Income tax in the United States
In the United States, a tax is imposed on income by the federal, most state, and many local governments. The income tax is determined by applying a tax rate, which may increase as income increases, to taxable income as 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. An alternative tax applies at the federal and some state levels.
Taxable income is total income less allowable deductions. Income is broadly defined. Most business expenses are deductible. Individuals may also deduct a personal allowance (exemption) and certain personal expenses, including home mortgage interest, state taxes, contributions to charity, and some other items. Some deductions are subject to limits.
Capital gains are taxable, and capital losses reduce taxable income only to the extent of gains (plus, in certain cases, $3,000 or $1,500 of ordinary income). Individuals currently pay a lower rate of tax on capital gains and certain corporate dividends.
Taxpayers generally must self assess income tax by filing tax returns. Advance payments of tax are required in the form of withholding tax or estimated tax payments. Taxes are determined separately by each jurisdiction imposing tax. Due dates and other administrative procedures vary by jurisdiction. April 15 following the tax year is the last day 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.
- 1 Basics
- 2 Federal income tax rates for individuals
- 3 Taxable income
- 4 Capital gains
- 5 Partnerships and LLCs
- 6 Corporate tax
- 7 Estates and trusts
- 8 Retirement savings and fringe benefit plans
- 9 Credits
- 10 Alternative minimum tax
- 11 Accounting periods and methods
- 12 Tax exempt entities
- 13 Special taxes
- 14 Special industries
- 15 International aspects
- 16 Social Insurance taxes
- 17 Withholding of tax
- 18 Tax returns
- 19 Tax examinations
- 20 Penalties
- 21 History
- 22 Sources of U.S. income tax laws
- 23 The complexity of the U.S. income tax laws
- 24 State, local and territorial income taxes
- 25 Controversies
- 26 See also
- 27 Notes
- 28 References
- 29 Additional reading
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. 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 2013 varied from 10% to 39.6%.
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.
Adjustments: (usually reductions) to gross income of individuals are made for alimony paid, 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 tax 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: Individuals are allowed several nonbusiness deductions. A flat amount per person is allowed as a deduction for personal exemptions. For 2014 this amount is $3,950. Taxpayers are allowed one such deduction for themselves and one for each person they support.
Standard deduction: In addition, individuals get a deduction from taxable income for certain personal expenses. Alternatively, the individual may claim a standard deduction. For 2014, the standard deduction is $6,200 for single individuals, $12,400 for a married couple, and $9,100 for a head of household. Note that the standard deduction is higher for individuals born before January 2, 1949 or who are blind.
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 10% of adjusted gross income,
- State, local, and foreign 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.
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: Most individuals must file income tax returns in each year their income exceeds the standard deduction plus one personal exemption. However, some taxpayers must file an income tax return because they satisfy one of the following conditions:
- Taxpayer owes any special taxes such as the Alternative Minimum Tax
- Taxpayer received any HSA, Archer MSA, or Medicare Advantage MSA distributions
- Taxpayer had net earnings from self-employment of at least $400
- Taxpayer had wages of $108.28 or more from a church or qualified church-controlled organization that is exempt from employer social security and Medicare taxes
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 three years).
Federal income tax rates for individuals
Marginal tax rates
Marginal tax rates since 2008
|Marginal Tax Rates and Income Brackets for 2008|
|Marginal Tax Rate||Single||Married Filing Jointly or Qualified Widow(er)||Married Filing Separately||Head of Household|
|10%||$0 – $8,025||$0 – $16,050||$0 – $8,025||$0 – $11,450|
|15%||$8,025 – $32,550||$16,050 – $65,100||$8,025 – $32,550||$11,450 – $43,650|
|25%||$32,550 – $78,850||$65,100 – $131,450||$32,550 – $65,725||$43,650 – $112,650|
|28%||$78,850 – $164,550||$131,450 – $200,300||$65,725 – $100,150||$112,650 – $182,400|
|33%||$164,550 – $357,700||$200,300 – $357,700||$100,150 – $178,850||$182,400 – $357,700|
|Marginal Tax Rates and Income Brackets for 2009|
|Marginal Tax Rate||Single||Married Filing Jointly or Qualified Widow(er)||Married Filing Separately||Head of Household|
|10%||$0 – $8,350||$0 – $16,700||$0 – $8,350||$0 – $11,950|
|15%||$8,351 – $33,950||$16,701 – $67,900||$8,351 – $33,950||$11,951 – $45,500|
|25%||$33,951 – $82,250||$67,901 – $137,050||$33,951 – $68,525||$45,501 – $117,450|
|28%||$82,251 – $171,550||$137,051 – $208,850||$68,526 – $104,425||$117,451 – $190,200|
|33%||$171,551 – $372,950||$208,851 – $372,950||$104,426 – $186,475||$190,201 – $372,950|
|Marginal Tax Rates and Income Brackets for 2010|
|Marginal Tax Rate||Single||Married Filing Jointly or Qualified Widow(er)||Married Filing Separately||Head of Household|
|10%||$0 – $8,375||$0 – $16,750||$0 – $8,375||$0 – $11,950|
|15%||$8,376 – $34,000||$16,751 – $68,000||$8,376 – $34,000||$11,951 – $45,550|
|25%||$34,001 – $82,400||$68,001 – $137,300||$34,001 – $68,650||$45,551 – $117,650|
|28%||$82,401 – $171,850||$137,301 – $209,250||$68,651 – $104,625||$117,651 – $190,550|
|33%||$171,851 – $373,650||$209,251 – $373,650||$104,626 – $186,825||$190,551 – $373,650|
|Marginal Tax Rates and Income Brackets for 2011|
|Marginal Tax Rate||Single||Married Filing Jointly or Qualified Widow(er)||Married Filing Separately||Head of Household|
|10%||$0 – $8,500||$0 – $17,000||$0 – $8,500||$0 – $12,150|
|15%||$8,501 – $34,500||$17,001 – $69,000||$8,501 – $34,500||$12,151 – $46,250|
|25%||$34,501 – $83,600||$69,001 – $139,350||$34,501 – $69,675||$46,251 – $119,400|
|28%||$83,601 – $174,400||$139,351 – $212,300||$69,676 – $106,150||$119,401 – $193,350|
|33%||$174,401 – $379,150||$212,301 – $379,150||$106,151 – $189,575||$193,351 – $379,150|
|Marginal Tax Rates and Income Brackets for 2012|
|Marginal Tax Rate||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|
Marginal tax rates for 2013
|Marginal Tax Rate ||Single Taxable Income||Married Filing Jointly or Qualified Widow(er) Taxable Income||Married Filing Separately Taxable Income||Head of Household Taxable Income|
|10%||$0 – $8,925||$0 – $17,850||$0 – $8,925||$0 – $12,750|
|15%||$8,926 – $36,250||$17,851 – $72,500||$8,926 – $36,250||$12,751 – $48,600|
|25%||$36,251 – $87,850||$72,501 – $146,400||$36,251 – $73,200||$48,601 – $125,450|
|28%||$87,851 – $183,250||$146,401 – $223,050||$73,201 – $111,525||$125,451 – $203,150|
|33%||$183,251 – $398,350||$223,051 – $398,350||$111,526 – $199,175||$203,151 – $398,350|
|35%||$398,351 – $400,000||$398,351 – $450,000||$199,176 – $225,000||$398,351 – $425,000|
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.
Example of a tax computation
Income tax for year 2013:
Single taxpayer, no children, under 65 and not blind, taking standard deduction;
- $40,000 gross income – $6,100 standard deduction – $3,900 personal exemption = $30,000 taxable income
- $8,925 × 10% = $892.50 (taxation of the first income bracket)
- $30,000 – $8,925 = $21,075.00 (amount in the second income bracket)
- $21,075.00 × 15% = $3,161.25 (taxation of the amount in the second income bracket)
- Total income tax is $892.50 + $3,161.75 = $4,053.75 (~10.13% effective tax)
Note that in addition to income tax, a wage earner would also have to pay Federal Insurance Contributions Act tax (FICA) (and an equal amount of FICA tax must be paid by the employer):
- $40,000 (adjusted gross income)
- $40,000 × 6.2% = $2,480 (Social Security portion)
- $40,000 × 1.45% = $580 (Medicare portion)
- Total FICA tax paid by employee = $3,060 (7.65% of income)
- Total federal tax of individual = $4,053.75+ $3,060.00 = $7,113.75 (~17.78% of income)
Total federal tax including employer's contribution:
- Total FICA tax contributed by employer = $3,060 (7.65% of income)
- Total federal tax of individual including employer's contribution = $4,091.25 + $3,060.00 + $3,060.00 = $10,211.25 (~23.71% of income)
Effective income tax rates
Effective tax rates are typically lower than marginal rates due to various deductions, with some people actually having a negative liability. The individual income tax rates in the following chart include capital gains taxes, which have different marginal rates than regular income. Only the first $117,000 of someone's income is subject to social insurance (Social Security) taxes in 2014. The table below also does not reflect changes, effectively with 2013 law, which increased the average tax paid by the top 1% to the highest levels since 1979, at an effective rate of 33% while most other taxpayers have remained at the near the lowest levels since 1979.
|Effective Federal Tax Rates and Average Incomes for 2010|
|Quintile||Average Income Before Taxes||Effective Individual Income Tax Rate||Effective Payroll Tax Rate||Combined Effective Income and Payroll Tax Rate||Total Effective Federal Tax Rate (includes corporate income and excise taxes)|
|81st to 90th Percentiles||$134,600||8.1%||9.4%||17.5%||19.3%|
|91st to 95th Percentiles||$181,600||10.7%||8.9%||19.6%||21.6%|
|96th to 99th Percentiles||$286,400||15.1%||7.1%||22.2%||24.9%|
Income tax is imposed as a tax rate times taxable income. Taxable income is defined as gross income less allowable tax deductions. Taxable income as determined for federal tax purposes may be modified for state tax purposes.
The Internal Revenue Code states that "gross income means all income from whatever source derived," and gives specific examples. Gross income is not limited to cash received. "It includes income realized in any form, whether money, property, or services." Gross income includes wages and tips, fees for performing services, gain from sale of inventory or other property, interest, dividends, rents, royalties, pensions, alimony, and many other types of income. Items must be included in income when received or accrued. The amount included is the amount the taxpayer is entitled to receive. Gains on property are the gross proceeds less amounts returned, cost of goods sold, or tax basis of property sold.
Certain types of income are subject to tax exemption. Among the more common types of exempt income are interest on municipal bonds, a portion of Social Security benefits, life insurance proceeds, gifts or inheritances, and the value of many employee benefits.
Gross income is reduced by adjustments and tax deductions. Among the more common adjustments are reductions for alimony paid and IRA and certain other retirement plan contributions. Adjusted gross income is used in calculations relating to various deductions, credits, phase outs, and penalties.
Most business deductions are allowed regardless of the form in which the business is conducted. Thus, an individual small business owner is allowed most of the same business deductions as a publicly traded corporation. A business is an activity conducted regularly with an intent to make a profit. Only a few business related deductions are unique to a particular form of doing business. The deduction of investment expenses by individuals, however, has several limitations, along with other itemized (personal) deductions.
The amount and timing of deductions for income tax purposes is determined under tax rules, not accounting rules. See Accounting periods and methods, below. Tax rules are based on principles similar in many ways to accounting rules, but there are significant differences. Deductions for most meals and entertainment costs are limited to 50% of the costs, and costs of starting up a business (sometimes called pre-operating costs) are deductible ratably over 60 months. Deductions for lobbying and political expenses are limited. Some other limitations apply.
Expenses that are likely to produce future benefits must be capitalized. The capitalized costs are then deductible as depreciation (see MACRS) or amortization over the period future benefits are expected. Examples include costs of machinery and equipment and costs of making or building property. IRS tables specify lives of assets by class of asset or industry in which used. When an asset the cost of which was capitalized is sold, exchanged, or abandoned, the proceeds (if any) are reduced by the remaining unrecovered cost to determine gain or loss. The gain or loss may be ordinary (as in the case of inventory) or capital (as in the case of stocks and bonds), or a combination (for some buildings and equipment).
Most personal, living, and family expenses are not deductible. However, see Personal deductions, below. Most business deductions allowed for Federal income tax are almost always allowed in determining state income tax. Only some states, though, allow itemized deductions for individuals. Some states also limit deductions by corporations for investment related expenses. Many states allow different amounts for depreciation deductions. State limitations on deductions may differ significantly from Federal limitations.
Business deductions in excess of business income result in losses that may offset other income. However, losses from passive activities may reduce only income from other passive activities. Passive activities include most rental activities (except for real estate professionals) and business activities in which the taxpayer does not materially participate. In addition, losses may not, in most cases, be deducted in excess of the taxpayer's amount at risk (generally tax basis in the entity plus share of debt).
Individuals are allowed a special deduction called a personal exemption for dependents. This is a fixed amount allowed each taxpayer, plus an additional fixed amount for each child or other dependents the taxpayer supports. The amount of this deduction is $3,700 for 2011, $3,800 for 2012, and $3,900 for 2013. The amount is indexed annually for inflation. The amount of exemption is phased out at higher incomes through 2009 and after 2012 (no phase out in 2010-2012).
Citizens and individuals who have U.S. tax residence may deduct a flat amount as a standard deduction. Alternatively, they may claim an itemized deduction for actual amounts incurred for specific categories of nonbusiness expenses. Expenses incurred to produce tax exempt income and several other items are not deductible. Home owners may deduct the amount of interest and property taxes paid on their principal and second homes. Local and state income taxes are deductible, or the individual may elect to deduct state and local sales tax. Contributions to charitable organizations are deductible by individuals and corporations, but the deduction is limited to 50% and 10% of gross income respectively. Medical expenses in excess of 10% of adjusted gross income are deductible, as are uninsured casualty losses. Other income producing expenses in excess of 2% of adjusted gross income are also deductible. For years before 2010, the allowance of itemized deductions was phased out at higher incomes. The phase out expired for 2010.
Taxable income includes capital gains. A capital gain is the excess of the sales price over the tax basis (usually, the cost) of capital assets, such as corporate stock, land, buildings, etc. Capital losses (where basis is more than sales price) are deductible, but deduction for long term capital losses is limited to the total capital gains for the year, plus up to $3,000 of ordinary income ($1,500 if married filing separately). An individual may exclude $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of the individual's primary residence, subject to certain conditions and limitations. Gains on depreciable property used in a business are treated as ordinary income to the extent of depreciation previously claimed.
In determining gain, it is necessary to determine which property is sold and the amount of basis of that property. This may require identification conventions, such as first-in-first-out, for identical properties like shares of stock. Further, tax basis must be allocated among properties purchased together unless they are sold together. Original basis, usually cost paid for the asset, is reduced by deductions for depreciation or loss.
Certain capital gains are deferred; that is, they are taxed at a time later than the year of disposition. Gains on property sold for installment payments may be recognized as those payments are received. Gains on property exchanged for like kind property are not recognized, and the tax basis of the new property is based on the tax basis of the old property.
Before 1986 and from 2004 onward, individuals have been subject to a reduced rate of federal tax on long term capital gains. This reduced rate (limited to 15%) applies for regular tax and the Alternative Minimum Tax.
|Ordinary Income Rate||Long-term Capital Gain Rate*||Short-term Capital Gain Rate||Recapture of Depreciation on Long-term Gain of Real Estate||Long-term Gain on Collectibles||Long-term Gain on Certain Small Business Stock|
- * Capital gains up to $250,000 ($500,000 if filed jointly) on real estate used as primary residence are exempt.
After 2012, an additional tax bracket of 39.6% applies to ordinary income. The tax rate on long-term capital gains beginning 2013 for those in the 39.6% bracket is 20% plus a 3.8% surcharge for high-income filers.
Partnerships and LLCs
Business entities treated as partnerships are not subject to income tax at the entity level. Instead, their members include their shares of income, deductions, and credits in computing their own tax. The character of the partner's share of income (such as capital gains) is determined at the partnership level. Many types of business entities, including limited liability companies (LLCs), may elect to be treated as a corporation or as a partnership. Distributions from partnerships are not taxed as dividends.
Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Shareholders of a corporation wholly owned by U.S. citizens and resident individuals may elect for the corporation to be taxed similarly to partnerships (see S Corporation). Corporate income tax is based on taxable income, which is defined similarly to individual taxable income.
Shareholders (including other corporations) of corporations (other than S Corporations) are taxed on dividend distributions from the corporation. They are also subject to tax on capital gains upon sale or exchange of their shares for money or property. However, certain exchanges, such as in reorganizations, are not taxable.
Multiple corporations may file a consolidated return at the federal and some state levels with their common parent.
Corporate tax rates
Federal corporate income tax is imposed at graduated rates from 15% to 35%. The lower rate brackets are phased out at higher rates of income, with all income subject to tax at 34% to 35% where taxable income exceeds $335,000. Additional tax rates imposed at the state and local level vary widely by jurisdiction, from under 1% to over 16%. State and local income taxes are allowed as tax deductions in computing federal taxable income.
Deductions for corporations
Corporations are not allowed the personal deductions allowed to individuals, such as deductions for exemptions and the standard deduction. However, most other deductions are allowed. In addition, corporations are allowed certain deductions unique to corporate status. These include a partial deduction for dividends received from other corporations, deductions related to organization costs, and certain other items.
Some deductions of corporations are limited at federal or state levels. Limitations apply to items due to related parties, including interest and royalty expenses.
Estates and trusts
Estates and trusts may be subject to income tax at the estate or trust level, or the beneficiaries may be subject to income tax on their share of income. Where the all income must be distributed, the beneficiaries are taxed similarly to partners in a partnership. Where income may be retained, the estate or trust is taxed. It may get a deduction for later distributions of income. Estates and trusts are allowed only those deductions related to producing income, plus $1,000. They are taxed at graduated rates that increase rapidly to the maximum rate for individuals. The tax rate for trust and estate income in excess of $11,500 was 35% for 2009. Estates and trusts are eligible for the reduced rate of tax on dividends and capital gains through 2011.
Retirement savings and fringe benefit plans
Employers get a deduction for amounts contributed to a qualified employee retirement plan or benefit plan. The employee does not recognize income with respect to the plan until he or she receives a distribution from the plan. The plan itself is organized as a trust and is considered a separate entity. For the plan to qualify for tax exemption, and for the employer to get a deduction, the plan must meet minimum participation, vesting, funding, and operational standards.
Examples of qualified plans include:
- Pension plans (defined benefit pension plan),
- Profit sharing plans (defined contribution plan),
- Employee Stock Ownership Plan (ESOPs),
- Stock purchase plans,
- Health insurance plans,
- Employee benefit plans,
- Cafeteria plans.
Employees or former employees are generally taxed on distributions from retirement or stock plans. Employees are not taxed on distributions from health insurance plans to pay for medical expenses. Cafeteria plans allow employees to choose among benefits (like choosing food in a cafeteria), and distributions to pay those expenses are not taxable.
In addition, individuals may make contributions to Individual Retirement Accounts (IRAs). Those not currently covered by other retirement plans may claim a deduction for contributions to certain types of IRAs. Income earned within an IRA is not taxed until the individual withdraws it.
The federal and state systems offer numerous tax credits for individuals and businesses. Among the key federal credits for individuals are:
- Child credit: a credit up to $1,000 per qualifying child.
- Child and dependent care credit: a credit up to $6,000, phased out at incomes above $15,000.
- Earned Income Tax Credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount. For 2013, the maximum credit was $6,044.
- Credit for the elderly and disabled: A nonrefundable credit up to $1,125
- Two mutually exclusive credits for college expenses.
Businesses are also eligible for several credits. These credits are available to individuals and corporations, and can be taken by partners in business partnerships. Among the federal credits included in a "general business credit" are:
- Credit for increasing research expenses.
- Work Incentive Credit or credit for hiring people in certain enterprise zones or on welfare.
- A variety of industry specific credits.
In addition, a federal foreign tax credit is allowed for foreign income taxes paid. This credit is limited to the portion of federal income tax arising due to foreign source income. The credit is available to all taxpayers.
Business credits and the foreign tax credit may be offset taxes in other years.
States and some localities offer a variety of credits that vary by jurisdiction. States typically grant a credit to resident individuals for income taxes paid to other states, generally limited in proportion to income taxed in the other state(s).
Alternative minimum tax
Taxpayers must pay the higher of the regular income tax or the alternative minimum tax (AMT). Taxpayers who have paid AMT in prior years may claim a credit against regular tax for the prior AMT. The credit is limited so that regular tax is not reduced below current year AMT.
AMT is imposed at a nearly flat rate (20% for corporations, 26% or 28% for individuals, estates, and trusts) on taxable income as modified for AMT. Key differences between regular taxable income and AMT taxable income include:
- The standard deduction and personal exemptions are replaced by a single deduction, which is phased out at higher income levels,
- No deduction is allowed individuals for state taxes,
- Most miscellaneous itemized deductions are not allowed for individuals,
- Depreciation deductions are computed differently, and
- Corporations must make a complex adjustment to more closely reflect economic income.
Accounting periods and methods
The United States tax system allows individuals and entities to choose their tax year. Most individuals choose the calendar year. There are restrictions on choice of tax year for some closely held entities. Taxpayers may change their tax year in certain circumstances, and such change may require IRS approval.
Taxpayers must determine their taxable income based on their method of accounting for the particular activity. Most individuals use the cash method for all activities. Under this method, income is recognized when received and deductions taken when paid. Taxpayers may choose or be required to use the accrual method for some activities. Under this method, income is recognized when the right to receive it arises, and deductions are taken when the liability to pay arises and the amount can be reasonably determined. Taxpayers recognizing cost of goods sold on inventory must use the accrual method with respect to sales and costs of the inventory.
Methods of accounting may differ for financial reporting and tax purposes. Specific methods are specified for certain types of income or expenses. Gain on sale of property other than inventory may be recognized at the time of sale or over the period in which installment sale payments are received. Income from long term contracts must be recognized ratably over the term of the contract, not just at completion. Other special rules also apply.
Tax exempt entities
U.S. tax law exempts certain types of entities from income and some other taxes. These provisions arose during the late 19th century. Charitable organizations and cooperatives may apply to the IRS for tax exemption. Exempt organizations are still taxed on any business income. An organization which participates in lobbying, political campaigning, or certain other activities may lose its exempt status. Special taxes apply to prohibited transactions and activities of tax-exempt entities.
There are many federal tax rules designed to prevent people from abusing the tax system. Provisions related to these taxes are often complex. Such rules include:
- Accumulated earnings tax on corporation accumulations in excess of business needs,
- Personal holding company taxes,
- Passive foreign investment company rules, and
- Controlled foreign corporation provisions.
Tax rules recognize that some types of businesses do not earn income in the traditional manner and thus require special provisions. For example, insurance companies must ultimately pay claims to some policy holders from the amounts received as premiums. These claims may happen years after the premium payment. Computing the future amount of claims requires actuarial estimates until claims are actually paid. Thus, recognizing premium income as received and claims expenses as paid would seriously distort an insurance company's income.
Special rules apply to some or all items in the following industries:
- Insurance companies (rules related to recognition of income and expense; different rules apply to life insurance and to property and casualty insurance)
- Shipping (rules related to the revenue recognition cycle)
- Extractive industries (rules related to expenses for exploration and development and for recovery of capitalized costs)
In addition, mutual funds (regulated investment companies) are subject to special rules allowing them to be taxed only at the owner level. The company must report to each owner his/her share of ordinary income, capital gains, and creditable foreign taxes. The owners then include these items in their own tax calculation. The fund itself is not taxed, and distributions are treated as a return of capital to the owners. Similar rules apply to real estate investment trusts and real estate mortgage investment conduits.
The United States requires all citizens of the United States to file an annual income tax return with the IRS, including those who are residents of other countries, and even those who are also considered citizens of other countries through dual citizenship. This requires individuals who have a tenuous connection to the United States, such as people born outside the United States to American parents, or people with non-American parents who happened to visit the United States when their child was born. Eritrea and the United States are the only countries that require a filing of tax returns by non-resident citizens.
Federal income tax is imposed on citizens, residents, and U.S. corporations based on their worldwide income. To mitigate double taxation, a credit is allowed for foreign income taxes. This foreign tax credit is limited to that part of current year tax caused by foreign source income. Determining such part involves determining the source of income and allocating and apportioning deductions to that income. States tax resident individuals and corporations on their worldwide income, but few allow a credit for foreign taxes.
In addition, the U.S. federal income tax may be imposed in certain cases on individuals who are neither citizens nor residents of the United States, under section 2(d) of the Internal Revenue Code. For example, Federal and state income taxes are imposed on nonresident aliens on their income within the jurisdiction. Federal law imposes a tax on interest, dividends, royalties, and certain other income of nonresident aliens at a flat rate of 30%. This rate is often reduced under tax treaties. Foreign persons are taxed on income from a U.S. business similarly to U.S. persons. Nonresident aliens who are present in the United States for a period of 183 days in a given year are subject to U.S. capital gains tax on certain net capital gains realized during that year from sources within the United States. The states tax non-resident individuals only on income earned within the state (wages, etc.), and tax individuals and corporations on business income apportioned to the state. Most of the states otherwise do not impose income tax on persons not resident in the state.
The United States has income tax treaties with over 65 countries. These treaties reduce the chance of double taxation by allowing each country to fully tax its citizens and residents and reducing the amount the other country can tax them. Generally the treaties provide for reduced rates of tax on investment income and limits as to which business income can be taxed. The treaties each define which taxpayers can benefit from the treaty.
Social Insurance taxes
The United States social insurance system is funded by a tax similar to an income tax. Social Security tax of 6.2% is imposed on wages paid to employees. The tax is imposed on both the employer and the employee. For 2011 and 2012, the employee tax has been reduced from 6.2% to 4.2%. The maximum amount of wages subject to the tax for 2009, 2010, and 2011 was/is $106,800. This amount is indexed for inflation. A companion Medicare Tax of 1.45% of wages is imposed on employers and employees, with no limitation. A self-employment tax in like amounts (totaling 15.3%, 13.3% for 2011 and 2012) is imposed on self-employed persons.
Withholding of tax
Persons paying wages or making certain payments to foreign persons are required to withhold income tax from such payments. The Social Security tax is one type of withholding tax. Withholding of income tax is also required. Income tax withholding on wages is based on declarations by employees and tables provided by the IRS. Persons paying interest, dividends, royalties, and certain other amounts to foreign persons must also withhold income tax at a flat rate of 30%. This rate may be reduced by a tax treaty. Additional backup withholding provisions apply to some payments of interest or dividends to U.S. persons. The amount of income tax withheld is treated as a payment of tax by the person receiving the payment on which tax was withheld.
Individuals (with income above a minimum level), corporations, partnerships, estates, and trusts must file annual reports, called tax returns, with federal and appropriate state tax authorities. These returns vary greatly in complexity level depending on the type of filer and complexity of their affairs. On the return, the taxpayer reports income and deductions, calculates the amount of tax owed, reports payments and credits, and calculates the balance due.
Federal individual, estate, and trust income tax returns are due by April 15 for most taxpayers. Corporate returns are due two and one half months following the corporation's year end. Partnership returns are due three and one half months following the partnership's year end. Tax exempt entity returns are due four and one half months following the entity's year end. All federal returns may be extended, with most extensions available upon merely filing a single page form. Due dates and extension provisions for state and local income tax returns vary.
Income tax returns generally consist of the basic form with attached forms and schedules. Several forms are available for individuals and corporations, depending on complexity and nature of the taxpayer's affairs. Many individuals are able to use the one page Form 1040-EZ, which requires no attachments except wage statements from employers (Forms W-2). Individuals claiming itemized deductions must complete Schedule A. Similar schedules apply for interest (B), dividends (B), business income (C), capital gains (D), farm income (F), and self-employment tax (SE). All taxpayers must file those forms for credits, depreciation, AMT, and other items that apply to them.
Electronic filing of tax returns may be done for taxpayers by registered tax preparers.
If a taxpayer discovers an error on a return, or determines that tax for a year should be different, the taxpayer should file an amended return. These returns constitute claims for refund if taxes are determined to have been overpaid.
The IRS and state, and local tax authorities may examine a tax return and propose changes. Changes to tax returns may be made with minimal advance involvement by taxpayers, such as changes to wage or dividend income to correct errors. Other examination of returns may require extensive taxpayer involvement, such as an audit by the IRS. These audits often require that taxpayers provide the IRS or other tax authority access to records of income and deductions. Audits of businesses are usually conducted by IRS personnel at the business location.
Changes to returns are subject to appeal by the taxpayer, including going to court. IRS changes are often first issued as proposed adjustments. The taxpayer may agree to the proposal, or may advise the IRS why it disagrees. Proposed adjustments are often resolved by the IRS and taxpayer agreeing to what the adjustment should be. For those adjustments to which agreement is not reached, the IRS issues a 30-day letter advising of the adjustment. The taxpayer may appeal this preliminary assessment within 30 days within the IRS.
The Appeals Division reviews the IRS field team determination and taxpayer arguments, and often proposes a solution that the IRS team and the taxpayer find acceptable. Where agreement is still not reached, the IRS issues an assessment as a notice of deficiency or 90-day letter. The taxpayer then has three choices: file suit in United States Tax Court without paying the tax, pay the tax and sue for refund in regular court, or pay the tax and be done. Recourse to court can be costly and time consuming, but is often successful.
IRS computers routinely make adjustments to correct mechanical errors in returns. In addition, the IRS conducts an extensive document matching computer program that compares taxpayer amounts of wages, interest, dividends, and other items to amounts reported by taxpayers. These programs automatically issue 30-day letters advising of proposed changes. Only a very small percentage of tax returns are actually examined. These are selected by a combination of computer analysis of return information and random sampling. The IRS has long maintained a program to identify patterns on returns most likely to require adjustment.
Procedures for examination by state and local authorities vary by jurisdiction.
Taxpayers are required to pay all taxes owed based on the self-assessed tax returns, as adjusted. The IRS collection process allows taxpayers to in certain circumstances, and provides time payment plans that include interest and a "penalty" that is merely added interest. Where taxpayers do not pay tax owed, the IRS has strong means to enforce collection. These include the ability to levy bank accounts and seize property. Generally, significant advance notice is given before levy or seizure. However, in certain rarely used jeopardy assessments the IRS may immediately seize money and property. The IRS Collection Divisions are responsible for most collection activities.
Statute of limitations
Taxpayers and the IRS are both precluded from charging tax after a certain period of time. Generally, this period is three years from the later of the due date of the original tax return or the date the original return was filed. The IRS has an additional three more years to make changes if the taxpayer has substantially understated gross income. The period under which the IRS may make changes is unlimited in the case of fraud by the taxpayer.
Taxpayers who fail to file returns, file late, or file returns that are wrong, may be subject to penalties. These penalties vary based on the type of failure. Some penalties are computed like interest, some are fixed amounts, and some are based on other measures. Penalties for filing or paying late are generally based on the amount of tax that should have been paid and the degree of lateness. Penalties for failures related to certain forms are fixed amounts, and vary by form from very small to huge.
Intentional failures, including tax fraud, may result in criminal penalties. These penalties may include jail time or forfeiture of property. Criminal penalties are assessed in coordination with the United States Department of Justice.
Article I, Section 8, Clause 1 of the United States Constitution (the "Taxing and Spending Clause"), specifies Congress's power to impose "Taxes, Duties, Imposts and Excises", but Article I, Section 8 requires that, "Duties, Imposts and Excises shall be uniform throughout the United States."
The Constitution specifically stated Congress' method of imposing direct taxes, by requiring Congress to distribute direct taxes in proportion to each state's population "determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons". It has been argued that head taxes and property taxes (slaves could be taxed as either or both) were likely to be abused, and that they bore no relation to the activities in which the federal government had a legitimate interest. The fourth clause of section 9 therefore specifies that, "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken."
Taxation was also the subject of Federalist No. 33 penned secretly by the Federalist Alexander Hamilton under the pseudonym Publius. In it, he asserts that the wording of the "Necessary and Proper" clause should serve as guidelines for the legislation of laws regarding taxation. The legislative branch is to be the judge, but any abuse of those powers of judging can be overturned by the people, whether as states or as a larger group.
The courts have generally held that direct taxes are limited to taxes on people (variously called "capitation", "poll tax" or "head tax") and property. All other taxes are commonly referred to as "indirect taxes," because they tax an event, rather than a person or property per se. What seemed to be a straightforward limitation on the power of the legislature based on the subject of the tax proved inexact and unclear when applied to an income tax, which can be arguably viewed either as a direct or an indirect tax.
Early federal income taxes
The first income tax suggested in the United States was during the War of 1812. The idea for the tax was based on the British Tax Act of 1798. The British tax law applied progressive rates to income. The British tax rates ranged from 0.833% on income starting at £60 to 10% on income above £200. The tax proposal was developed in 1814. Because the treaty of Ghent was signed in 1815, ending hostilities and the need for additional revenue, the tax was never imposed in the United States.
In order to help pay for its war effort in the American Civil War, Congress imposed its first personal income tax in 1861. It was part of the Revenue Act of 1861 (3% of all incomes over US $800). This tax was repealed and replaced by another income tax in 1862.
In 1894, Democrats in Congress passed the Wilson-Gorman tariff, which imposed the first peacetime income tax. The rate was 2% on income over $4000, which meant fewer than 10% of households would pay any. The purpose of the income tax was to make up for revenue that would be lost by tariff reductions.
In 1895 the United States Supreme Court, in its ruling in Pollock v. Farmers' Loan & Trust Co., held a tax based on receipts from the use of property to be unconstitutional. The Court held that taxes on rents from real estate, on interest income from personal property and other income from personal property (which includes dividend income) were treated as direct taxes on property, and therefore had to be apportioned (divided among the states based on their populations). Since apportionment of income taxes is impractical, this had the effect of prohibiting a federal tax on income from property. However, the Court affirmed that the Constitution did not deny Congress the power to impose a tax on real and personal property, and it affirmed that such would be a direct tax. Due to the political difficulties of taxing individual wages without taxing income from property, a federal income tax was impractical from the time of the Pollock decision until the time of ratification of the Sixteenth Amendment (below).
Ratification of the Sixteenth Amendment
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
The Supreme Court in Brushaber v. Union Pacific Railroad, 240 U.S. 1 (1916), indicated that the amendment did not expand the federal government's existing power to tax income (meaning profit or gain from any source) but rather removed the possibility of classifying an income tax as a direct tax on the basis of the source of the income. The Amendment removed the need for the income tax to be apportioned among the states on the basis of population. Income taxes are required, however, to abide by the law of geographical uniformity.
Some tax protesters and others opposed to income taxes cite what they contend is evidence that the Sixteenth Amendment was never properly ratified, based in large part on materials sold by William J. Benson. In December 2007, Benson's "Defense Reliance Package" containing his non-ratification argument which he offered for sale on the Internet, was ruled by a federal court to be a "fraud perpetrated by Benson" that had "caused needless confusion and a waste of the customers' and the IRS' time and resources". The court stated: "Benson has failed to point to evidence that would create a genuinely disputed fact regarding whether the Sixteenth Amendment was properly ratified or whether United States Citizens are legally obligated to pay federal taxes." See also Tax protester Sixteenth Amendment arguments.
Modern interpretation of the power to tax incomes
The modern interpretation of the Sixteenth Amendment taxation power can be found in Commissioner v. Glenshaw Glass Co. 348 U.S. 426 (1955). In that case, a taxpayer had received an award of punitive damages from a competitor for antitrust violations and sought to avoid paying taxes on that award. The Court observed that Congress, in imposing the income tax, had defined gross income, under the Internal Revenue Code of 1939, to include:
gains, profits, and income derived from salaries, wages or compensation for personal service . . . of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.
(Note: The Glenshaw Glass case was an interpretation of the definition of "gross income" in section 22 of the Internal Revenue Code of 1939. The successor to section 22 of the 1939 Code is section 61 of the current Internal Revenue Code of 1986, as amended.)
The Court held that "this language was used by Congress to exert in this field the full measure of its taxing power", id., and that "the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted."
The Court then enunciated what is now understood by Congress and the Courts to be the definition of taxable income, "instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." Id. at 431. The defendant in that case suggested that a 1954 rewording of the tax code had limited the income that could be taxed, a position which the Court rejected, stating:
The definition of gross income has been simplified, but no effect upon its present broad scope was intended. Certainly punitive damages cannot reasonably be classified as gifts, nor do they come under any other exemption provision in the Code. We would do violence to the plain meaning of the statute and restrict a clear legislative attempt to bring the taxing power to bear upon all receipts constitutionally taxable were we to say that the payments in question here are not gross income.
Tax statutes passed after the ratification of the Sixteenth Amendment in 1913 are sometimes referred to as the "modern" tax statutes. Hundreds of Congressional acts have been passed since 1913, as well as several codifications (i.e., topical reorganizations) of the statutes (see Codification).
In Central Illinois Public Service Co. v. United States, 435 U.S. 21 (1978), the U.S. Supreme Court confirmed that wages and income are not identical as far as taxes on income are concerned, because income not only includes wages, but any other gains as well. The Court in that case noted that in enacting taxation legislation, Congress "chose not to return to the inclusive language of the Tariff Act of 1913, but, specifically, 'in the interest of simplicity and ease of administration,' confined the obligation to withhold [income taxes] to 'salaries, wages, and other forms of compensation for personal services'" and that "committee reports ... stated consistently that 'wages' meant remuneration 'if paid for services performed by an employee for his employer'".
Other courts have noted this distinction in upholding the taxation not only of wages, but also of personal gain derived from other sources, recognizing some limitation to the reach of income taxation. For example, in Conner v. United States, 303 F. Supp. 1187 (S.D. Tex. 1969), aff’d in part and rev’d in part, 439 F.2d 974 (5th Cir. 1971), a couple had lost their home to a fire, and had received compensation for their loss from the insurance company, partly in the form of hotel costs reimbursed. The court acknowledged the authority of the IRS to assess taxes on all forms of payment, but did not permit taxation on the compensation provided by the insurance company, because unlike a wage or a sale of goods at a profit, this was not a gain. As the Court noted, "Congress has taxed income, not compensation".
By contrast, other courts have interpreted the Constitution as providing even broader taxation powers for Congress. In Murphy v. IRS, the United States Court of Appeals for the District of Columbia Circuit upheld the federal income tax imposed on a monetary settlement recovery that the same court had previously indicated was not income, stating: "[a]lthough the 'Congress cannot make a thing income which is not so in fact,' [ . . . ] it can label a thing income and tax it, so long as it acts within its constitutional authority, which includes not only the Sixteenth Amendment but also Article I, Sections 8 and 9."
Similarly, in Penn Mutual Indemnity Co. v. Commissioner, the United States Court of Appeals for the Third Circuit indicated that Congress could properly impose the federal income tax on a receipt of money, regardless of what that receipt of money is called:
It could well be argued that the tax involved here [an income tax] is an "excise tax" based upon the receipt of money by the taxpayer. It certainly is not a tax on property and it certainly is not a capitation tax; therefore, it need not be apportioned. [ . . . ] Congress has the power to impose taxes generally, and if the particular imposition does not run afoul of any constitutional restrictions then the tax is lawful, call it what you will.
Income tax rates in history
History of top rates
- In 1913, the top tax rate was 7% on incomes above $500,000 ($10 million 2007 dollars) and a total of $28.3 million was collected.
- During World War I, the top rate rose to 77% and the income threshold to be in this top bracket increased to $1,000,000 ($16 million 2007 dollars).
- Under Treasury Secretary Andrew Mellon, top tax rates were reduced in 1921, 1924, 1926, and 1928. Mellon argued that lower rates would spur economic growth. By 1928, the top rate was scaled down to 24% along with the income threshold for paying this rate lowered to $100,000 ($1 million 2007 dollars).
- During the Great Depression and World War II, the top income tax rate rose from pre-war levels. In 1939, the top rate was 75% applied to incomes above $5,000,000 ($75 million 2007 dollars). During 1944 and 1945, the top rate was its all-time high at 94% applied to income above $200,000.
- The highest marginal tax rate for individuals for U.S. federal income tax purposes for tax years 1952 and 1953 was 92%.
- Since 1964, the threshold for paying top income tax rate has generally been between $200,000 and $400,000. The one exception is the period from 1982–1992 when the top income tax brackets were removed and incomes above around $100,000 (varies by year) paid the top rate. From 1981 until 1986 the top marginal rate was lowered to 50%. From 1988–1990, the threshold for paying the top rate was even lower, with incomes above $29,750 to $32,450 ($51,000 in 2007 dollars) paying the top rate of 28% in those years.
- Top tax rates were increased in 1992 and 1994, culminating in a 39.6% top individual rate applicable to all classes of income.
- Top individual tax rates were lowered in 2004 to 35% and tax rates on dividends and capital gains lowered to 15%, with the Bush administration claiming lower rates would spur economic growth.
- Based on the summary of federal tax income data in 2009, with a tax rate of 35%, the highest earning 1% of people paid 36.7% of the United States’ income tax revenue.
- In 2012, President Obama announced plans to raise the two top tax rates from 35% to 39.6% and from 33% to 36%.
|History of income tax rates adjusted for inflation (1913-2010)|
|Number of||First Bracket||Top Bracket|
|1913||7||1%||7%||$500,000||$11.86M||First permanent income tax|
|1917||21||2%||67%||$2,000,000||$36.68M||World War I financing|
|1925||23||1.5%||25%||$100,000||$1.34M||Post war reductions|
|1941||32||10%||81%||$5,000,000||$79.86M||World War II|
|1942||24||19%||88%||$200,000||$2.75M||Revenue Act of 1942|
|1944||24||23%||94%||$200,000||$2.88M||Individual Income Tax Act of 1944|
|1964||26||16%||77%||$400,000||$3.03M||Tax reduction during Vietnam war|
|1981||16||14%||70%||$215,400||$563k||Reagan era tax cuts|
|1982||14||12%||50%||$85,600||$211k||Reagan era tax cuts|
|1987||5||11%||38.5%||$90,000||$186k||Reagan era tax cuts|
|1988||2||15%||28%||$29,750||$59k||Reagan era tax cuts|
|1991||3||15%||31%||$82,150||$142k||Omnibus Budget Reconciliation Act of 1990|
|1993||5||15%||39.6%||$250,000||$406k||Omnibus Budget Reconciliation Act of 1993|
|2003||6||10%||35%||$311,950||$398k||Bush tax cuts|
|2013||7||10%||39.6%||$400,000||$403k||American Taxpayer Relief Act of 2012|
Federal income tax rates
Federal and state income tax rates have varied widely since 1913. For example, in 1954, the federal income tax was based on layers of 24 income brackets at tax rates ranging from 20% to 91% (for a chart, see Internal Revenue Code of 1954).
Below is a table of historical marginal income tax rates for married filing jointly tax payers at stated income levels. Note that these income numbers are not the amounts used in the tax laws at the time.
|Historical income tax rates
not adjusted for inflation (1913–2010)
Sources of U.S. income tax laws
United States income tax law comes from a number of sources. These sources have been divided into three tiers as follows:
- Tier 1
- United States Constitution
- 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)
- 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;
- Treasury Notices and Announcements;
- Public Administrative Rulings (IRS Revenue Rulings, which provide informal guidance on specific questions and are binding on all taxpayers)
- Agency interpretative regulations (executive authority, written by the Internal Revenue Service (IRS) and Department of the Treasury), including:
- 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. 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.
The complexity of the U.S. income tax laws
United States tax law attempts to define a comprehensive system of measuring income in a complex economy. Many provisions defining income or granting or removing benefits require significant definition of terms. Further, many state income tax laws do not conform with federal tax law in material respects. These factors and others have resulted in substantial complexity. Even venerable legal scholars like Judge Learned Hand have expressed amazement and frustration with the complexity of the U.S. income tax laws. In the article, Thomas Walter Swan, 57 Yale Law Journal No. 2, 167, 169 (December 1947), Judge Hand wrote:
In my own case the words of such an act as the Income Tax… merely dance before my eyes in a meaningless procession: cross-reference to cross-reference, exception upon exception—couched in abstract terms that offer [me] no handle to seize hold of [and that] leave in my mind only a confused sense of some vitally important, but successfully concealed, purport, which it is my duty to extract, but which is within my power, if at all, only after the most inordinate expenditure of time. I know that these monsters are the result of fabulous industry and ingenuity, plugging up this hole and casting out that net, against all possible evasion; yet at times I cannot help recalling a saying of William James about certain passages of Hegel: that they were no doubt written with a passion of rationality; but that one cannot help wondering whether to the reader they have any significance save that the words are strung together with syntactical correctness.
Complexity is a separate issue from flatness of rate structures. Also, in the United States, income tax laws are often used by legislatures as policy instruments for encouraging numerous undertakings deemed socially useful — including the buying of life insurance, the funding of employee health care and pensions, the raising of children, home ownership, development of alternative energy sources and increased investment in conventional energy. Special tax provisions granted for any purpose increase complexity, irrespective of the system's flatness or lack thereof.
State, local and territorial income taxes
Income tax is also levied by most U.S. states and many localities on individuals, corporations, estates, and trusts. These taxes are in addition to federal income tax and are deductible for federal tax purposes. State and local income tax rates vary from 1% to 16% of taxable income. Some state and local income tax rates are flat (single rate) and some are graduated. State and local definitions of what income is taxable vary highly. Some states incorporate the federal definitions by reference. Taxable income is defined separately and differently for individuals and corporations in some jurisdictions. Some states impose alternative or additional taxes based on a second measure of income or capital.
States and localities tend to tax all income of residents. States and localities only tax nonresidents on income allocated or apportioned to the jurisdiction. Generally, nonresident individuals are taxed on wages earned in the state based on the portion of days worked in the state. Many states require partnerships to pay tax for nonresident partners.
Tax returns are filed separately for states and localities imposing income tax, and may be due on dates that differ from federal due dates. Some states permit related corporations to file combined or consolidated returns. Most states and localities imposing income tax require estimated payments where tax exceeds certain thresholds, and require withholding tax on payment of wages.
Puerto Rico is treated as a separate taxing entity from the USA; its income tax rates are set independently, and only some residents there pay federal income taxes (though everyone must pay all other federal taxes).[Note 1] The unincorporated territories Guam, American Samoa, and the Virgin Islands also impose income tax separately, under a "mirror" tax law based on federal income tax law.
Proposals for changes of income taxation
In 2005, the President's Advisory Panel for Federal Tax Reform criticized the tax system as being extremely complex, requiring detailed record-keeping, lengthy instructions, and complicated schedules, worksheets, and forms. They stated that it penalizes work, discourages saving and investment, and hinders the competitiveness of American business. "The tax code is commonly riddled with provisions that treat similarly situated taxpayers differently and create perceptions of unfairness." The panel's major reform push was for the removal of the Alternative Minimum Tax, which is not indexed for inflation.
Several organizations and individuals are working to change the income tax system in the United States including Citizens for Tax Justice, Americans for Tax Reform, Americans for Tax Fairness, Citizens for an Alternative Tax System, Americans For Fair Taxation, and FreedomWorks. Various proposals have been put forth for tax simplification in Congress including the Fair Tax Act and various Flat tax plans.
Proponents of a consumption tax argue that the income tax system creates perverse incentives by encouraging taxpayers to spend rather than save: a taxpayer is only taxed once on income spent immediately, while any interest earned on saved income is itself taxed. To the extent that this is considered unjust, it may be remedied in a variety of ways, e.g. excluding investment income from taxable income, making investments deductible and therefore only taxing them when gains are realized, or replacing the income tax by other forms of tax, such as a sales tax.
Taxation vs. the states
Some economists believe income taxation offers the federal government a technique to diminish the power of the states, because the federal government is then able to distribute funding to states with conditions attached, often giving the states no choice but to submit to federal demands.
Numerous tax protester arguments have been raised asserting that the federal income tax is unconstitutional, including discredited claims that the Sixteenth Amendment was not properly ratified. All such claims have been repeatedly rejected by the federal courts as frivolous.
In the United States, a progressive tax system is employed which equates to higher income earners paying a larger percentage of their income in taxes. According to the IRS, the top 1% of income earners for 2008 paid 38% of income tax revenue, while earning 20% of the income reported. The top 5% of income earners paid 59% of the total income tax revenue, while earning 35% of the income reported. The top 10% paid 70%, earning 46% and the top 25% paid 86%, earning 67%. The top 50% paid 97%, earning 87% and leaving the bottom 50% paying 3% of the taxes collected and earning 13% of the income reported.
From 1979 to 2007 the average federal income tax rate fell 110% for the second lowest quintile, 56% for the middle quintile, 39% for the fourth quintile, 8% for the highest quintile, and 15% for the top 1%, with the bottom quintile moving from a tax rate of zero to negative liability. Despite this, individual income tax revenue only dropped from 8.7 to 8.5% of GDP over that time, and total federal revenue was 18.5% of GDP in both 1979 and 2007, above the postwar average of 18%. Tax code changes have dropped millions of lower earning people from the federal income tax rolls in recent decades. Those with zero or negative liability who weren't claimed as dependents by a payer increased from 14.8% of the population in 1984 to 49.5% in 2009.
While there is consensus that overall federal taxation is progressive, there is dispute over whether progressivity has increased or decreased in recent decades, and by how much. The total effective federal tax rate for the top 0.01% of income earners declined from around 75% to around 35% between 1960 and 2005. Total effective federal tax rates fell from 19.1% to 12.5% for the three middle quintiles between 1979 and 2010, from 27.1% to 24% for the top quintile, from 7.5% to 1.5% for the bottom quintile, and from 35.1% to 29.4% for the top 1%.
A 2008 OECD study ranked 24 OECD nations by progressiveness of taxes and separately by progressiveness of cash transfers, which include pensions, unemployment and other benefits. The United States had the highest concentration coefficient in income tax, a measure of progressiveness, before adjusting for income inequality. The United States was not at the top of either measure for cash transfers. Adjusting for income inequality, Ireland had the highest concentration coefficient for income taxes. Overall income tax rates for the US are below the OECD average.
Effects on income inequality
According to the CBO, U.S. federal tax policies substantially reduce income inequality measured after taxes. Taxes became less progressive (i.e., they reduced income inequality relatively less) measured from 1979 to 2011. The tax policies of the mid-1980s were the least progressive period since 1979. Government transfer payments contributed more to reducing inequality than taxes.
- Hylton v. United States 3 U.S. 171 (1796)
- Internal Revenue Code § 212 – tax deductibility of investment expenses.
- Payroll taxes in the United States
- Tax Day
- Tax preparation
- Taxation of illegal income in the United States
- U.S. State Non-resident Withholding Tax
Other Federal taxation:
US State taxes:
- Contrary to common misconception, residents of Puerto Rico do pay U.S. federal taxes: customs taxes (which are subsequently returned to the Puerto Rico Treasury) (See Dept of the Interior, Office of Insular Affairs. DOI.gov), import/export taxes (See Stanford.wellsphere.com), federal commodity taxes (See Stanford.wellsphere.com), social security taxes (See IRS.gov), etc. Residents pay federal payroll taxes, such as Social Security (See IRS.gov) and Medicare (See Reuters.com), as well as Commonwealth of Puerto Rico income taxes (See Puertorico-herald.org and HTRCPA.com). All federal employees (See Heritage.org), those who do business with the federal government (See MCVPR.com), Puerto Rico-based corporations that intend to send funds to the U.S. (See p. 9, line 1.), and some others (For example, Puerto Rican residents that are members of the U.S. military, See Heritage.org; and Puerto Rico residents who earned income from sources outside Puerto Rico, See pp 14-15.) also pay federal income taxes. In addition, because the cutoff point for income taxation is lower than that of the U.S. IRS code, and because the per-capita income in Puerto Rico is much lower than the average per-capita income on the mainland, more Puerto Rico residents pay income taxes to the local taxation authority than if the IRS code were applied to the island. This occurs because "the Commonwealth of Puerto Rico government has a wider set of responsibilities than do U.S. State and local governments" (See GAO.gov). As residents of Puerto Rico pay into Social Security, Puerto Ricans are eligible for Social Security benefits upon retirement, but are excluded from the Supplemental Security Income (SSI) (Commonwealth of Puerto Rico residents, unlike residents of the Commonwealth of the Northern Mariana Islands and residents of the 50 States, do not receive the SSI. See Socialsecurity.gov), and the island actually receives less than 15% of the Medicaid funding it would normally receive if it were a U.S. state. However, Medicare providers receive less-than-full state-like reimbursements for services rendered to beneficiaries in Puerto Rico, even though the latter paid fully into the system (See p 252). In general, "many federal social welfare programs have been extended to Puerto Rican (sic) residents, although usually with caps inferior to those allocated to the states." (The Louisiana Purchase and American Expansion: 1803-1898. By Sanford Levinson and Bartholomew H. Sparrow. New York: Rowman and Littlefield Publishers. 2005. Page 167. For a comprehensive coverage of federal programs made extensive to Puerto Rico see Richard Cappalli's Federal Aid to Puerto Rico (1970)). It has also been estimated (See Egleforum.org) that, because the population of the Island is greater than that of 50% of the States, if it were a state, Puerto Rico would have six to eight seats in the House, in addition to the two seats in the Senate.(See Eagleforum.org, CRF-USA.org and Thomas.gov [Note that for the later, the official US Congress database website, you will need to resubmit a query. The document in question is called "House Report 110-597 - Puerto Rico Democracy Act of 2007." These are the steps to follow: THOMAS.gov > Committee Reports > 110 > drop down "Word/Phrase" and pick "Report Number" > type "597" next to Report Number. This will provide the document "House Report 110-597 - 2007", then from the Table of Contents choose "Background and need for legislation".). Another misconception is that the import/export taxes collected by the U.S. on products manufactured in Puerto Rico are all returned to the Puerto Rico Treasury. This is not the case. Such import/export taxes are returned only for rum products, and even then the US Treasury keeps a portion of those taxes (See the "House Report 110-597 - Puerto Rico Democracy Act of 2007" mentioned above.)
- JCX-49-11, Joint Committee on Taxation, September 22, 2011, pp 48, 50. http://www.jct.gov/publications.html?func=startdown&id=4363
- 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.
- "Iowa Tax / Fee Descriptions and Rates". Iowa.gov. Retrieved 7 December 2013.
- "2013 Tax Table". IRS. Retrieved 30 September 2014.
- 26 CFR.
- JCX-49-11, Joint Committee on Taxation, September 22, 2011, pp 4, 50. http://www.jct.gov/publications.html?func=startdown&id=4363
- "Line 40 Instructions". IRS. Retrieved 30 September 2014.
- Note: limit is 7.5% for those born prior to January 2, 1949 "Schedule A". IRS. Retrieved 30 September 2014.
- "Chart C—Other Situations When You Must File". IRS. Retrieved 30 September 2014.
- "Income inequality: Top 1 percent took record share of 2012 U.S. income, Associated Press, Sept. 10, 2013
- "The Distribution of Household Income and Federal Taxes, 2010". The US Congressional Budget Office (CBO). 2013-12-04. Retrieved 2014-01-06.
- IRS.gov – Publication 505, Chapter 2, 2011 Tax Rate Schedules
- IRS.gov – 2012 Tax Rate Tables
- Revenue Procedure 2013-15, sec. 2.01, Internal Revenue Service, U.S. Dep't of the Treasury (Jan. 2013).
- 26 USC 1411.
- Payroll Tax Cut to Boost Take-Home Pay for Most Workers
- "Effective Income Tax Rates". The New York Times. 2012-01-17.
- "Publication 15-A". Retrieved 30 September 2014.
- "The Distribution of Household Income and Federal Taxes, 2011". Congressional Budget Office. Retrieved 20 January 2015.
- 26 USC 61.
- 26 CFR 1.61-1(a).
- 26 USC 162, et seq.
- IRS Publication 535, Business Expenses; Fox chapter 22, Hoffman chapters 6 and 7, Pratt chapters 7 and 10.
- 26 USC 263.
- 26 USC 168, et seq, IRS Publication 946, How to Depreciate Property; Fox chapter 24, Hoffman chapter 8, Pratt chapter 9.
- 26 USC 1001, et seq., IRS Topic 409, Capital Gains and Losses, Fox chapters 13-14, Hoffman chapters 13-14, Pratt chapters 14-17.
- 26 USC 469, IRS Publication 925, Passive Activities. Losses from an activity are deductible against other income on disposal of the activity.
- 26 USC 151.
- 26 USC 262, 163, 164, 170; IRS Form 1040, Schedule A; Fox chapter 21, Hoffman chapter 10, Pratt chapter 11.
- 26 USC 265, et seq.
- 26 USC 68.
- 26 USC 121.
- See generally 26 USC 1045, IRS Topic 409, Capital Gains and Losses and Publication 535, above; Fox chapter 13, Hoffman chapters 13-14, Pratt chapters 16-17.
- Lowrey, Annie (2013-01-04). "Tax Code May Be the Most Progressive Since 1979". The New York Times. Retrieved 2014-01-06.
- http://www.irs.gov/Individuals/EITC-Income-Limits,-Maximum-Credit--Amounts-and-Tax-Law-Updates EITC website at irs.gov
- Fox, chapter 32; Hoffman, chapter 16; Pratt, chapter 5.
- Campbell, Andrea (September–October 2012). "America the Undertaxed, U.S. Fiscal Policy in Perspective". Foreign Affairs. Retrieved 1 October 2012.
- See subsection (a) of 26 U.S.C. § 871.
- See subsection (b) of 26 U.S.C. § 871.
- See paragraph (2) of subsection (a) of 26 U.S.C. § 871.
- US Constitution.net
- Hylton v. United States, 3 U.S. 171 (1796). Penn Mutual Indemnity Co. v. Commissioner, 227 F.2d 16, 19-20 (3rd Cir. 1960).
- Steward Machine Co. v. Davis, 301 U.S. 548 (1937), 581-582
- "A History of Taxation". Taxworld. Retrieved 7 December 2013.
- Joseph A. Hill, "The Civil War Income Tax," Quarterly Journal of Economics Vol. 8, No. 4 (Jul., 1894), pp. 416-452 in JSTOR; appendix in JSTOR
- Revenue Act of 1861, sec. 49, ch. 45, 12 Stat. 292, 309 (Aug. 5, 1861).
- Sections 49, 51, and part of 50 repealed by Revenue Act of 1862, sec. 89, ch. 119, 12 Stat. 432, 473 (July 1, 1862); income taxes imposed under Revenue Act of 1862, section 86 (pertaining to salaries of officers, or payments to "persons in the civil, military, naval, or other employment or service of the United States ...") and section 90 (pertaining to "the annual gains, profits, or income of every person residing in the United States, whether derived from any kind of property, rents, interest, dividends, salaries, or from any profession, trade, employment or vocation carried on in the United States or elsewhere, or from any other source whatever....").
- Charles F. Dunbar, "The New Income Tax," Quarterly Journal of Economics, Vol. 9, No. 1 (Oct., 1894), pp. 26-46 in JSTOR.
- Chief Justice Fuller's opinion, 158 U.S. 601, 634.
- United States Government Printing Office, at Amendments to the Constitution of the United States of America; see generally United States v. Thomas, 788 F.2d 1250 (7th Cir. 1986), cert. denied, 107 S.Ct. 187 (1986); Ficalora v. Commissioner, 751 F.2d 85, 85-1 U.S. Tax Cas. (CCH) paragr. 9103 (2d Cir. 1984); Sisk v. Commissioner, 791 F.2d 58, 86-1 U.S. Tax Cas. (CCH) paragr. 9433 (6th Cir. 1986); United States v. Sitka, 845 F.2d 43, 88-1 U.S. Tax Cas. (CCH) paragr. 9308 (2d Cir.), cert. denied, 488 U.S. 827 (1988); United States v. Stahl, 792 F.2d 1438, 86-2 U.S. Tax Cas. (CCH) paragr. 9518 (9th Cir. 1986), cert. denied, 107 S. Ct. 888 (1987); Brown v. Commissioner, 53 T.C.M. (CCH) 94, T.C. Memo 1987-78, CCH Dec. 43,696(M) (1987); Lysiak v. Commissioner, 816 F.2d 311, 87-1 U.S. Tax Cas. (CCH) paragr. 9296 (7th Cir. 1987); Miller v. United States, 868 F.2d 236, 89-1 U.S. Tax Cas. (CCH) paragr. 9184 (7th Cir. 1989); also, see generally Boris I. Bittker, Constitutional Limits on the Taxing Power of the Federal Government, The Tax Lawyer, Fall 1987, Vol. 41, No. 1, p. 3 (American Bar Ass'n).
- Memorandum Opinion, p. 14, Dec. 17, 2007, docket entry 106, United States v. Benson, case no. 1:04-cv-07403, United States District Court for the Northern District of Illinois, Eastern Division.
- Memorandum Opinion, p. 9, Dec. 17, 2007, docket entry 106, United States v. Benson, case no. 1:04-cv-07403, United States District Court for the Northern District of Illinois, Eastern Division.
- 348 U.S. at 429
- Id. at 430.
- Id. at 432-33.
- Id. at 27.
- Opinion on rehearing, July 3, 2007, p. 16, Murphy v. Internal Revenue Service and United States, case no. 05-5139, United States Court of Appeals for the District of Columbia Circuit, 2007-2 U.S. Tax Cas. (CCH) paragr. 50,531 (D.C. Cir. 2007).
- Penn Mutual Indemnity Co. v. Commissioner, 277 F.2d 16, 60-1 U.S. Tax Cas. (CCH) paragr. 9389 (3d Cir. 1960) (footnotes omitted).
- "U.S. Federal Individual Income Tax Rates History, 1913-2011". Tax Foundation. 9 September 2011.
- "Distribution of the Income Tax". The Independent. Jul 20, 1914. Retrieved August 23, 2012.
- Tax History Project, under year 1920.
- Page 12 of Instructions for 1952 Form 1040, Internal Revenue Service, U.S. Dep't of the Treasury; page 12 of Instructions for 1953 Form 1040, Internal Revenue Service, U.S. Dep't of the Treasury.
- History of Federal Individual Income Bottom and Top Bracket Rates. Retrieved 2010-02-04.
- Logan, D. S. (2011, October 24). Summary of latest federal individual income tax data. Tax Foundation. Retrieved from http://www.taxfoundation.org/
- Outline of major tax law provisions in 2013 under multiple scenarios. (2012, April 12). Tax Foundation. Retrieved from http://www.taxfoundation.org/
- Personal Exemptions and Individual Income Tax Rates: 1913-2002, Internal Revenue Service
- U.S. Federal Individual Marginal Income Tax Rates History, 1913-2009, The Tax Foundation.
- U.S. Federal Individual Income Tax Rates History, 1913-2011 (Nominal and Inflation-Adjusted Brackets)Tax Foundation. Accessed: 10 November 2011.
- Samuel A. Donaldson, Federal Income Taxation of Individuals: Cases, Problems and Materials, 4 (2nd Ed. 2007).
- See, e.g., CCH 2013 State Tax Handbook, ISBN 978-0-8080-3227-4, Fox Income Tax in the USA, appendix, ISBN 978-0-9851-8233-5, ASIN B00BCSNOGG.
- All residents of PR pay federal taxes, with the exception of federal income taxes which only some residents of Puerto Rico must still pay.
- "America Needs a Better Tax System". The President’s Advisory Panel on Federal Tax Reform. 2005-04-13. Retrieved 2007-01-28.
- John Stuart Mill's argument, reported by Marvin A. Chirelstein, Federal Income Taxation, p. 433 (Foundation Press, 10th Ed., 2005)
- Chirelstein, loc.cit.
- "The Truth About Frivolous Tax Arguments". 2013-03-04. Retrieved 2013-07-30.
- "The Distribution of Household Income and Federal Taxes 2011". Congressional Budget Office, US Government. November 2014.
- McCormally, Kevin (2010-12-18). "Where Do You Rank as a Taxpayer?". Kiplinger. Retrieved 2010-06-18.
- Reynolds, Alan (May 3, 2011). "The Increasing Progressivity of U.S. Taxes: And the Shrinking Tax Base". Cato Institute. Retrieved 18 January 2014.
- Bluey, Rob (February 19, 2012). "Chart of the Week: Nearly Half of All Americans Don’t Pay Income Taxes". Heritage Foundation. Retrieved 28 October 2013.
- Will Freeland; Scott A. Hodge (July 20, 2012). "Tax Equity and the Growth in Nonpayers". Tax Foundation. Retrieved 28 October 2013.
- Thomas Piketty; Emmanuel Saez (2007). "How Progressive is the U.S. Federal Tax System? A Historical and International Perspective". Journal of Economic Perspective 21 (1): 23–24. Retrieved 25 January 2014.
- Michael D. Stroup; Keith Hubbard (August 2013). "An improved index and estimation method for assessing tax progressivity". Mercatus Center, George Mason University. Retrieved 18 January 2014.
- "The Distribution of Household Income and Federal Taxes, 2010". Congressional Budget Office. December 4, 2013. Retrieved 21 January 2014.
- Growing Unequal?: Income Distribution and Poverty in OECD Countries, OECD Publishing, ISBN 978-92-64-04418-0, 2008, pgs. 103, 104.
- IRS Publication 17, Your Federal Income Tax
- IRS Publication 334, Tax Guide for Small Business
- IRS Publication 509, Tax Calendar
- IRS Publication 541, Partnerships
- IRS Publication 542, Corporations
- IRS Publication 544, Sales and Other Dispositions of Assets
- IRS Publication 556 Examination of Returns, Appeal Rights, and Claims for Refund
- IRS Tax Topics
- IRS videos on tax topics
- IRS links to state websites
Law & regulations:
- Fox, Stephen C, Income Tax in the USA. 2013 edition ISBN ISBN 978-0-9851-8233-5, ASIN B00BCSNOGG.
- Hoffman, William H. Jr.; Willis, Eugene; et al., South-Western Federal Taxation. 2013 edition ISBN 978-1-1331-8955-8, ASIN B00B6F3AWI.
- Pratt, James W.; Kulsrud, William N.; et al, Federal Taxation". 2013 edition ISBN 978-1-1334-9623-6.
- Whittenberg, Gerald; Altus-Buller, Martha; Gill, Stephen, Income Tax Fundamentals 2010. 2013 edition ISBN 978-1-1119-7251-6, ASIN B00B6FBDHW.
- Thorndike, Joseph J. Their Fair Share: Taxing the Rich in the Age of FDR. Washington, DC: Urban Institute, 2013.
Reference works (annual):
- CCH U.S. Master Tax Guide, 2013 ISBN 978-0-8080-2980-9
- RIA Federal Tax Handbook 2013 ISBN 978-0-7811-0472-2
Consumer publications (annual):