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Individual Income Tax

The U.S. tax system is set up so that most Americans who earn income must pay the federal income tax. It is also an important source of government funding, with roughly 50% of federal revenue coming from annual income tax payments. Due to the importance of individual income tax revenue, collecting it is a high priority for the federal government.

Congress established the Internal Revenue Service (IRS) as the federal agency responsible for assessing and collecting taxes, including individual and corporate income tax. The IRS is also responsible for implementing the rules and regulations governing income tax collection and is often responsible for interpreting the tax laws written by Congress.

The following sections will provide an overview of the individual income tax, including who must pay the tax and how the IRS determines how much of your income is taxable.

Federal Individual Income Tax

The federal government imposes a tax on the income of individuals, businesses, trusts, and other entities. The individual income tax is assessed on all the earnings that make up an individual's taxable income, including wages, salaries, bonuses, tips, and commissions. The government also taxes unearned income, which includes income from investments.

The federal individual income tax system is progressive in that, as an individual's income increases, their tax rate usually increases along with it. Individual income tax rates run from 10% to 37% percent, based on income thresholds set by the IRS each winter for the following tax year.

In addition to raising revenue, the individual income tax serves a social function by allocating resources, subsidizing some persons or activities, encouraging certain kinds of economic and social behavior, redistributing wealth, stimulating economic growth, and addressing specific social problems such as pollution and urban decay.

Determining Your Taxable Income

While you need to report your total income to the IRS each year, you are not taxed on the full amount you earn. The IRS will make adjustments to your gross income and subtract deductions from your adjusted gross income to arrive at the taxable income used to calculate the tax due.

Gross Income

Your gross income is your total income from all sources. If you file a joint return with your spouse, your gross income will be your combined income.

Individuals and married couples must file federal returns if their gross income exceeds a specified threshold based on their age, marital status, and other factors that the IRS adjusts each year for inflation. For example, for the 2022 tax year, single individuals under the age of 65 were not required to file if their gross income was $12,950 or less (it was $14,700 for taxpayers 65 and over).

Most of an individual's income is taxable unless specifically excluded from gross income by the tax code. Items that are excluded from gross income include life insurance death benefits, child support, and welfare payments.

Adjusted Gross Income

Once your gross income has been calculated, certain adjustments are subtracted from that amount to determine your adjusted gross income. Common adjustments include payments into retirement accounts, contributions to medical savings accounts, and student loan interest. Your adjusted gross income is used to determine your tax bracket, which, in turn, will be used to establish your federal income tax rate.

Tax Deductions

Taxpayers are allowed to make additional deductions from their adjusted gross income. These generally fall into two categories: the standard deduction and itemized deductions. It is important to understand the difference between the two because you are only allowed to use one, and the choice could significantly impact your tax bill.

Standard Deduction

All U.S. citizens and residents are entitled to claim the standard deduction, which was added to the tax code in 2017 to replace the personal exemption. The amount of the standard deduction is based on your filing status and is adjusted by the IRS each year for inflation. For 2023, the standard deduction for single filers is $13,850, for married filing jointly it is $27,700, and it is $20,800 for heads of households.

Non-resident noncitizens and dual-status noncitizens are not entitled to the deduction and must itemize.

Itemized Deductions

While most taxpayers choose the standard deduction, taxpayers have the option of itemizing their deductions if it saves them money on their tax bill. Common itemized deductions include:

  • Donations to tax-exempt nonprofit organizations
  • Mortgage interest
  • State income taxes
  • Local taxes
  • Sales taxes
  • Property taxes

Tax Credits

While they are often confused with tax deductions, tax credits offer a dollar-for-dollar reduction of the amount of tax you owe after any deductions have been claimed. Additionally, while you can only claim deductions up to the amount of income you receive, tax credits can be refundable.

A refundable tax credit means that when the amount of the credit is worth more than the tax you owe, you will receive a refund for the difference. For example, if you owed $500 in taxes and received a $1,000 tax credit, you would receive a $500 tax refund.

Congress likes to use tax credits to provide federal benefits to Americans as part of its tax policy. For example, it instituted the earned income tax credit (EITC) to provide a boost to qualifying low-income workers and the child tax credit to benefit parents.

Estimated Taxes

If you work for an employer, it is usually required to withhold a portion of your income each pay period and submit it to the IRS to cover your anticipated tax obligations. However, if you are earning income that is not subject to withholding, the IRS will require you to pay estimated taxes each quarter. This keeps these taxpayers from needing to pay their tax bill as a lump sum each year.

Individuals who are often subject to withholding include the self-employed, contract workers, and those who earn most of their income from investments.

Marginal Tax Rates

Because the income tax is progressive, you generally pay a lower overall rate than that for your federal income tax bracket. This overall rate is your marginal tax rate.

For example, if you were single and earned $75,000 in 2023, you would be in the 22% tax bracket. However, you would pay a 10% rate on the first 11,000 in income, 12% on income between $11,001 and $44,725, and 22% on income above $44,725. If you claim the standard deduction, your entire tax bill for 2023 would be $8,761, which would give you a marginal tax rate of 11.7%.

Capital Gains Taxes

The money you earn from investments in assets like property and stocks that you own for more than one year is not taxed as income. The profits you make from the sale of these assets are known as capital gains and are subject to the capital gains tax, which is usually lower than the income tax would be on those profits. The maximum capital gains tax rate is 20%, which is substantially lower than the highest income tax rate of 37%.

Other Individual Taxes

While the largest tax bill for most individuals will be their personal income tax liability, there are other types of taxes they must pay on their income. These include payroll taxes, such as Social Security and Medicare taxes. There are additional taxes that may apply to your individual income tax bill, such as self-employment taxes, household employment taxes, tax on early distributions from retirement plans, and the alternative minimum tax.

When To File Individual Income Tax Returns

Individual income tax returns are due on April 15 in the year after the tax year, but the tax filing date can be later if April 15 falls on a weekend or holiday. Although taxpayers can file for an automatic six-month extension for filing their return, the taxes are due by April 15. The IRS can impose penalties and interest for failure to pay the taxes owed by April 15 or failure to file by the due date (either April 15 or the extended date.)

State Income Taxes

Most states also collect an individual income tax. Taxpayers are potentially subject to state income tax in their state of residence and in any state where they work. Many states determine a resident's taxable income in a manner that is similar to that used by the federal government.

Still Have Questions? Talk to a Tax Lawyer

If you have questions about your federal income tax return, a local tax attorney can help. People can have complicated personal or financial situations that require the help of an expert to find the proper tax forms and fill them out appropriately. A tax lawyer is skilled at tax preparation and can help you resolve complex tax issues.

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