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 (with some exceptions in the case of federal income taxation), 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 (AMT) 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 (not corporate) income tax, the average rate paid in 2020 on adjusted gross income (income after deductions) 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, (gradually declining from 5% in 2001 to 2.3% in 2020) 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 Sources of U.S. income tax laws United States income tax law comes from a number of sources. These sources have been divided by one author into three tiers as follows:Samuel A. Donaldson, Federal Income Taxation of Individuals: Cases, Problems and Materials, 4 (2nd Ed. 2007). Tier 1 United States Constitution (16th Amendment) Internal Revenue Code (IRC) (legislative authority, written by the United States Congress through legislation) Treasury regulations Federal court opinions (judicial authority, written by courts as interpretation of legislation) Treaties (executive authority, written in conjunction with other countries, subject to ratification in the United States by advice and consent of the U.S. Senate - other countries have their own ratification procedures) Tier 2 Agency interpretative regulations (executive authority, written by the Internal Revenue Service (IRS) and Department of the Treasury), including: Final, Temporary and Proposed Regulations promulgated under IRC § 7805 or other specific statutory authority; Treasury Notices and Announcements; Executive agreements with other countries; Public Administrative Rulings (IRS Revenue Rulings, which provide informal guidance on specific questions and are binding on all taxpayers) Tier 3 Legislative History Private Administrative Rulings (private parties may approach the IRS directly and ask for a Private Letter Ruling on a specific issue – these rulings are binding only on the requesting taxpayer).
Where conflicts exist between various sources of tax authority, an authority in Tier 1 outweighs an authority in Tier 2 or 3. Similarly, an authority in Tier 2 outweighs an authority in Tier 3.Id. Where conflicts exist between two authorities in the same tier, the "last-in-time rule" is applied. As the name implies, the "last-in-time rule" states that the authority that was issued later in time is controlling.
Regulations and case law serve to interpret the statutes. Additionally, various sources of law attempt to do the same thing. Revenue Rulings, for example, serves as an interpretation of how the statutes apply to a very specific set of facts. Treaties serve in an international realm.
Basic concepts
A tax is imposed on net taxable income in the United States by the federal, most state, and some local governments.See below for additional reading. The U.S. Internal Revenue Service offers many free publications which are available online, including one for individuals and one for corporations, in both .pdf and web formats. An incomplete index is available by topic. Many states offer similar publications. 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.CCH State Tax Handbook 2018, page 617, et seq.
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.CCH State Tax Handbook 2018, page 254, et seq.
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 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 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.IRS instructions for Form 1120 Schedule M-3.
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, proceeds from selling crops, and many other types of income. Some income, such as municipal bond interest, is exempt from income tax.
Adjustments (usually reductions) to gross income 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 may result in a loss. Generally, such loss can reduce other taxable income, subject to some limits.
Personal deductions: The former deduction for personal exemptions was repealed for 2018 through 2025.
Standard deduction: Individuals get a deduction from taxable income for certain personal expenses. An individual may claim a standard deduction. For 2021, the basic 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 itemized deductions may deduct the following, subject to many conditions and limitations: Medical expenses in excess of 7.5% of adjusted gross income, Note: the threshold was reduced from 10% to 7.5% in 2018 Certain taxes limited to $10,000 or $5,000 in 2018 through 2025, 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.
Capital gains: 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 tax basis (cost less depreciation deductions allowed) of the property. This lower rate of tax also applies to qualified 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 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, 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 additional 3.8% tax 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 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 or face penalties.
Tax penalties: Failing to make payments on time, or failing to file returns, can result in substantial penalties. Certain intentional failures may result in criminal penalties, including monetary fines and/or imprisonment.
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 three or four years from the tax return due date).
Federal income tax rates for individuals
Federal income brackets and tax rates for individuals are adjusted annually for inflation. The Internal Revenue Service (IRS) accounts for changes to the CPI and publishes the new rates as "Tax Rate Schedules".
Marginal tax rates