AGI, you subtract either:

The standard deduction, or
Your total itemised deductions (Schedule A)

Itemised deductions may include:

State and local taxes (subject to caps)
Mortgage interest
Charitable contributions
Medical expenses exceeding 7.5% of AGI

Most taxpayers use the standard deduction.

After this step, and potentially the Qualified Business Income (QBI) deduction for eligible business owners, you arrive at taxable income.

Step 4: How US Tax Rates Actually Work

The US system is progressive.

Ordinary Income Brackets

There are seven federal brackets:

10%, 12%, 22%, 24%, 32%, 35%, and 37%

Each portion of your income is taxed at increasing rates as it moves through the brackets.

Your:

Marginal rate = the highest rate applied to your last dollar
Effective rate = total tax divided by total income

They are not the same.

Long-Term Capital Gains Brackets

Long-term capital gains are taxed separately at:

0%, 15%, or 20%

In 2025, for example, the 0% long-term capital gains bracket applies up to certain taxable income thresholds depending on filing status.

Income Stacking: A Crucial Concept

When you have both ordinary income and long-term capital gains, the IRS uses “income stacking”:

Ordinary income is taxed first.
Long-term capital gains are stacked on top.

This can significantly influence your total tax bill.

Case Study: First-Year US Professional

Daniel, age 39, moves to the US for a senior role.

In 2025, he earns:

USD 145,000 in wages
USD 6,000 in interest
USD 28,000 in long-term capital gains

His total income is USD 179,000.

After claiming the standard deduction of USD 15,750 (single filer), his ordinary taxable income is reduced accordingly.

His ordinary income is taxed progressively:

First portion at 10%
Next at 12%
Then 22%
Then 24%

His long-term capital gains are stacked on top and fall entirely within the 15% capital gains bracket.

Although his marginal ordinary rate is 24%, his effective tax rate on total income is closer to 17%.

Understanding how different types of income are taxed allows Daniel to plan investment sales and retirement contributions more strategically in future years.

Additional Taxes You Should Be Aware Of

Beyond regular income tax, you may encounter:

Self-employment tax (Schedule SE)
Additional Medicare Tax
Net Investment Income Tax (3.8%) for higher-income taxpayers
10% early withdrawal penalties on retirement distributions

These are reported on additional forms and added to total tax before credits.

Tax Credits: What Reduces Your Tax Bill

After calculating tax, you subtract tax credits.

Non-refundable Credits

These reduce tax to zero but do not create a refund:

Foreign Tax Credit
Child Tax Credit
Retirement savings contribution credit

Refundable Credits

These can generate a refund:

Earned Income Tax Credit
Additional Child Tax Credit
Premium Tax Credit

Credits are applied after tax is calculated.

Payments and Refunds

Taxes already paid through:

Employer withholding (W-2)
Estimated tax payments

are subtracted from total tax.

If you paid too much, you receive a refund.
If you paid too little, you owe the difference, possibly with an underpayment penalty.

Why Understanding the US Tax System Matters Early

In your first year in the US, it is tempting to focus only on reducing this year’s tax bill. However, the US system is designed in a way that makes long-term planning essential.

When it comes to tax planning, tactics used during your working years must be evaluated based on their eventual tax impact in drawdown years. We cannot assess them in isolation based solely on what benefits the tax return in this tax year.

For example, choosing between a traditional 401(k) and a Roth 401(k) should not be based purely on whether it lowers your taxable income today. Pre-tax contributions reduce current tax but may increase taxable income in retirement. Likewise, decisions around realising capital gains, structuring investment income, or accelerating deductions should be considered in light of future tax brackets and withdrawal strategies.

Because the US system taxes ordinary income and long-term capital gains differently, and applies progressive brackets, the decisions you make early in your career directly shape your future tax profile.

Understanding how the system works from the outset allows you to ensure that the actions you take today support your broader long-term financial plan, not just this year’s return.

Final Thoughts on US Tax System for Newly Arrived Australian Expats

Moving to the United States is a major professional and financial step. The US federal income tax system is structured, rules-based, and highly sensitive to how income is earned and reported.

Taking time to understand how taxable income is calculated, and how different income types are taxed, can help you avoid costly mistakes and make better financial decisions from day one.

If you are unsure how the rules apply to your situation, it is wise to seek guidance from a licensed US tax accountant or qualified professional.

Contact Us

If managing your financial affairs across borders is starting to feel overwhelming, you’re definitely not alone. It’s a complex space, and having the right support can make all the difference. At Atlas Wealth Group, we specialise in supporting Australian expats with cross-border tax planning, superannuation, mortgages and wealth management. Contact us to arrange a consultation with a qualified adviser who specialises in Australian expat financial planning to get personalised guidance tailored to your circumstances.

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Disclaimer: This article is intended for informational purposes only and does not constitute legal or financial advice. Individuals should consult licensed professionals when seeking guidance regarding their financial circumstances.