Income tax in USA

 

CONTENTS

 

 

 

 

 

 

 

INTRODUCTION

Income taxes in the United States are levied by the federal government and by state and local governments. The federal income tax, upon which this text focuses, is collected by the Internal Revenue Service (IRS), part of the Department of the Treasury. The rules for collecting income taxes are set in the Internal Revenue Code (IRC), Title 26 of the United States Code. The IRC is a statute written and regularly revised by Congress. Treasury Regulations are more detailed rules written by the IRS to effectuate the implementation of the IRC. Code provisions, which are statutory, always trump contrary regulatory provisions. Regulations can be of two types: legislative and interpretive. With legislative regulations, Congress says, for example, that depreciation will be an allowable expense "in accordance with regulations to be established by the IRS." It gives the IRS the power to make the rules. Interpretive regulations are those in which the IRS says how it will interpret and apply a given statute.

Disputes over tax rules are generally heard in the United States Tax Court before the tax is paid, or in a United States District Court or United States Court of Federal Claims after the tax is paid. Appeals from the Tax Court go to the United States Court of Appeals for the circuit in which the taxpayer resides, or was domiciled when the tax return in controversy was originally filed. From the Court of Appeals the taxpayer may file a writ of certiorari with the Supreme Court, which may or may not be granted. The IRS also periodically issues Revenue Rulings when taxpayers have questions about how to declare certain transactions. These rulings are only opinions, and are trumped by court rulings or contrary legislation. Revenue Rulings should not be confused with Private Letter Rulings. A Private Letter Ruling is a request by a specific taxpayer to the IRS to rule on the tax consequences of a specific transaction before the action is taken. A Private Letter Ruling is directed only towards the requesting taxpayer, and therefore can`t be relied upon by other taxpayers considering the exact action. Private Letter Rulings are released every Friday by the IRS.

 

 

1. Principal

The "tax net" refers to the types of payment that are taxed, which included personal earnings (wages), capital gains, and business income. The rates for different types of income may vary and some may not be taxed at all. Capital gains may be taxed when realized (e.g. when shares are sold) or when incurred (e.g. when shares appreciate in value). Business income may only be taxed if it is significant or based on the manner in which it is paid. Some types of income, such as interest on bank savings, may be considered as personal earnings (similar to wages) or as a realized property gain (similar to selling shares). In some tax systems, personal earnings may be strictly defined where labor, skill, or investment is required (e.g. wages); in others, they may be defined broadly to include windfalls (e.g. gambling wins).

Tax rates may be progressive, regressive, or proportional. A progressive tax applies progressively higher tax rates as earnings reach higher levels. For example, the first $10,000 in earnings may be taxed at 7%, the next $10,000 at 10%, and any more income at 30%. Alternatively, a proportional tax takes all earnings at the same rate. A regressive income tax may apply to income up to a certain amount, such as taxing only the first $90,000 earned. A tax system may use different taxation methods for different types of income.

Personal income tax is often collected on a pay-as-you-earn basis, with small corrections made soon after the end of the tax year. These corrections take one of two forms: payments to the government by taxpayers who did not pay enough during the tax year; and tax refunds from the government to those who overpaid. Income tax systems often have deductions available that lessen the total tax liability by reducing total taxable income. They may allow losses from one type of income to be counted against another. For example, a loss on the stock market may be deducted against taxes paid on wages. Other tax systems may isolate the loss, such that business losses can only be deducted against business tax by carrying forward the loss to later tax years.

The idea of a progressive tax has garnered support from macro economists and political scientists of many different ideologies - ranging from Adam Smith to Karl Marx, although there are differences of opinion about the optimal level of progressivity. Some economists trace the origin of modern progressive taxation to Adam Smith, who wrote in The Wealth of Nations:

The necessaries of life occasion the great expense of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be anything very unreasonable. It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.

Income taxes are used in most countries around the world, but are not without criticism. Frank Chodorov wrote "... you come up with the fact that it gives the government a prior lien on all the property produced by its subjects." The government "unashamedly proclaims the doctrine of collectivized wealth. ... That which it does not take is a concession."^[5] Some have argued that the economic effects of an income tax system penalize work, discourage saving and investing, and hinder the competitiveness of business and economic growth. Income taxes are also not border-adjustable; meaning the tax component embedded into products via taxes imposed on companies cannot be removed when exported to a foreign country (see Effect of taxes and subsidies on price). Alternate tax systems such as a national sales tax or value added tax remove the tax component when goods are exported and apply the tax component on imports.

2. Types

Personal

A personal or individual income tax is levied as a percentage of a person's wages and salaries, with some deductions permitted, along with the net income or loss from businesses and investments. It is typically collected on a pay-as-you-earn basis, with corrections at the end of the year for over payments and under payments. Income tax systems typically offer exemptions, deductions, or credits which lessen the total tax liability; these are frequently a method of rewarding income-use-patterns encouraged by the government (home ownership, supporting children, charitable contributions). Tax structures may allow losses from one type of income to be counted against another. For example, a loss from businesses and investments might offset wages before calculating the taxes due.

Corporate

Corporate tax or company tax refers to a tax imposed on entities that are taxed at the entity level. Such taxes may include income taxes, capital gains taxes, or other taxes. The tax systems of most countries impose an income tax on certain types of entities (company or corporation). Many systems additionally tax owners or members of those entities on dividends or other distributions from the entity to the members. The tax is generally calculated on net taxable income, which is generally the financial statement income with modifications which are defined in great detail. The rate of tax varies by jurisdiction and is frequently progressive.

Payroll

A payroll tax generally refers to two kinds of taxes: employee and employer payroll taxes. Employee payroll taxes are taxes which employers are required to withhold from employees' pay, also known as withholding, pay-as-you-earn (PAYE) or pay-as-you-go (PAYG) tax. These withholdings contribute to the payment of an employee's personal income tax obligation; if the payments exceed this obligation, the employee may be eligible for a tax refund or carry forward to future periods.

Employer payroll taxes are paid from the employer's own funds, either as a fixed charge per employee or as a percentage of each employee's pay. Payroll taxes often cover government social insurance programs, such as social security, health care, unemployment, and disability. These payments do not count toward the income taxes of employees and employers, but are normally deductible by the employer as a business expense.

Inheritance

The inheritance tax, estate tax and death duty are the names given to various taxes which arise on the death of an individual. In international tax law, there is a distinction between an estate tax and an inheritance tax: the former taxes the personal representatives of the deceased, while the latter taxes the beneficiaries of the estate. However, this distinction is not universally recognized. For example, the "inheritance tax" in the UK is a tax on personal representatives, and is therefore, strictly speaking, an excise tax.

Capital gains tax

A capital gains tax is levied on profits from the sale of capital assets (e.g., real estate, machinery, stocks, bonds, art, commodities). In many cases, the amount of a capital gain is treated as ordinary income and subject to the marginal rate of income tax, so the distinction becomes unimportant. Typically, trading in assets or commodities is recognized as a business venture, thus the profits are considered ordinary income rather than capital gains. Partly to compensate for changes in the value of money over time, some systems index for inflation before applying a tax rate, others have lower tax rates for longer-term capital gains.

3. History

The concept of taxing income is a modern innovation and presupposes several things: a money economy, reasonably accurate accounts, a common understanding of receipts, expenses and profits, and an orderly society with reliable records. For most of the history of civilization, these preconditions did not exist, and taxes were based on other factors. Taxes on wealth, social position, and ownership of the means of production (typically land and slaves) were all common. Practices such as tithing, or an offering of first fruits, existed from ancient times, and can be regarded as a precursor of the income tax, but they lacked precision and certainly were not based on a concept of net increase.

China

In the year 10 AD, Emperor Wang Mang of the Xin Dynasty instituted an unprecedented tax—the income tax—at the rate of 10 percent of profits, for professionals and skilled labor. (Previously, all taxes were either head tax or property tax.) He was overthrown 13 years later in 23 AD and earlier laissez-faire policies were restored during the Later Han.

United Kingdom

One of the first recorded taxes on income was the Saladin tithe introduced by Henry II in 1188 to raise money for the Third Crusade. The tithe demanded that each layperson in England be taxed a tenth of their personal income and moveable property. However, the inception date of the modern income tax is typically accepted as 1799.

Income tax was announced in Britain by William Pitt the Younger in his budget of December 1798 and introduced in 1799, to pay for weapons and equipment in preparation for the Napoleonic wars. Pitt's new graduated income tax began at a levy of 2d in the pound (0.8333%) on annual incomes over £60 and increased up to a maximum of 2s in the pound (10%) on incomes of over £200 (£170,542 in 2007). Pitt hoped that the new income tax would raise £10 million (£8,527,100,000 in 2007), but actual receipts for 1799 to talled just over £6 million.

The tax was repealed in 1816 and opponents of the tax, who thought it should only be used to finance wars, wanted all records of the tax destroyed along with its repeal. Records were publicly burned by the Chancellor of the Exchequer but copies were retained in the basement of the tax court.^[14]

4. Around the world

Systems of taxation on personal income  

No income tax on individuals  

Territorial  

Residential  

Citizenship-based

Income taxes are used in most countries around the world. The tax systems vary greatly and can be progressive, proportional, or regressive, depending on the type of tax. Comparison of tax rates around the world is a difficult and somewhat subjective enterprise. Tax laws in most countries are extremely complex, and tax burden falls differently on different groups in each country and sub-national unit. Of course, services provided by governments in return for taxation also vary, making comparisons all the more difficult.

Countries that tax income generally use one of two systems: territorial or residential. In the territorial system, only local income – income from a source inside the country – is taxed. In the residential system, residents of the country are taxed on their worldwide (local and foreign) income, while nonresidents are taxed only on their local income. In addition, a very small number of countries, notably the United States, also tax their nonresident citizens on worldwide income.

Countries with a residential system of taxation usually allow deductions or credits for the tax that residents already pay to other countries on their foreign income. Many countries also sign tax treaties with each other to eliminate or reduce double taxation.

Countries do not necessarily use the same system of taxation for individuals and corporations. For example, France uses a residential system for individuals but a territorial system for corporations, while Singapore does the opposite, and Brunei taxes corporate but not personal income.

5. Basics

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 of higher amounts of income are higher than on lower amounts. The lower rate on lower income was phased out at higher incomes prior to 2010. Some states and localities impose an income tax at a graduated rate, and some at a flat rate on all taxable income. federal tax rates in 2009 varied from 10% to 35%.

From 2003 through 2011, individuals were 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 filing status. 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 regulations issued by the Department of Treasury and the Internal Revenue Service. Taxable income is gross income as adjusted minus tax deductions. Most states and localities follow this definition 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 all income earned or received from whatever source. 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, alimony received, proceeds from selling crops, and many other types of income. Some income, however, is exempt from income tax. This includes interest on municipal bonds.

Capital gains: and qualified dividends may be taxed as part of taxable income. However, the tax is limited to a lower tax rate. Capital gains include gains on selling stocks and bonds, real estate, and other capital assets. The gain is the excess of the proceeds over the adjusted basis (cost less depreciation deductions allowed) of the property. This limit on tax also applies to dividends from U.S. corporations and many foreign corporations. There are limits on how much net capital loss may reduce other taxable income.

Tax credits: All taxpayers are allowed a tax credit for foreign taxes and for a percentage of certain types of business expenses. Individuals are also allowed credits related to education expenses, retirement savings, child care expenses, and a credit for each child. 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.

Tax returns: Individuals must file income tax returns in each year their income exceeds the standard deduction plus one personal exemption, or if any tax is due. Other taxpayers must file income tax returns each year. These returns may be filed electronically. Generally, an individual's tax return covers the calendar year. Corporations may elect a different tax year. Most states and localities follow the federal tax year, and require separate returns.

Tax payment: Taxpayers must pay income tax due without waiting for an assessment. Many taxpayers are subject to withholding taxes when they receive income. To the extent withholding taxes do not cover all taxes due, all taxpayers must make estimated tax payments.

Tax penalties: Failing to make payments on time, or failing to file returns, can result in substantial penalties. Certain intentional failures may result in jail time.

Tax returns may be examined and adjusted by tax authorities. Taxpayers have rights to appeal any change to tax, and these rights vary by jurisdiction. Taxpayers may also go to court to contest tax changes. Tax authorities may not make changes after a certain period of time (generally 3 years).

Federal income tax rates

Marginal tax rates

 Marginal tax rates for 2012

Marginal Tax Rate[8]	Single	Married Filing Jointly or Qualified Widow(er)	Married Filing Separately	Head of Household
10%	$0 – $8,700	$0 – $17,400	$0 – $8,700	$0 – $12,400
15%	$8,701 – $35,350	$17,401 – $70,700	$8,701 – $35,350	$12,401 – $47,350
25%	$35,351 – $85,650	$70,701 – $142,700	$35,351 – $71,350	$47,351 – $122,300
28%	$85,651 – $178,650	$142,701 – $217,450	$71,351 – $108,725	$122,301 – $198,050
33%	$178,651 – $388,350	$217,451 – $388,350	$108,726 – $194,175	$198,051 – $388,350
35%	$388,351+	$388,351+	$194,176+	$388,351+

 

Marginal tax rates for 2013

Marginal Tax Rate[9][10]	Single	Married Filing Jointly or Qualified Widow(er)	Married Filing Separately	Head of Household
10%	$0 – $8,925	$0 – $17,850		$0 – $12,750
15%	$8,926 – $36,250	$17,851 – $72,500		$12,751 – $48,600
25%	$36,251 – $87,850	$72,501 – $146,400		$48,601 – $122,300
28%	$87,851 – $183,250	$146,401 – $223,050		$122,301 – $203,150
33%	$183,251 – $398,350	$223,051 – $398,350		$203,151 – $398,350
35%	$398,351 – $400,000	$398,351 – $450,000		$398,351 – $425,000
39.6%	$400,001+	$450,001+		$425,001+