A Helpful Guide to Income Tax
Income tax, the amount of money individuals or companies owe to the government, can seem a daunting and confusing topic. However, understanding income tax is essential to ensure compliance with laws and to avoid overpaying or underpaying tax. In this article, we will provide a comprehensive guide to income tax in the United States, outlining what it is, how it’s calculated, and how to file your tax returns.
What is income tax?
Income tax is the tax levied on the earnings of individuals and businesses by the government. In the United States, the Federal income tax is collected by the Internal Revenue Service (IRS) and forms a significant source of revenue for the government.
How is income tax calculated?
The United States income tax system is progressive, which means that individuals with higher income pay a higher percentage of their earnings as tax. However, calculating income tax is not as straightforward as a simple percentage of the income earned. Instead, it requires the consideration of several factors, including filing status, deductions, exemptions, and credits.
Taxable Income
In the United States, taxable income is the amount of income subject to taxation after deductions, exemptions, and credits. It is calculated by subtracting the total of allowable deductions and exemptions from the total gross income.
Deductions
Deductions are expenses that are allowed to reduce taxable income, reducing the amount of income tax paid. The IRS allows two options for deductions:
1) Standard Deduction
This is a fixed amount that depends on one’s filing status. The standard deduction was increased in 2021 for single individuals to $12,550, for married couples filing jointly to $25,100, and for head of household to $18,800.
An individual who qualifies for the standard deduction cannot claim itemized deductions unless the itemized deductions are higher than the standard deduction.
2) Itemized Deductions
Itemized deductions are actual expenses that the taxpayer has incurred over the year. Some examples of itemized deductions include charitable donations, state and local taxes, mortgage interest, and medical expenses. However, itemized deductions may not include all expenses.
Exemptions
Exemptions reduce taxable income by a fixed amount, calculated when filing one’s tax returns. Before the Tax Cuts and Jobs Act of 2017, deductions were allowed for each dependent. However, under the new law, personal exemptions are no longer applicable.
Credits
Tax credits are more beneficial than deductions or exemptions because they directly reduce the amount of tax owed rather than taxable income. There are two types of tax credits: refundable and non-refundable.
1) Refundable Credits
Refundable credits such as the earned income tax credit (EITC) can be refunded to taxpayers even if their tax liability is zero or less than their refund amount.
2) Non-refundable Credits
Non-refundable credits, such as the child tax credit (CTC), can only reduce the amount of your tax liability to zero. If the non-refundable credit amount exceeds the tax liability, the excess amount cannot be refunded but can be carried over to future tax years.
Tax Brackets
The United States federal income tax system uses a progressive tax structure, where the percentage of tax an individual pays increases with a higher level of income. Income tax brackets are typically adjusted for inflation annually and are calculated based on filing status.
Here is the 2021 Federal Income Tax Bracket Table for Single Individuals:
| Taxable Income | Tax Rate |
| —————– | ———– |
| $0 to $9,950 | 10% |
| $9,951 to $40,525 | 12% |
| $40,526 to $86,375 | 22% |
| $86,376 to $164,925 | 24% |
| $164,926 to $209,425 | 32% |
| $209,426 to $523,600 | 35% |
| Over $523,600 | 37% |
Let’s say that you are a single filer with a taxable income of $50,000. According to the table above, you would fall into the 22% tax bracket. This doesn’t mean that you pay a 22% tax on your entire income, though. Instead, you pay 10% on the first $9,950, then 12% on the income between $9,951 and $40,525 ($30,575), and finally 22% on the remaining $9,475, giving you a total tax liability of $8,789.
Withholding and Estimated Tax Payments
Employers are required to withhold taxes from their employees’ paychecks and remit the funds to the IRS throughout the year. Individuals with self-employment income or individuals who didn’t have enough taxes withheld from their paycheck by their employer can estimate their tax liability and make estimated tax payments to the IRS four times a year, typically due on April 15th, June 15th, September 15th, and January 15th of the following year.
Filing Tax Returns
Taxpayers must file an annual tax return with the IRS by April 15th of each year. The tax return summarizes all income, deductions, and credits for the previous year, and based on that information, the IRS calculates the tax liability or refund for the taxpayer.
There are several options for filing a tax return. The IRS has a free online option called Free File, which is a partnership with several tax preparation software companies. Alternatively, taxpayers can use an IRS-approved tax preparer, and some tax preparers offer free filing for low-income filers.
Conclusion
Income tax, though complex, is an essential obligation for citizens and businesses in the United States. Understanding income tax requires knowledge of taxable income, deductions, exemptions, and credits, as well as tax brackets for different filing statuses. By following the guidelines for filing tax returns and making estimated tax payments, taxpayers can minimize their tax liability or maximize their refund while staying compliant with federal income tax laws.
Personal income taxes are taxes paid by individuals that reach the minimum threshold of income. Income taxes that are imposed on certain businesses and other entities, are called corporate income taxes. Income from any source, is often considered as a contributing factor in determining an individuals or corporation’s income tax responsibility.
Their are personal income taxes, which are the singular responsibility of each tax payer. There are alsocorporate income taxes which each business is responsible for. Income taxes are a federal tax but a majority of the states also have a separate income tax. There are however, several states that do not impose income taxes. States that do impose income taxes, and all federal income taxes, have allowable deductions allotted that can lower income taxes.
Income taxes are determined by adding total income, from any source. Sources of income are limitless and can include salary, garage sales, short term capital gains, property sales, and the sale of antiques. The list of possible types of income is exhaustive. In general, any money that a person receives, whether for work, the sale of an item or continued income from royalties, falls under the income tax.
The manner of ways that individuals can make income, is limitless. Once all of the income has been totaled, there are allowable deductions. Individuals can deduct things such as dependents, medical expenses and travel expenses for work. Businesses calculate income differently than individual taxpayers. Before a business takes allowable deductions from their income, they subtract all business related expenses from their income. In fact, a businesses income tax is actually a tax placed on their profit.
Income taxes were legalized when the Sixteenth Amendment was ratified. That Amendment grants the government the right to collect a direct tax on the income of each citizen, or entity, such as a business. However, there are some individuals and organizations that are tax exempt, such as members of the clergy and churches.
The Amendment has been declared constitutional, despite being challenged in court on dozens of occasions. The constitutionality of income taxes has been challenged based on several different factors, but the Amendment has been upheld in every case. In each case, the courts have decided that income taxes are constitutional as long as they follow specific rules, such as those Uniformity and Equal Protection Clause. Taxes cannot be levied by either the federal or state government unless they are fair and free of discrimination and prejudice. Income taxes collected by any jurisdiction, must also be used for a public purpose, such as education.
