Home Income Tax An Overview to Income Taxes

An Overview to Income Taxes

Introduction

Income taxes are a vital source of government revenue that enable the govt to finance various public goods such as infrastructure, defense, public health, education, and social security among others. It is obligatory for individuals and corporations to pay taxes on their incomes annually, based on their earning capacity and tax laws. The amount of tax levied on an individual or corporation depends on various factors such as the net income, tax credits, tax deductions, tax exemptions, and filing status.

According to statistics from the Tax Foundation, an average American worker works 102 days each year to pay their income taxes. This highlights the significance of income taxes and their contribution to financing government operations.

This article examines the basics of income taxes—defining it’s meaning, the history of income taxes, the current taxation system in the US, income tax brackets, tax deductions and credits, and the role of taxation in the economy.

A Brief History of Income Taxes

Income tax can be traced as far back as the Ancient Egyptians, who levied a form of income tax on their citizens to finance their government’s operations. In the Western civilization, the concept of income taxes dates back to ancient Greece and Rome, where the government would impose taxes on the wealth of their citizens.

In the United States, the first federal income tax was introduced during the Civil War in 1861 and was included in the Revenue Act of 1861. This initial income tax was levied on individuals based on their incomes. The taxation was progressive—the higher the income, the higher the tax rate. The revenue generated was used to finance the Civil War. In 1872, the income tax was abolished, but it was later reintroduced in 1894 following political pressure from the populist movement.

However, the Supreme Court declared the income tax unconstitutional in 1895, citing that income tax was a direct tax that had to be levied among states depending on population, which obligated Congress to apportion it. A resolution to the impediment emerged with the passing of the 16th amendment to the U.S. Constitution in 1913, which declared that Congress had the power to impose taxes on incomes, thereby ending the long-held position by the courts.

The Current Federal Income Tax System

The US tax system is a complex and progressive system that is administered by the Internal Revenue Service (IRS), a tax-collecting agency of the federal government. According to the Tax Policy Center, the top 1 percent of taxpayers paid 25.4 percent of the federal income tax in 2018, while the bottom half of taxpayers accounted for only 2.9 percent of the federal income tax paid.

Who Pays Income Taxes?

Not everyone is obligated to pay income taxes. In the US, income taxes are paid based on earning capacity and the IRS filing rules. If you earn below the minimum threshold, you may not be required to pay income taxes. Thresholds differ based on your age, filing status, and whether you are claimed as a dependent on someone else’s tax return.

Income tax brackets are divided into seven different income levels, ranging from 10 percent for those earning less than $9,700 annually to 37 percent for those earning more than $518,400 annually. Current tax rates are derived from the Tax Cuts and Jobs Act, passed in 2017, which lowered tax rates for most Americans, and doubled the standard deduction, among other provisions.

Deductions, Credits, and Other Ways to Reduce Taxes

Many taxpayers opt to use tax deductions, credits, exemptions, and other ways to reduce their tax bills. A deduction is a reduction in taxable income, whereas a credit reduces the overall tax liability dollar-for-dollar. The IRS allows taxpayers to choose between the standard deduction or itemized deductions. The standard deduction is a fixed amount that reduces the taxable income, while itemized deductions allow taxpayers to deduct eligible expenses such as mortgage interest, charitable donations, and property taxes.

Tax credits, on the other hand, directly reduce the overall tax liability, and they come in two forms: refundable and non-refundable. Refundable tax credits are used to the extent that they exceed the total tax liability, enabling taxpayers to receive a refund of the excess. Non-refundable tax credits, however, have a maximum limit on the amount that can be claimed as a credit.

Taxpayers can also reduce their tax liability by making contributions to a qualifying retirement savings account, such as a 401(k) or IRA, or by taking advantage of tax deductions for business expenses such as mileage, equipment purchases, or home office expenses.

The Role of Income Taxes in the Economy

The role of income taxes goes beyond raising revenue to finance the government’s operations. Income tax is a tool for government policy in promoting economic growth, social justice, and public welfare. For example, the government may use income taxes to incentivize investment and savings, encourage charitable giving, or discourage activities that contribute to environmental degradation.

A fair and efficient tax system ensures that the government collects sufficient revenue to fund public goods and services while keeping the economy competitive and maximizing social welfare. One of the main challenges of income taxation is striking a balance between promoting economic development and ensuring that wealth is distributed equitably across society. As such, the issue of tax equity remains a contentious debate in public policy, with different interest groups advocating for different changes to the tax code.

Conclusion

Income taxes play a vital role in the United States and globally, providing governments with a crucial source of revenue to fund public goods and services. The US income tax system is progressive, meaning that taxpayers with high incomes pay a higher percentage of their income in taxes than those with low incomes. Deductions, credits, and exemptions are all available tools for reducing the tax bill.

The government uses tax policy for socioeconomic purposes such as encouraging investment and savings, promoting charitable giving, and discouraging activities that contribute to environmental degradation. By striking a balance between public welfare and economic development, the government can achieve a fair and efficient tax system that maximizes social welfare.


The tax revenue stream for local, state and federal government is vital to provide certain services for taxpayers within those tax jurisdictions. The manner in which tax revenue is accumulated can vary. For example, sales taxes are a regressive tax, which means that taxpayers with a lower salary are responsible for a higher tax burden as a percentage of their salary.

There are taxes that can be imposed in a more progressive manner, which means that the tax burden would be equally distributed as a percentage of each taxpayers salary. If Income tax were accessed as a flat rate of each taxpayers salary, the tax would be progressive. On the same token, taxes can be income elastic or income inelastic.

Taxes that could be considered income elastic, are taxes that depend on an individuals salary, or overall income. For example, the capital gains tax and the income tax are both income elastic. There are taxes that do not depend on an individuals salary, such as property taxes. Those taxes are not imposed as a percentage of salary, but as percentage of the value of some piece of property.

It could be argued that property taxes are income elastic because the wealthy can afford more expensive property, which results in a higher tax based on their income. Overall however, the property tax is accessed on the value of the property and an individuals salary has no bearing over that determination.

Taxes can be imposed in a number of ways. First, many taxes are imposed in a cyclical manner. For example, payroll taxes are taken out on a cyclical schedule, or every pay period. Cyclical taxes are simply those that are imposed on a regular basis, or according to some set schedule. There are also taxes that are non-cyclical, such as sales taxes, which are imposed at the point of purchase, as a percentage of the sales price.

Individuals may shop on a fairly typical schedule, but the sales taxes are imposed as a random pattern, controlled by the shopper. Taxes can be imposed in a pattern, without a pattern or in opposition of the state of the economy. Taxes that are countercyclical, work in oppositions of the economy. For example, in a bad economy, a countercyclical tax would be raised. In a good economy, a countercyclical tax would be lowered.

In order for taxes to be constitutional, they must adhere to the substantial nexus,fair appointment, non-discrimination and relationship to service rules. In essence, the taxes must be imposed when there is a direct relationship between the taxable item, the tax jurisdiction and the individual making the purchase. The taxes cannot be imposed unfairly and must apply to all equally, as not to discriminate against certain groups of people, or certain types of businesses.

Income Taxes:

Income taxes are imposed against any salary in the United States. Each employee’s paycheck is subject to the tax on a cyclical basis. Income taxes must be taken out of each paycheck, according to law. Those taxes are an estimate of each employees income tax burden, based on their overall salary. Income taxes are the responsibility of all employed Americans.

At the end of the tax year, the taxpayer may find that they have overpaid their taxes, but only after they have taken all allowable deductions. In that case, the taxpayer will receive a refund from the government which includes any over payments.

If however, the taxpayer owes money for their income taxes, they must make that payment by the tax filing deadline, generally April 15th.  If they are unable to make a payment at that time, the amount owed will be subjected to an interest payment, in addition to possible late fees.

Exemptions for income taxes include deductions for dependents. For example, a parent that has three children under the age of eighteen, may take four deductions, including themselves.Personal income taxes have different allowable deductions and exemptions, than those that are allowed for corporate income taxes.

Personal deductions include those that apply to that individual taxpayer. Whereas corporate deductions are those allowed for a business. Business deductions include losses, especially if the company had no profit that tax year.

Income taxes are estimated according totax brackets as set out by each tax jurisdiction. For example, the Federal government has a tax bracket which allows employers to estimate each employees income tax burden based on their salary.

Although their actual tax burden may differ from that listed on the bracket, it helps to establish a set amount of taxes to be deducted form their paycheck. Each state will also have income tax brackets which work in the same manner. Taxpayers must calculate their actual income tax burden at years end, so that they can file taxes, and pay the government if they owe addition taxes. In addition, taxpayers that are due a refund from the government, should file their taxes promptly so that they can receive their refund.

Income taxes are imposed on a wide variety of income types. Individuals must pay income taxes on any profit made during that tax year, regardless of where the income cam from. For example, individuals that have a garage sale, would be required to pay a capital gains tax on any profit from that sale. There are many that question the legal validity of income taxes.

However, when the Sixteenth Amendment was ratified, it gave Congress the right to impose taxes. In fact, Congress has the ability to impose taxes, or to overturn taxes imposed by state and local jurisdictions. Although income taxes have continuously been challenged as unconstitutional, they have been held legally valid in every case.

Capital Gains Tax:

The capital gains tax is a tax which is imposed on any income other than a taxpayer’s regular salary. For example, investments which have a positive return, are subjected to the capitals gains tax. If the investor holds that investment for more than one year after the date of purchase, that would be a long term capital gain. If however, they were to sell that investment for profit, after less than a year has passed after the date of purchase, they would be subject to a short term capital gain tax. A short term capital gain is taxed at a higher rate than a long term capital gain tax.

There are many strategies a taxpayer can utilize to defer their capital gains tax burden. Taxpayers may pay a lower tax on capital gains if they donate some of their proceeds to charity, which is an excellent deferment strategy.  Taxpayers can also subtract capital losses indefinitely. In other words,  a loss can be deducted up to the amount of actual capital gains in that tax year. Left over losses can be carried over into proceeding tax years and subtracted until the full loss has been deducted, regardless of how many years have passed since the original loss.

Taxpayers may be able to avoid paying a capital gains tax if their losses matched or exceeded their gains in that tax year. In fact, capital losses can be deducted indefinitely, until the total loss is totally deducted from capital gains and other income. Capital gains taxes may also be deferred in real estate sales, if the person making the profit makes a similar purchase with the profit from the sale of the original real estate.

However, this can sometimes be difficult, as it is not always easy to find a property that is similar in price and type. In order to take advantage of this tax deferment, their can be no money left over from the profit, after they have purchased the new property.

There have been many criticisms of the capital gains tax. First, it is assumed that the tax discourages investments. Taxpayers may forgo investments in favor of simple interest bearing accounts, simply to avoid being taxed at the higher rate. Conversely, capital gains are a source of income, which means that the capital gains tax is simply an extension of income taxes.

Payroll Tax:

A payroll tax is applied to any Americana’s salary. The payroll tax is cyclical, which means that each pay period, a certain percentage of a salary is taken out to meet the individuals payroll tax burden. However, employees share the tax burden with their employers. Once the total tax burden has been calculated as a percentage of an employees total salary, the tax burden is equally split between the employee and the employer.

The payroll tax is utilized to cover such things as Social Security and Medicare taxes. Social Security taxes are taxed at a percentage of an employees salary and those payments are capped. In other words, no taxpayer contributes more then the maximum Social Security payment in a given year. If they do, because they switch employers, they can add the overpayment as a deduction from the income tax. Medicare payments however, continue to be taxed as a percentage of salary, with no maximum threshold.

Medicare payments continue as a percentage of a salary, no matter how high the salary is. Medicare taxes are currently imposed at a rate of about one and one half percent of each taxpayers salary. That means that both the employee and the employer each contribute that percentage, for a total of about three percent of an individuals salary being contributed to Medicare with no maximum contribution.

The total Social Security tax rate is about thirteen percent, divided between the employee and the employer. The amount of Social Security payments that a retired American in entitled to collect, is directly correlated with the amount of their lifetime contribution.

Payroll taxes are also imposed in order to fund unemployment benefits and Disability insurance. The percentage of money taken out of each employees paycheck in order to fund unemployment benefits, will vary according the unique and specific laws in each state. In any case, the employer and the employee both contribute to unemployment insurance through a payroll tax. Regular employees payroll tax is divided between their employers and themselves. However, self employed individuals, must pay the payroll taxes on their own.

The payroll taxes originated because of the consequences of the Great Depression. When the economy crashed,  it meant that many Americans were unable to support themselves. American citizens were unable to find jobs, afford health insurance, or financially survive after retirement. Payroll taxes are part of a measure that is meant to prevent that from happening again. When each taxpayer contributes to the payroll tax, they are assured that they will be entitled to the benefits which are funded through those taxes.

Estate Tax:

An estate tax is imposed against the value of an estate, which the benefactor has left behind after passing away. The estate tax is assessed on the total value of the estate. Whereas, an inheritance tax is imposed on the value of property inherited by each benefactor.The Estate tax is imposed on the estate of an individual that passes away, separate form any inheritance tax imposed within that tax jurisdiction. An estate tax can be imposed on both the federal and state level. The tax is imposed on the total vale of the estate on the day that the benefactor passes away.

The value of the gross estate is reduced according to several factors before the estate tax is actually applied. First, the cost of the funeral of the benefactor, is deducted from the value of the estate. In addition, any debt incurred when the benefactor was alive, must be paid off before the estate can be distributed to the beneficiaries. There are some other deductions that may be taken against an estate tax.

For example, close relatives, such as children and spouses of the deceased, may be exempt from the estate tax, on inheritance valued up to a certain threshold. In fact, the Federal government allows the children of benefactors to inherit up to one million dollars tax free.

The manner in which inheritance tax is imposed, will depend on the jurisdiction that imposes the tax. There is a Federal estate tax and some states also impose a state estate tax and an inheritance tax. If the tentative tax is used to determine the amount of estate tax, there is a formula used. First, the amount of inheritance will fall within some range on the inheritance tax bracket.

Within each range, there is a flat rate of tax imposed. However, any amount over the minimum threshold, will also have a tax at a percentage of that amount over the threshold. For example, an inheritance valued at one and a half million dollars, may fall within the range of one million dollars. That amount will receive the flat tax rate in that range. Then, the remainder of one half million dollars, will be taxed at the percentage which applies to that range.

There are credits available for inheritance tax. On the Federal level, their are lifetime credits, with a maximum allowable estate value per benefactor or beneficiary. For example, there is a lifetime credit available for children to inherit up to million dollars tax free, from either parent, in their lifetime. Yet, that credit may not currently apply because the Federal inheritance tax rate for 2010 is zero.

The rates set to go into effect in 2011, will revert back to those found almost a decade ago. In fact, the rates will increase and the exemptions will decrease from what they were in 2009. Yet, the inheritance and estate tax for this tax year are zero, as a result of a loophole to tax laws that currently applies. Yet, many suspect that the government will impose next years tax rate retroactively, which means it could apply to estates and inheritance from 2010.

Estate taxes generally have to be filed within nine months of the death of the benefactor. If however, the beneficiaries are not yet able to pay the taxes, they can get an extension. However, they will likely have to pay penalties and interest on those taxes. There are many that criticize the estate tax as unfair, especially to the wealthy.

In fact, the higher the value of the estate, the more tentative tax which will be applied. In addition, many claim that the estate tax discourages entrepreneurship because families know that when they pass away, a majority of their estate will be pad to the Federal and state government in the form of taxes. Conversely, many argue that no one is entitled to the money which resulted for the hard work of another, even when they are family.

Inheritance Tax:

Like an estate tax, an inheritance tax is imposed when a benefactor passes away. However, the inheritance tax is imposed differently than the estate tax. The estate tax is imposed on the value of the estate, or the gross estate value, on the day that the benefactor passes away. However, there are some allowable deductions, such as the cost of the benefactor’s funeral, before the estate tax is actually applied. The inheritance tax is separately imposed as a percentage of the value of inheritance for each beneficiary. In some states, there is no inheritance tax. In states that do impose an inheritance tax, there are differing rules and tax rates.

Like the estate tax, there are often allowable deductions for the inheritance tax. In some tax jurisdictions, beneficiaries may be exempt form the inheritance tax, if they are a descendant of, or a spouse of the benefactor. Somestate’s tax jurisdictions do not take that factor into consideration at all. Spouses may be able to avoid the inheritance tax if any of the property involved, was jointly owned before the benefactor passed away. On the Federal level, children may inherit up to one million dollars tax free, during their lifetime.

Taxes on Legalized Gambling:

Taxes on legalize gambling apply on the state and Federal level, in most cases. There are only a few states that prohibit all forms of legalized gambling, including the lottery. In contrast, there are states that allow legalized gambling, but do not tax winnings. For example, Florida does not tax winnings on the lottery in that state.

However, other states tax winnings at different percentage rates, even changing that percentage depending on the type of gambling. In New Jersey, there is a twenty five percent tax withheld on casino gambling, when the winners have won above a certain amount. However, New Jersey only taxes lottery at eleven percent, although eleven percent is one of the highest lottery taxes in the nation.

On the Federal level, amounts of winnings that are subjected to the automatic tax withholding, have an automatic withholding of that percent before the winner receives any monies. For slot machines, the threshold at which the twenty five percent is automatically withheld, is one thousand and two hundred dollars. For card games, the amount subject to automatic gambling tax with holdings, is five thousand dollars.

In all gambling winnings that meet the federally set threshold standards, twenty five percent is withheld. That percentage may vary if winners can not verify their identity, or are not United States Citizens. The automatic withholding is not necessarily indicative of that persons total tax burden. The actual tax on that amount may be higher or lower, depending on other factors unique to each taxpayer.

In addition, gambling winnings are subject to a deduction based on losses, including the wager that was necessary for those winnings. In most cases, gamblers will need to have proof of loses, such as losing lottery tickets. However, if they have no proof, or if their losses fall below the standard allowable tax deduction, they should utilize the standard loss deduction.

Gamblers that have winnings that are not subjected to an automatic withholding, are required to report all winnings on their taxes, no matter how small their winnings are. Tax revenue from legalized gambling is vital to many economies that allow gambling. In fact, the tax revenue from legalized gambling in Atlantic city provides millions of dollars in tax revenue to New Jersey and to the Federal government.

Yet, there is still a lot of controversy surrounding legalized gambling. There have been studies that suggest an increase in organized crime in locations that allow legalized gambling. In addition, gambling may promote unhealthy and addicting behavior for individuals that take part in gambling.

Yet, in cities like Atlantic city, the job growth in the area has amounted to thirty five thousand new jobs. Those jobs have included total salaries of billions of dollars each tax year. That means there is also an increase in income tax revenue for the state and Federal government. This debate rages in regards to online gambling.

Currently, online gambling is not technically legal in the United States. However, online gambling does represent an added source of tax revenue, which could total in the billions of dollars, based on estimates from previous online gambling. While online gambling may not present as many job opportunities as casinos, the tax revenue would far exceed tax revenues from casino gambling an lottery gambling.

Consumption Taxes:

Consumption taxes are imposed on a myriad of merchandise and services. There are sales taxes which are imposed as a flat percentage of the price of merchandise. There is currently no Federal sales tax in place, except the one imposed on indoor tanning. However, many in the economic sector have proposed the VAT, or value added tax, which would be the federal equivalent of a state sales tax. That tax would be imposed on purchases across the country, and would be added to the tax already imposed within each tax jurisdiction.