Income tax in the United States
The United States federal government and most state governments impose an income tax. They are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. Most business expenses are deductible. Individuals may deduct certain personal expenses, including home mortgage interest, state taxes, contributions to charity, and some other items. Some deductions are subject to limits, and an Alternative Minimum Tax applies at the federal and some state levels.
The federal government has imposed an income tax since the Sixteenth Amendment to the U.S. Constitution was ratified in 1913, and 42 U.S. states impose state income taxes. Income taxes are levied on wages as well as on capital gains, and fund federal and state governments. Payroll taxes are levied only on wages, not gross incomes, but contribute to reducing the after-tax income of most Americans. The most common payroll taxes are FICA taxes that fund Social Security and Medicare. Capital gains are currently taxable at a lower rate than wages, and capital losses reduce taxable income to the extent of gains.
Taxpayers generally must determine for themselves the income tax that they owe by filing tax returns. Advance payments of tax are required in the form of tax withholding or estimated tax payments. Due dates and other procedural details vary by jurisdiction, but April 15, Tax Day is the deadline for individuals to file tax returns for federal and many state and local returns. Tax as determined by the taxpayer may be adjusted by the taxing jurisdiction.
For federal individual income tax, the average rate paid in 2020 on adjusted gross income was 13.6%. However, the tax is progressive, meaning that the tax rate increases with increased income. Over the last 20 years, this has meant that the bottom 50% of taxpayers have always paid less than 5% of the total individual federal income taxes paid, with the top 50% of taxpayers consistently paying 95% or more of the tax collected, and the top 1% paying 33% in 2001, increasing to 42% by 2020.
Basics
Basic concepts
A tax is imposed on net taxable income in the United States by the federal, most state, and some local governments. Income tax is imposed on individuals, corporations, estates, and trusts. The definition of net taxable income for most sub-federal jurisdictions mostly follows the federal definition.The rate of tax at the federal level is graduated; that is, the tax rates on higher amounts of income are higher than on lower amounts. Federal individual tax rates vary from 10% to 37%. Some states and localities impose an income tax at a graduated rate, and some at a flat rate on all taxable income.
Individuals are eligible for a reduced rate of federal income tax on capital gains and qualifying dividends. The tax rate and some deductions are different for individuals depending on . Married individuals may compute tax as a couple or separately. Single individuals may be eligible for reduced tax rates if they are head of a household in which they live with a dependent.
Taxable income is defined in a comprehensive manner in the Internal Revenue Code and tax regulations issued by the Department of Treasury and the Internal Revenue Service. Taxable income is gross income as adjusted minus deductions. Most states and localities follow these definitions at least in part, though some make adjustments to determine income taxed in that jurisdiction. Taxable income for a company or business may not be the same as its book income.
Gross income includes . This includes salaries and wages, tips, pensions, fees earned for services, price of goods sold, other business income, gains on sale of other property, rents received, interest and dividends received, proceeds from selling crops, and many other types of income. Some income, such as municipal bond interest, is exempt from income tax.
of individuals are made for contributions to many types of retirement or health savings plans, certain student loan interest, half of self-employment tax, and a few other items. The cost of goods sold in a business is a direct reduction of gross income.
Business deductions: Taxable income of all taxpayers is reduced by deductions for expenses related to their business. These include salaries, rent, and other business expenses paid or accrued, as well as allowances for depreciation. The deduction of expenses . Generally, such loss can reduce other taxable income, subject to some limits.
Personal deductions: The former deduction for personal exemptions was .
Standard deduction: Individuals get a deduction from taxable income for certain personal expenses. An individual may claim a standard deduction. was $12,550 for single individuals or married persons filing separately, $25,100 for a joint return or surviving spouse, and $18,800 for a head of household.
Itemized deductions: Those who choose to claim actual may deduct the following, subject to many conditions and limitations:
- Medical expenses in excess of 7.5% of adjusted gross income,
- Certain taxes ,
- Home mortgage interest,
- Contributions to charities,
- Losses on nonbusiness property due to casualty, and
- Deductions for expenses incurred in the production of income in excess of 2% of adjusted gross income.
Tax credits: All taxpayers are allowed a credit for foreign taxes and for a percentage of . Individuals are also allowed related to education expenses, retirement savings, and child care expenses. Each of the credits is subject to specific rules and limitations. Some credits are treated as refundable payments.
Alternative minimum tax: All taxpayers are also subject to the Alternative Minimum Tax if their income exceeds certain exclusion amounts. This tax applies only if it exceeds regular income tax and is reduced by some credits.
Additional Medicare tax: High-income earners may also have to pay an additional 0.9% tax on wages, compensation, and self-employment income.
Net investment income tax: Net investment income is subject to an for individuals with income in excess of certain thresholds.
Tax returns: U.S. corporations and most resident individuals must file income tax returns to self assess income tax if any tax is due or to claim a tax refund. Some people must file an income tax return because they satisfy one of several other conditions. Tax returns may be filed electronically with Free File or Direct File. Generally, an individual's . Most states and localities follow the federal tax year and require separate returns.
Tax payment: Taxpayers must https://uscode.house.gov/view.xhtml?req=.
Federal income tax rates for individuals
Federal income brackets and tax rates for individuals are adjusted annually for inflation. [The Internal Revenue Service accounts for changes to the CPI and publishes the new rates as "Tax Rate Schedules".Marginal tax rates
Beginning in 2013, an additional tax of 3.8% applies to net investment income in excess of certain thresholds.An individual pays tax at a given bracket only for each dollar within that tax bracket's range. The top marginal rate does not apply in certain years to certain types of income. Significantly lower rates apply after 2003 to capital gains and qualified dividends.
Example of a tax computation
Income tax for year 2017:Single taxpayer making $40,000 gross income, no children, under 65 and not blind, taking standard deduction;
- $40,000 gross income – $6,350 standard deduction – $4,050 personal exemption = $29,600 taxable income
- * amount in the first income bracket = $9,325; taxation of the amount in the first income bracket = $9,325 × 10% = $932.50
- * amount in the second income bracket = $29,600 – $9,325 = $20,275.00; taxation of the amount in the second income bracket = $20,275.00 × 15% = $3,041.25
- Total income tax is $932.50 + $3,041.25 = $3,973.75
In addition to income tax, a wage earner would also have to pay Federal Insurance Contributions Act tax :
- $40,000
- * $40,000 × 6.2% = $2,480
- * $40,000 × 1.45% = $580
- Total FICA tax paid by employee = $3,060
- Total federal tax of individual = $3,973.75 + $3,060.00 = $7,033.75
- Total FICA tax contributed by employer = $3,060
- Total federal tax of individual including employer's contribution = $3,973.75 + $3,060.00 + $3,060.00 = $10,093.75
Effective income tax rates