income tax

income tax,

assessment levied upon individual or corporate incomes. Although personal incomes were occasionally taxed in medieval Italian cities, the income tax is essentially a modern form of taxation. The first important income tax was levied in Great Britain from 1799 to 1816 in order to raise funds for the Napoleonic Wars. After several other temporary income taxes, Britain adopted a permanent one in 1874. The first income tax in the United States was imposed in 1864, during the Civil War, but was discontinued in 1872. Various European countries, as well as Australia, New Zealand, and Japan, adopted regular income taxes during the latter half of the 19th cent.

In the United States, the income tax law of 1894 was declared unconstitutional on the grounds that it was a direct tax not apportioned according to state population. The adoption of the Sixteenth Amendment (1913) permitted both the corporate and individual income tax to become a lawful element in the federal tax structure. Since then they have been a major source of revenue for the federal government, yielding as much as 85% of all its receipts in some years. Income taxes had been levied sporadically by various states since 1789; since 1919 most states have adopted the tax. The first major American city to impose a tax on incomes was Philadelphia (1939).

In general, personal incomes below a certain amount are exempted from the individual income tax, with the actual income subject to tax affected by exemptions, deductions, credits, and the like. The tax is applied to the net income remaining after these modifications, and the rate becomes progressively higher for larger incomes. From the mid-1960s until 1982 the tax rate ranged from about 15% for the lowest brackets to about 70% for the highest, with a similar structure for corporate income taxes. In 1982, Congress passed President ReaganReagan, Ronald Wilson
, 1911–2004, 40th president of the United States (1981–89), b. Tampico, Ill. In 1932, after graduation from Eureka College, he became a radio announcer and sportscaster.
..... Click the link for more information. 's plan to cut the highest rate on personal income tax from 70% to 50% and the capital gains tax from 50% to 20%. The Tax Reform Act of 1986 further lowered the maximum marginal tax rates from 50% to 28%, the lowest since the 1920s. A top rate of 31% was added in 1991, and additional rates of 36% and 39.6% for the wealthiest individuals were approved in 1993. Under changes enacted in 1997, the tax rate on most long-term capital gains is 20%—10% for people in the 15% tax bracket; the rate is slightly lower for investments held at least five years. Further changes enacted under President George W. BushBush, George Walker,
1946–, 43d President of the United States (2001–9), b. New Haven, Conn. The eldest son of President George H. W. Bush, he was was raised in Texas and, like his father, attended Phillips Academy in Andover, Mass., and Yale, graduating in 1968.
..... Click the link for more information. in 2001 reduced the rate in the lowest income-tax bracket to 10% and called for the tax rates of all brackets above the 15% rate to be reduced to 25%, 28%, 33%, and 35% by 2006; the changes became permanent, with the exception of the restoration of a 39.6% top rate, in 2013. A tax overhaul signed by President Trump in 2017 altered the income tax brackets somewhat, to 10%, 12%, 22%, 24%, 32%, 35%, and 37%, but also shifted the ranges of income in those brackets and greatly altered exemptions, deductions, and other rules used to determine net income. The most significant changes, however, affected the corporate income tax, including dropping the rate from 35% to 21%. In many states and cities, lowered federal income taxes have been offset by higher state and local income and property taxes. In the 1980s and 90s, the call for a "flat tax"—a single tax rate (around 17%–20%) for individuals and businesses—was a recurring campaign issue among American conservatives. Such an income tax has been adopted by a number of E European countries.

Bibliography

See D. J. Gaffney and D. H. Skadden, Principles of Federal Income Taxation (1982); J. Creedy, The Dynamics of Income Distribution (1985); M. Levi, Of Rule and Revenue (1988).

Income Tax

the chief type of direct tax collected from the wages, profits, and other revenues of natural and legal (artificial) persons.

In capitalist countries. The income tax was instituted in Great Britain in 1842, in Japan in 1887, in Germany in 1891, in the United States in 1913, in France in 1914, and in prerevolutionary Russia in January 1917. In Great Britain, Italy, Sweden, and Switzerland the incomes of natural and legal persons are subject to one general income tax. In the United States, France, the Federal Republic of Germany, and certain other countries, an income tax is collected from individuals, while legal persons are taxed according to a special tax on corporate profits.

Two systems for determining the structure of income taxes are used: the schedule system and the universal system. The schedule system originated in Great Britain and has been preserved in Italy and a few other countries. Under this system, incomes are divided according to their sources, into parts called schedules, each of which is taxed separately. Two taxes are collected: the basic tax at a proportional rate and the surtax at a progressive rate. The universal system first appeared in Prussia and is used in most countries, including the United States, France, the Federal Republic of Germany, and Japan. Under this system, the income tax is collected on the total annual income according to a progressive rate scale. Thus, in the United States, the minimum income tax rate is 14 percent, on incomes up to $500, and the maximum is 70 percent, on incomes of $100,000 or more. In Great Britain the corresponding figures are 30 percent, on incomes up to £5,000, and 75 percent, on incomes of more than £20,000, and in France, 10 percent, on incomes up to 11,500 francs and 60 percent, on incomes of more than 173,000 francs. The highly graduated tax on very large incomes hardly touches the profits of the capitalists, because the capitalists enjoy tax advantages and various deduction allowances. As a result, their incomes are taxed primarily at low and medium rates.

In the period of the general crisis of capitalism, the income tax is becoming more important as a means of increasing the exploitation of the workers by raising the rates for low incomes and reducing the exemptions, or untaxed minimum income. These changes have broadened the range of persons paying income tax. Thus in the United States, the number of taxpayers has grown from 3 million in 1938 to 66 million in 1972, that is, by a factor of 22. As a result of state-monopoly intervention in the economy, the income tax has become one of the chief sources of revenue for the state budgets of the capitalist countries, serving as a tool for redistribution of national income in favor of the monopolies. For example, in the United States, income tax revenues were $1.3 billion in 1937–38, or 22.4 percent of the total federal budget, while the figure for 1973–74 was $129 billion, or about 44 percent of all federal revenues.

In socialist countries. The income tax is one of the sources of state budgetary income and is used to regulate the income and savings of various social groupings and of cooperative enterprises and social and public organizations.

In the USSR, income tax is paid by the population, kolkhozes, consumer cooperatives, and the economic agencies of social and public organizations. A national income tax, in combination with a property tax, was instituted by a Nov. 16, 1922, decree. Known as the income and property tax, this combined tax replaced the previously existing income tax, which had ceased to be collected in early 1921. In 1924 the income and property tax was converted to an income tax. The tax is computed at rates that are differentiated by groups of taxpayers and amount of income. Five main groups of taxpayers are distinguished: production workers, clerical and professional employees, and other persons placed in the same category for tax purposes; writers and those employed in the arts; doctors, teachers, and others with private practices; craftsmen; and persons who receive income from work not done for wages. Income tax rates are progressive. They are lower for the first group of taxpayers and highest for the last. The maximum tax rate on the wages of production workers and clerical and professional employees is 13 percent. This maximum rate is applied to wages of more than 100 rubles a month. Significant concessions have been established for certain categories of income-tax payers. Low-paid workers do not have to pay income taxes. Production workers and clerical and professional employees enjoy tax exemptions on minimum incomes of 60 rubles a month, and in some regions the exemption is 70 rubles. Since 1973, taxes have been cut an average of 35.5 percent for production workers and clerical and professional employees receiving wages of 71–90 rubles a month in regions where the minimum wage is 70 rubles a month.

An income tax on kolkhozes, including a tax on the agricultural incomes of fishing kolkhozes, was instituted in 1936, in place of the previously collected agricultural tax. The tax is paid quarterly. Since 1966, income tax has been imposed as follows: a kolkhoz’s net income that exceeds a rate of profit of 15 percent is taxed at 0.3 percent for each percentage of profitability above 15 percent, to a maximum rate of 25 percent. At kolkhozes where the wages fund exceeds an average of 60 rubles a month per working kolkhoz member the fund is taxed at a rate of 8 percent. Kolkhozes based on the resources of new arrivals and kolkhozes made up of the peoples who populate the frontiers of the USSR do not have to pay income tax.

An income tax on consumer cooperatives and on the economic agencies of social and public organizations was introduced in 1923. It is paid quarterly at a rate of 35 percent of the profit shown in the bookkeeping balance for consumer cooperatives and at 25 percent of the balance profit for the economic agencies of social and public organizations. Newly organized consumer-cooperative enterprises that prepare goods from local raw materials and scrap are exempt from income taxes for two years. Clubs, palaces of culture, and economic organizations that are managed by party and Komsomol organizations are tax-exempt.

In other socialist countries, income tax is paid by the population and by cooperative enterprises. Income tax from the population is collected at progressive rates that are computed according to the form of income and category of the taxpayer. In Bulgaria, for example, wages and other forms of labor payment are taxed at rates of 2 to 12 percent. Higher rates are established for the incomes of artisans, merchants, and others. In the German Democratic Republic, income tax rates for wageworkers range from 0.4 to 20 percent, depending on family and social status.

Income taxes on cooperative enterprises are paid primarily by the economic agencies of consumer and producer cooperatives. Tax rates are usually differentiated according to the form and amount of income and the level of enterprise profitability.

REFERENCES

See references under TAXES.

G. F. EREMEEVA

income tax

a personal tax, usually progressive, levied on annual income subject to certain deductions

income tax

Related to income tax: Income Tax Rates

Income Tax

A charge imposed by government on the annual gains of a person, corporation, or other taxable unit derived through work, business pursuits, investments, property dealings, and other sources determined in accordance with the Internal Revenue Code or state law.

Taxes have been called the building block of civilization. In fact, taxes existed in Sumer, the first organized society of record, where their payment carried great religious meaning. Taxes were also a fundamental part of ancient Greece and the Roman Empire. The religious aspect of taxation in Renaissance Italy is depicted in the Brancacci Chapel, in Florence. The fresco Rendering of the Tribute Money depicts the gods approving the Florentine income tax. In the United States, the federal tax laws are set forth in the Internal Revenue Code and enforced by the Internal Revenue Service (IRS).

History

The origin of taxation in the United States can be traced to the time when the colonists were heavily taxed by Great Britain on everything from tea to legal and business documents that were required by the Stamp Tax. The colonists' disdain for this taxation without representation (so-called because the colonies had no voice in the establishment of the taxes) gave rise to revolts such as the Boston Tea Party. However, even after the Revolutionary War and the adoption of the U.S. Constitution, the main source of revenue for the newly created states was money received from customs and excise taxes on items such as carriages, sugar, whiskey, and snuff. Income tax first appeared in the United States in 1862, during the Civil War. At that time only about one percent of the population was required to pay the tax. A flat-rate income tax was imposed in 1867. The income tax was repealed in its entirety in 1872.

Income tax was a rallying point for the Populist party in 1892, and had enough support two years later that Congress passed the Income Tax Act of 1894. The tax at that time was two percent on individual incomes in excess of $4,000, which meant that it reached only the wealthiest members of the population. The Supreme Court struck down the tax, holding that it violated the constitutional requirement that direct taxes be apportioned among the states by population (pollock v. farmers' loan & trust, 158 U.S. 601, 15 S. Ct. 912, 39 L. Ed. 1108 [1895]). After many years of debate and compromise, the Sixteenth Amendment to the Constitution was ratified in 1913, providing Congress with the power to lay and collect taxes on income without apportionment among the states. The objectives of the income tax were the equitable distribution of the tax burden and the raising of revenue.

Since 1913 the U.S. income tax system has become very complex. In 1913 the income tax laws were contained in eighteen pages of legislation; the explanation of the Tax Reform Act of 1986 was more than thirteen hundred pages long (Pub. L. 99-514, Oct. 22, 1986, 100 Stat. 2085). Commerce Clearing House, a publisher of tax information, released a version of the Internal Revenue Code in the early 1990s that was four times thicker than its version in 1953.

Changes to the tax laws often reflect the times. The flat tax of 1913 was later replaced with a graduated tax. After the United States entered World War I, the War Revenue Act of 1917 imposed a maximum tax rate for individuals of 67 percent, compared with a rate of 13 percent in 1916. In 1924 Secretary of the Treasury Andrew W. Mellon, speaking to Congress about the high level of taxation, stated,

The present system is a failure. It was an emergency measure, adopted under the pressure of war necessity and not to be counted upon as a permanent part of our revenue structure…. The high rates put pressure on taxpayers to reduce their taxable income, tend to destroy individual initiative and enterprise, and seriously impede the development of productive business…. Ways will always be found to avoid taxes so destructive in their nature, and the only way to save the situation is to put the taxes on a reasonable basis that will permit business to go on and industry to develop.

Consequently, the Revenue Act of 1924 reduced the maximum individual tax rate to 43 percent (Revenue Acts, June 2, 1924, ch. 234, 43 Stat. 253). In 1926 the rate was further reduced to 25 percent.

The Revenue Act of 1932 was the first tax law passed during the Great Depression (Revenue Acts, June 6, 1932, ch. 209, 47 Stat. 169). It increased the individual maximum rate from 25 to 63 percent, and reduced personal exemptions from $1,500 to $1,000 for single persons, and from $3,500 to $2,500 for married couples. The National Industrial Recovery Act of 1933 (NIRA), part of President franklin d. roosevelt's New Deal, imposed a five percent excise tax on dividend receipts, imposed a capital stock tax and an excess profits tax, and suspended all deductions for losses (June 16, 1933, ch. 90, 48 Stat. 195). The repeal in 1933 of the Eighteenth Amendment, which had prohibited the manufacture and sale of alcohol, brought in an estimated $90 million in new liquor taxes in 1934. The Social Security Act of 1935 provided for a wage tax, half to be paid by the employee and half by the employer, to establish a federal retirement fund (Old Age Pension Act, Aug. 14, 1935, ch. 531, 49 Stat. 620).

The Wealth Tax Act, also known as the Revenue Act of 1935, increased the maximum tax rate to 79 percent, the Revenue Acts of 1940 and 1941 increased it to 81 percent, the Revenue Act of 1942 raised it to 88 percent, and the Individual Income Tax Act of 1944 raised the individual maximum rate to 94 percent.

The post-World War II Revenue Act of 1945 reduced the individual maximum tax from 94 percent to 91 percent. The Revenue Act of 1950, during the Korean War, reduced it to 84.4 percent, but it was raised the next year to 92 percent (Revenue Act of 1950, Sept. 23, 1950, ch. 994, Stat. 906). It remained at this level until 1964, when it was reduced to 70 percent.The Revenue Act of 1954 revised the Internal Revenue Code of 1939, making major changes that were beneficial to the taxpayer, including providing for Child Care deductions (later changed to credits), an increase in the charitable contribution limit, a tax credit against taxable retirement income, employee deductions for business expenses, and liberalized depreciation deductions. From 1954 to 1962, the Internal Revenue Code was amended by 183 separate acts.

In 1974 the Employee Retirement Income Security Act (ERISA) created protections for employees whose employers promised specified pensions or other retirement contributions (Pub. L. No. 93-406, Sept. 2, 1974, 88 Stat. 829). ERISA required that to be tax deductible, the employer's plan contribution must meet certain minimum standards as to employee participation and vesting and employer funding. ERISA also approved the use of individual retirement accounts (IRAs) to encourage tax-deferred retirement savings by individuals.

The Economic Recovery Tax Act of 1981 (ERTA) provided the largest tax cut up to that time, reducing the maximum individual rate from 70 percent to 50 percent (Pub. L. No. 97-34, Aug. 13, 1981, 95 Stat. 172). The most sweeping tax changes since World War II were enacted in the Tax Reform Act of 1986. This bill was signed into law by President ronald reagan and was designed to equalize the tax treatment of various assets, eliminate tax shelters, and lower marginal rates. Conservatives wanted the act to provide a single, low tax rate that could be applied to everyone. Although this single, flat rate was not included in the final bill, tax rates were reduced to 15 percent on the first $17,850 of income for singles and $29,750 for married couples, and set at 28 to 33 percent on remaining income. Many deductions were repealed, such as a deduction available to two-income married couples that had been used to avoid the "marriage penalty" (a greater tax liability incurred when two persons filed their income tax return as a married couple rather than as individuals). Although the personal exemption exclusion was increased, an exemption for elderly and blind persons who itemize deductions was repealed. In addition, a special capital gains rate was repealed, as was an investment tax credit that had been introduced in 1962 by President john f. kennedy.

The Omnibus Budget Reconciliation Act of 1993, the first budget and tax act enacted during the Clinton administration, was vigorously debated, and passed with only the minimum number of necessary votes (Pub. L. No. 103-66, Aug. 10, 1993, 107 Stat. 312). This law provided for income tax rates of 15, 28, 31, 36, and 39.6 percent on varying levels of income and for the taxation of Social Security income if the taxpayer receives other income over a certain level. In 2001 Congress enacted a major income tax cut at the urging of President george w. bush. Over the course of 11 years the law reduces marginal income tax rates across all levels of income. The 36 percent rate will be lowered to 33 percent, the 31 percent rate to 28 percent, the 28 percent rate to 25 percent. In addition, a new bottom 10 percent rate was created. (Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16, 115 Stat. 38.)

Since the early 1980s, a flat-rate tax system rather than the graduated bracketed method has been proposed. (The graduated bracketed method is the one that has been used since graduated taxes were introduced: the percentage of tax differs based on the amount of taxable income.) The flat-rate system would impose one rate, such as 20 percent, on all income and would eliminate special deductions, credits, and exclusions. Despite firm support by some, the flat-rate tax has not been adopted in the United States.

Computation of Income Tax

Regardless of the changes made by legislators since 1913, the basic formula for computing the amount of tax owed has remained basically the same. To determine the amount of income tax owed, certain deductions are taken from an individual's gross income to arrive at an adjusted gross income, from which additional deductions are taken to arrive at the taxable income. Once the amount of taxable income has been determined, tax rate charts determine the exact amount of tax owed. If the amount of tax owed is less than the amount already paid through tax prepayment or the withholding of taxes from paychecks, the taxpayer is entitled to a refund from the IRS. If the amount of tax owed is more than what has already been paid, the taxpayer must pay the difference to the IRS.

Calculating the gross income of restaurant employees whose income is partially derived from gratuities left by customers has led to disputes with the IRS and employers over how much they should contribute in federal insurance contribution act (fica) taxes. Although customers pay these tips directly to employees, federal law deems the tips to have been wages paid by the employer for FICA tax purposes. Employers are imputed to have paid large sums of money they never handled and for which they no way of ascertaining the exact amount. The Supreme Court, in United States v. Fior D'Italia, 536 U.S. 238, 122 S. Ct. 2117, 153 L. Ed. 2d 280 (2002), upheld the IRS "aggregate method" of reporting tip income. Instead of requiring the IRS to make individual determinations of unreported tips for each employee when calculating FICA tax, the Court held that the IRS could make employers report their gross sales on a monthly statement to help determine tip income. Employees also must report their tip income monthly on a form. The IRS then uses these two pieces of information to calculate what the employer needs to contribute in FICA tax.

Gross Income The first step in computing the amount of tax liability is the determination of gross income. Gross income is defined as "all income from whatever source derived," whether from personal services, business activities, or capital assets (property owned for personal or business purposes). Compensation for services in the form of money, wages, tips, salaries, bonuses, fees, and commissions constitutes income. Problems in defining income often arise when a taxpayer realizes a benefit or compensation that is not in the form of money.

An example of such compensation is the fringe benefits an employee receives from an employer. The Internal Revenue Code defines these benefits as income and places the burden on the employee to demonstrate why they should be excluded from gross income. Discounts on the employer's products and other items of minimal value to the employer are usually not considered income to the employee. These benefits (which include airline tickets at nominal cost for airline employees and merchandise discounts for department store employees) are usually of great value to the employee but do not cost much for the employer to provide, and build good relationships between the employee and the employer. As long as the value to the employer is small and the benefit generates goodwill, it usually is not deemed to be taxable to the employee.

The value of meals and lodging provided to an employee and paid for by an employer is not considered income to the employee if the meals and lodging are furnished on the business premises of the employer for the employer's convenience (as when an apartment building owner provides a rent-free apartment for a caretaker who is required to live on the premises). However, a cash allowance for meals or lodging that is given to an employee as part of a compensation package is considered compensation, and is counted as gross income. An employer's payment for a health club membership is also included in gross income, as are payments to an employee in the form of stock. An amount contributed by an employer to a pension, qualified stock bonus, profit-sharing, Annuity,or bond purchase plan in which the employee participates is not considered income to the employee at the time the contribution is made, but will be taxed when the employee receives payment from the plan. Medical insurance premiums paid by an employer are generally not considered income to the employee. Although military pay is taxable income, veterans' benefits for education, disability and pension payments, and veterans' insurance proceeds and dividends are not included in gross income.

Other sources of income directly increase the wealth of the taxpayer and are taxable. These sources commonly include interest earned on bank accounts; dividends; rents; royalties from copyrights, Trademarks, and Patents; proceeds from life insurance if paid for a reason other than the death of the insured; annuities; discharge from the obligation to pay a debt owed (the amount discharged is considered income to the debtor); recovery of a previously deductible item, which gives rise to income only to the extent the previous deduction produced a tax benefit (this is commonly referred to as the tax benefit rule and is most often used when a taxpayer has recovered a previously deducted bad debt or previously deducted taxes); gambling winnings; lottery winnings; found property; and income from illegal sources. Income from prizes and awards is taxable unless the prize or award is made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement; the recipient was chosen, without any action on his or her part, to enter the selection process; and the recipient is not required to render substantial future services as a condition to receiving the prize or award. For example, recipients of Nobel Prizes meet these criteria and are not taxed on the prize money they receive.

In some situations a taxpayer's wealth directly increases through income that is not included in the determination of income tax. For example, gifts and inheritances are excluded from income in order to encourage the Transfer of Assets within families. However, any income realized from a gift or inheritance is considered income to the beneficiary—most notably rents, interest, and dividends. In addition, most scholarships, fellowships, student loans, and other forms of financial aid for education are not included in gross income, perhaps to equalize the status of students whose education is funded by a gift or inheritance and of students who do not have the benefit of such assistance. Cash rebates to consumers from product manufacturers and most state Unemployment Compensation benefits are also not included in gross income.

Capital gains and losses pose special considerations in the determination of income tax liability. Capital gains are the profits realized as a result of the sale or exchange of a capital asset. Capital losses are the deficits realized in such transactions. Capital gains and losses are determined by establishing a taxpayer's basis in the property. Basis is generally defined as the taxpayer's cost of acquiring the property. In the case of property received as a gift, the donee basically steps into the shoes of the donor and is deemed to have the same basis in the property as did the donor.

The basis is subtracted from the amount realized by the sale or other disposition of the property, and the difference is either a gain or a loss to the taxpayer.

Capital gains are usually included in gross income, with certain narrow exclusions, and capital losses are generally excluded from gross income. An important exception to this favorable treatment of capital losses occurs when the loss arises from the sale or other disposition of property held by the taxpayer for personal use, such as a personal residence or jewelry. When a capital gain is realized from the disposition of property held for personal use, it is included as income even though a capital loss involving the same property cannot be excluded from income. This apparent discrepancy is further magnified by the fact that capital losses on business or investment property can be excluded from income. Consequently, there have been many lawsuits over the issue of whether a personal residence, used at some point as rental property or for some other income producing use, is deemed personal or business property for income tax purposes.

Taxpayers age 55 or older who sell a personal residence in which they have resided for a specific amount of time can exclude their capital gains. This is a one-time exclusion, with specific dollar limits. Consequently, if future, greater gains are anticipated, a taxpayer age 55 or older may choose to pay the capital gains tax on a transaction that qualifies for the exclusion but produces smaller capital gains.

Even though a capital gain on a personal residence is realized, it may be temporarily deferred from inclusion in gross income if the taxpayer buys and occupies another home two years before or after the sale, and the new home costs the same as or more than the old home. The gain is merely postponed. This type of transaction is called a rollover. The gain that is not taxed in the year of sale will be deducted from the cost of the new home, thereby establishing a basis in the property that is less than the price paid for the home. When the new home is later sold, the amount of gain recognized at that time will include the gain that was not recognized when the home was purchased by the taxpayer.

Deductions and Adjusted Gross Income Once the amount of gross income is determined, the taxpayer may take deductions from the income in order to determine adjusted gross income. Two categories of deductions are allowed. Above-the-line deductions are taken in full from gross income to arrive at adjusted gross income. Below-the-line, or itemized, deductions are taken from adjusted gross income and are allowed only to the extent that their combined amount exceeds a certain threshold amount. If the total amount of itemized deductions does not meet the threshold amount, those deductions are not allowed. Generally, above-the-line deductions are business expenditures, and below-the-line deductions are personal, or non-business, expenditures.

The favorable tax treatment afforded business and investment property is also evident in the treatment of business and investment expenses. Ordinary and necessary expenses are those incurred in connection with a trade or business. Ordinary and necessary business expenses are those that others engaged in the same type of business incur in similar circumstances. With regard to deductions for expenses incurred for investment property, courts follow the same type of "ordinary-and-necessary" analysis used for business expense deductions, and disallow the deductions if they are personal in nature or are capital expenses. Allowable business expenses include insurance, rent, supplies, travel, transportation, salary payments to employees, certain losses, and most state and local taxes.

Personal, or nonbusiness, expenses are generally not deductible. Exceptions to this rule include casualty and theft losses that are not covered by insurance. Certain expenses are allowed as itemized deductions. These below-the-line deductions include expenses for medical treatment, interest on home mortgages, state income taxes, and charitable contributions. Expenses incurred for tax advice are deductible from federal income tax, as are a wide array of state and local taxes. In addition, an employee who incurs business expenses may deduct those expenses to the extent they are not reimbursed by the employer. Typical unreimbursed expenses that are deductible by employees include union dues and payments for mandatory uniforms. Alimony payments may be taken as a deduction by the payer and are deemed to be income to the recipient; however, Child Support payments are not deemed income to the parent who has custody of the child and are not deductible by the paying parent.

Contributions made by employees to an Individual Retirement Account (IRA) or by self-employed persons to keogh plans are deductible from gross income. Allowable annual deductions for contributions to an IRA are lower than allowable contributions to a Keogh account. Contributions beyond the allowable deduction are permitted; however, amounts in excess are included in gross income. Both IRAs and Keogh plans create tax-sheltered retirement funds that are not taxed as gross income during the taxpayer's working years. The contributions and the interest earned on them become taxable when they are distributed to the taxpayer. Distribution may take place when the taxpayer is 59 and one-half years old, or earlier if the taxpayer becomes disabled, at which time the taxpayer will most likely be in a lower tax bracket. Distribution may take place before either of these occurrences, but if so, the funds are taxable immediately and the taxpayer may also incur a substantial penalty for early withdrawal of the money.

Additional Deductions and Taxable Income Once adjusted gross income is determined, a taxpayer must determine whether to use the standard deduction or to itemize deductions. In most cases the standard deduction is used because it is the most convenient option. However, if the amount of itemized deductions is substantially more than the standard deduction and exceeds the threshold amount, a taxpayer will receive a greater tax benefit by itemizing.

After the standard deduction or itemized deductions are subtracted from adjusted gross income, the income amount is further reduced by personal and dependency exemptions. Each taxpayer is allowed one personal exemption. A taxpayer may also claim a dependency exemption for each person who meets five specific criteria: the dependent must have a familial relationship with the taxpayer; have a gross income that is less than the amount of the deduction, unless she or he is under nineteen years old or a full-time student; receive more than one-half of her or his support from the taxpayer; be a citizen or resident of the United States, Mexico, or Canada; and, if married, be unable to file a joint return with her or his spouse. Each exemption is valued at a certain dollar amount, by which the taxpayer's taxable income is reduced.

Tax Tables and Tax Owed Once the final deductions and exemptions are taken, the resulting figure is the taxpayer's taxable income. The tax owed on this income is determined by looking at applicable tax tables. This figure may be reduced by tax prepayments or by an applicable tax credit. Credits are available for contributions made to candidates for public office; child and dependent care; earned income; taxes paid in another country; and residential energy. For each dollar of available credit, a taxpayer's liability is reduced by one dollar.

Refund or Tax Owed Finally, after tax prepayments and credits are subtracted, the amount of tax owed the IRS or the amount of refund owed the taxpayer is determined. The taxpayer's tax return and payment of tax owed must be mailed to the IRS by April 15 unless an extension is sought. Taxpayers who make late payments without seeking an extension will be charged interest on the amount due and may be charged a penalty. A tax refund may be requested for up to several years after the tax return is filed. A refund is owed usually because the taxpayer had more tax than necessary withheld from his or her paychecks.

Tax Audits The IRS may audit a taxpayer to verify that the taxpayer correctly reported income, exemptions, or deductions on the return. The majority of returns that are audited are chosen by computer, which selects those that have the highest probability of error. Returns may also be randomly selected for audit or may be chosen because of previous investigations of a taxpayer for Tax Evasion or for involvement in an activity that is under investigation by the IRS. Taxpayers may represent themselves at an audit, or may have an attorney, certified public accountant, or the person who prepared the return accompany them. The taxpayer will be told what items to bring to the audit in order to answer the questions raised. If additional tax is found to be owed and the taxpayer disagrees, she or he may request an immediate meeting with a supervisor. If the supervisor supports the audit findings, the taxpayer may appeal the decision to a higher level within the IRS or may take the case directly to court.

Cross-references

Tax Avoidance; Tax Court; Taxpayer Bill of Rights.

income tax

n. a tax on an individual's net income, after deductions for various expenses and payments such as charitable gifts, calculated on a formula which takes into consideration whether it is paid jointly by a married couple, the number of dependents of the taxpayers, special breaks for ages over 65, disabilities, and other factors. Federal income taxes have been collected since 1913 when they were authorized by the 16th Amendment to the Constitution. Most states also assess income taxes, but at a substantially lower rate than that of the federal government. (See: tax, income)

income tax

a tax on individuals, executors and trustees. Those who are resident in the UK are taxed upon worldwide income and those who are not are taxed on UK sources of income. The sources of income are employment, trading, property, savings and investments, and miscellaneous other minor categories brought into charge by statute. Each particular source has a set of rules for determining the amount which is counted in a particular tax year and any deductions allowable in measuring the income chargeable. There are many sources which are specifically exempted from income tax, including National Savings Certificates, personal equity plans, individual savings accounts, winnings from betting, competition prizes and Premium Bond prizes, statutory redundancy pay and the first £30,000 of compensation received for loss of employment. Scholarships, discounts and cashbacks received by retail customers and certain income received by individuals renting a room within their residence are also exempt. Having determined the taxable income from all sources, these are added together and deductions are given for interest paid on certain qualifying loans and for the value of quoted shares and securities or land and buildings gifted to a charity. The result after these deductions is called the total income from which the personal allowance (which is increased for those aged over 64 with low incomes) is deducted to arrive at taxable income. This is then charged to income tax working up through the tax bands of the starting rate, the basic rate and finally the higher rate. However, a special lower rate of tax is applied to savings income instead of the basic rate. Dividends are subject to a special regime so that no further tax is payable upon them unless the taxpayer is liable to higher rate tax, in which case a special dividend rate is applied.

income tax

income tax

income tax

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income

income tax

income tax

income tax,

Bibliography

Income Tax

REFERENCES

income tax

income tax

Income Tax

History

Computation of Income Tax

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Cross-references

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Income tax

Income Tax

income tax

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Words related to income tax

noun a personal tax levied on annual income

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