Federal Tax Laws

All U.S. citizens and permanent residents must meet their federal tax obligations, even if they are working overseas. While you will only pay taxes to state and local governments when you live within their borders, federal taxes apply regardless of where you live.

The sections that follow provide a brief overview of federal tax law. Unfortunately, U.S. tax law is extremely complicated. This is why many Americans turn to professional tax preparers to prepare the tax forms that are part of their federal tax returns every year.

U.S. Tax Code

Nearly all U.S. tax laws are included in the Internal Revenue Code (IRC), which is part of the United States Code. The U.S. Code is the set of laws that Congress established to set rules for the operations of the federal government. The official title of the tax code is U.S.C. Title 26, but most references to the IRC only include the section number. For example, you would say nonprofits are governed by Section 501(c)(3).

The IRS then establishes specific rules that apply to many of the provisions in the IRC based on their reading of the statute. These rules are issued in the form of treasury regulations (the IRS is a division of the Treasury Department) that are included in the Code of Federal Regulations. But they are usually just called "tax regulations." The IRS also issues revenue rulings after taxpayers ask it to apply a law or regulation to a specific tax situation.

Most states with an income tax have a tax code modeled on the IRC. However, there are sometimes significant differences between the rules that apply to state income taxes and the federal rules.

Federal Income Tax

The federal income tax is a tax imposed on the income of every U.S. citizen and resident, as well as all businesses operating in the United States. It requires filing an income tax return each year. For individual taxpayers, the amount they pay is based on their taxable income, which is the total of the wages, salaries, commissions, bonuses, investment income, and other payments they receive over the course of the tax year.

The U.S. income tax system is based on progressive tax rates ranging from 10% to 37%, which is based on your income. Under a progressive tax system, the more income you receive, the higher your tax rate. The government sets specific income thresholds each year, so the cutoff point for each tax bracket changes.

Yet, this tax rate only applies to the top portion of your earnings. Taxpayers pay the same rate for income up to each threshold. For example, your income tax rate might be as high as 24% based on your total taxable income, but you might only pay 10% on, say, the first $10,000 you earned. Again, the amount for each bracket usually changes every year. Check IRS guidelines to see the most current threshold amounts. 

It is important to remember that federal income tax liability is based on your taxable income, which often does not include all the income you earn each year. Taxable income is usually calculated as your adjusted gross income (AGI), minus the standard deduction or itemized deductions. AGI is your income after subtracting certain adjustments, such as business expenses or student loan payments.

The IRC also provides a tax exemption for things like payments from certain retirement accounts and gifts under a specified amount.

Types of Taxable Income

Taxable income generally falls into two categories: earned and unearned. Some examples of earned income include:

• The pay you receive working for an employer
• Income from a business you own
• Retirement benefits, including pensions
• Unemployment benefits
• Self-employment income

Unearned income is often referred to as "passive income" and usually comes from one of the following sources:

• Selling assets
• Real estate rental income
• Interest
• Dividends

Deductions, Credits, and Exemptions

Taxpayers can reduce their tax bill by taking advantage of tax deductions and tax credits. A tax deduction is when you reduce the amount of taxed income. A tax credit is when the amount of tax you owe is reduced by a specified dollar amount. An exemption is similar to a deduction in that it reduces your taxable income, but it is usually subject to fewer restrictions.

Other Federal Taxes

While the federal income tax is usually the largest tax bill an individual pays each year, there are other types of federal taxes, including:

• Social Security taxes
• Medicare taxes
• Capital gains taxes
• Excise taxes on certain goods

Questions About Federal Tax Laws? Talk to a Lawyer

It is not uncommon for taxpayers to have questions about how the federal income tax applies to their financial situation. A local tax attorney is a trained tax professional who can assess your financial circumstances. They can determine how your tax information should be reported on your federal income tax return. Most tax attorneys can also apply income tax law to help with tax planning to ensure that your financial affairs are set up to reduce your future tax bills.