Introduction
Income tax refers to tax that is levied on income earned by individuals and businesses. It is typically calculated as a percentage of the taxpayer’s income, and it is used to fund government expenses. In this article, we will explore different aspects of income tax, including its history, how it is calculated, types of income, exemptions and deductions, and the current tax laws. We will also provide updated information using government resources to help you understand everything you need to know about income tax.
History of Income Tax
The history of income tax dates back to the early days of civilization. The first known instance of a tax on income was recorded in ancient Egypt. However, modern income tax systems have their roots in the 19th century. Britain introduced an income tax system during the Napoleonic Wars to help fund the war effort. The United States also introduced an income tax system during the Civil War.
In 1913, the 16th Amendment to the United States Constitution was passed, allowing Congress to impose a federal income tax. The first income tax rate was set at only 1%, but this has increased over time to support government programs and expenses.
How Income Tax is Calculated
The amount of income tax that an individual or business must pay is determined by their taxable income, which is calculated by subtracting allowable deductions and exemptions from gross income. Taxable income is then subject to a graduated tax rate, meaning that the more income someone earns, the higher the tax rate they will pay.
The Internal Revenue Service (IRS) is responsible for administering and collecting federal income taxes. Each year, taxpayers must file a tax return by a certain deadline (usually April 15th). This return reports the individual or business’s income for the prior year, along with any deductions and exemptions they are entitled to claim.
Types of Income
There are different types of income that are subject to income tax. The two main categories are earned income and unearned income.
Earned income refers to income that is earned from working, such as wages, salaries, and tips. This type of income is subject to both federal and state income taxes, as well as Social Security and Medicare taxes.
Unearned income refers to income that is not earned from working, such as investment income, rental income, and capital gains. This type of income is also subject to federal and state income taxes, but not Social Security or Medicare taxes.
Exemptions and Deductions
Individuals and businesses can reduce their taxable income through exemptions and deductions.
Exemptions are amounts of income that are not subject to income tax. For example, in 2020, the federal government allowed a $4,050 personal exemption for each taxpayer and dependent. However, personal exemptions were eliminated from the tax code starting in 2018 with the Tax Cuts and Jobs Act.
Deductions are expenses that can be subtracted from taxable income. Some common deductions include:
– Mortgage interest
– Charitable contributions
– State and local taxes
– Medical expenses
– Business expenses
The amount of the deduction varies by the expense, and some expenses have limits. Deductions are either itemized or taken as a standard deduction. Itemized deductions can be claimed more thoroughly with the help of a tax preparation professional like H&R Block.
Current Tax Laws
Tax laws are constantly changing, and it is important to stay up to date on the most recent changes. The Tax Cuts and Jobs Act was signed into law on December 22, 2017, making significant changes to the tax code.
One of the key changes was the increase in the standard deduction to $12,400 for single taxpayers and $24,800 for married taxpayers filing jointly. This change means that fewer people will need to itemize deductions. Additionally, the child tax credit doubled to $2,000 per child.
The Tax Cuts and Jobs Act also lowered the corporate tax rate from 35% to 21% and eliminated the corporate alternative minimum tax. Pass-through businesses, such as partnerships, sole proprietorships, and S corporations, are now able to deduct 20% of their business income from their taxable income.
Conclusion
Income tax is an important source of revenue for the government, and understanding how it works is essential to avoid costly mistakes. Knowing about the history of income tax, how it is calculated, the types of income subject to tax, and exemptions and deductions can help individuals and businesses plan ahead and optimize their tax situation. Keeping up to date with current tax laws and regulations can help you avoid errors on your taxes and ensure that you are paying the right amount of tax. By doing so, taxpayers can stay on track financially and avoid penalties.
What is Income Tax?
Income tax is a government imposed obligation for reporting and paying the required taxes for earnings during a tax year. Many different tax structures for income tax may be calculated, such as progressive, proportional, or regressive. Income tax is also levied upon business and companies, which is usually referred to as the corporate tax.
Income Tax requirements in the United States
In the United States, income tax is collected by the federal government, most state and local governments. United State citizens are responsible for paying federal income taxes no matter where they reside in the world and as such, may be subject to double taxation if they earn income in another foreign nation.
1. Basis for determining Income Tax
Every income earner is placed within an income bracket, which determines the rate for which they will be taxed. The lowest income earners, who earn between $0 and $8,500 in a taxable year, are subject to a 10% rate for income tax. The highest tax bracket is for income over $379,151, which is taxed at a rate of 35%.
The income is taxed on a graduated scale, which means earnings in between certain amounts are taxed at different rated. For example, an individual who earns $34,000 in one year will be taxed at 10% for the first $8,500 earned and 15% for the income between $8,500 and $34,000.
2. Tax filing classifications
A taxpayer may file their taxes and must define themselves as one of 4 different types: Single, married filing jointly, married filing separately, or head of household. The primary effect of the classification system is to determine the amount of the standard deduction the taxpayers may claim against their income. Deductions are credits against their income that act to lower the overall tax liability. For example, in 2009, a single tax filer could claim a $5,700 standard deduction, while a married couple could claim an $11,400 deduction with a $3,600 personal exemption.
3. Self-reporting requirement of Income Tax
All taxpayers are required to self report their income to the IRS. This is what is typically considered “doing ones taxes” or the services that are provided by tax preparation services. Following the required forms, a taxpayer is required to report all income derived from work, realized gains of the sale of assets (capital gains), and any other factors that determine ones income.
4. Exemptions and deductions
When determining the income tax required, a taxpayer is allowed to count certain funds received as non-income or certain costs as deductions. The following are some of the most common exemptions and deductions taken by individual taxpayers:
– Dependents Tax Credit and Child Tax Credit – Interest for property taxes paid by a homeowner – Local and state income taxes – Charitable gifts
Other sources of Income Tax
The usual source of income for most taxpayers is their yearly paycheck from their job. However, many other sources of income may count towards your tax filing. Capital gains from the sale of property must be counted as income. Also included are many government benefits, including unemployment income, inheritances, and certain gifts. Check with a tax professional to ensure you are not underreporting your taxes to protect yourself from an audit by the IRS.
