Federal Taxes

Most Americans know about the federal income tax because they must file an annual individual income tax return with the Internal Revenue Service (IRS) each year. But the federal government funds its expenditures by levying taxes on far more than people's income. For example, corporations and trusts must also pay income tax. The federal government imposes taxes beyond the income tax, such as capital gains and Social Security taxes.

This article discusses the different types of federal taxes the government collects and who pays them.

The Federal Tax System

The Internal Revenue Code (IRC) in the U.S. Code contains all the federal laws governing tax revenue, including income, employment, estate, gift, alcohol, and tobacco taxes. Congress wrote the IRC, and it governs most of the operations of the IRS. The IRS is the agency within the U.S. Treasury Department that oversees tax assessments and tax collection.

The IRS also interprets the tax code and provides taxpayers with tax guidance via various publications, notices, rulings, and statements. While the IRS is the agency given the most responsibility for interpreting federal tax law, if a taxpayer disagrees, they can challenge the IRS in federal court. If a judge determines that the IRS misinterpreted a tax statute, the agency must abide by their ruling.

Personal Income Tax

The government bases your personal income tax on the wages, salaries, dividends, interest, and other income you earn during the tax year. You generally must file your personal income tax return for the previous year on April 15, but the IRS can push that date back to as late as April 18, depending on whether it falls on a weekend or holiday.

Does Everyone Need to File?

People who earn less than a specified amount do not have to file a personal income tax return. For example, you don't need to file a return if you are under 65 and earn less than $12,950 in 2022 ($14,700 for those 65 and older). The government adjusts the threshold for filing a return annually for inflation. It varies depending on age and whether the filer is single, married, or head of household. Check out the IRS website for more information on which thresholds apply to you.

Even if you are under the filing threshold, it is generally a good idea to file a return even if you owe no taxes. That is because the federal government uses income tax returns to distribute financial benefits. Many low-income taxpayers are eligible for the earned income tax credit (EITC), which the government distributes in the form of a tax refund, even if you paid no taxes. But you can only claim the credit by filing a return. During the COVID-19 pandemic, the federal government provided a child tax credit to help distressed taxpayers, but that credit is no longer available.

Do Nonresidents Need to File?

The United States imposes an income tax on all its citizens and permanent residents, no matter where they live. Thus, U.S. citizens living abroad and permanent residents who may be working outside of the country are still treated the same as U.S. residents for tax purposes and must pay taxes on all their income.

How is Your Tax Calculated?

The federal income tax is a "graduated tax" in that taxpayers at higher income levels generally pay taxes at higher rates, with their tax rate increasing as their income increases. In theory, this means high earners pay more taxes than those earning less, but high-income taxpayers can often offset a large part of their income with deductions to lower their tax bill substantially.

Each fall, the IRS updates its income tax brackets for the upcoming year. These tax brackets determine the tax rates for income earned by individual taxpayers during the year. For example, if you earn $50,000 in 2023, you will fall into the 22% tax bracket. But, due to the way the IRS calculates the individual income tax rate, you will only pay the 22% rate on some of your income. You would pay 10% on the first $11,000 of income and 12% on all income between $11,001 and $44,725. Then, any income over $44,725 is taxed at 22%. Thus, you will only pay the 22% rate on the final $5,275 you earn ($50,000 minus $44,725).

What Income is Taxed?

It may come as a surprise, but the IRS doesn't use all the income you earn during the year to calculate your tax bill. This income will sometimes include Social Security benefits above a set amount. You can claim tax deductions and make other adjustments to reduce the income subject to tax. First, a taxpayer subtracts such items as student loan interest and contributions to retirement accounts from their total income to arrive at their adjusted gross income (AGI). The taxpayer then subtracts any deductions they are eligible to claim to arrive at their taxable income.

Most Americans claim the standard deduction based on their filing status. For 2023, the standard deduction was $13,850 for single taxpayers, $27,700 for married taxpayers filing jointly, and $20,800 for heads of household. But, if you have other deductions that total more than the standard deduction, you can itemize your deductions. Common itemized deductions include charitable contributions, property taxes, state taxes, local taxes, and sales taxes.

Other Types of Federal Taxes

The following sections provide a brief overview of some of the taxes that the federal government collects.

Employment Taxes

The income tax is not the only tax you will pay based on your earnings. Your Social Security taxes and Medicare taxes are also assessed as a percentage of your earnings. These payroll taxes are unusual in that your employer covers half of your tax burden. That means the 6.2% Social Security tax you pay on your earnings is matched by a 6.2% payment from your employer. Your employer also matches the 1.45% Medicare tax rate.

If you are self-employed, there is no employer to cover half of your Social Security and Medicare taxes. That means you must pay the entire 15.3% yourself. Fortunately, you can deduct half of that amount from your income for the year.

Estate Taxes

After the passage of the 2017 Tax Cuts and Jobs Act, most Americans no longer needed to worry about the estate tax. The legislation included a large estate tax exemption that gets adjusted for inflation each year. For 2023, the individual estate tax exemption is $12.92 million ($25.84 million per married couple). For estates above those amounts, the estate tax rate runs from 18% to 40%.

Gift Taxes

A gift's giver pays the federal gift tax, not the recipient. It applies to any transfer of money or assets where the recipient does not give something of equal value in return. But the IRS excludes gift amounts of $17,000 or less ($34,000 for married couples) from the tax. For gifts that exceed the exclusion amount, the IRS taxes the gift at 18% to 40%, depending on the size.

Capital Gains Taxes

When you sell an asset that you've had for longer than one year, you pay capital gains taxes on the profits from the sale. This usually applies to the sale of items like real estate, stocks, and bonds. As a general rule, the capital gains tax rate is lower than the income tax rate as part of a tax policy that encourages long-term investments.

Corporate Income Tax

Companies registered as C corporations during their fiscal year pay a corporate income tax on business income. This business tax usually only applies to large companies because most small businesses operate as sole proprietorships, partnerships, or S corporations, that are taxed like partnerships.

Excise Taxes

We pay excise taxes on specific goods, services, and activities. We pay excise taxes on things like tobacco, airline tickets, fuel, and heavy trucks.

More Questions? Talk to a Tax Lawyer

Federal taxes are often complex, and many taxpayers need help figuring out how tax laws apply to their personal tax situation. That's where a skilled local tax attorney can help. A tax lawyer can help you determine which taxes you must pay and your tax liability. If you owe the IRS money, a tax attorney can help you get tax relief by helping set up a payment plan or negotiating an offer in compromise.