Sources of U.S. income tax lawsUnited States income tax law comes from a number of sources. These sources have been divided by one author into three tiers as follows: *''Tier 1'' ** ** (IRC) (legislative authority, written by the through ) ** ** (judicial authority, written by courts as interpretation of legislation) ** (executive authority, written in conjunction with other countries, subject to ratification in the United States by advice and consent of the U.S. Senate - other countries have their own ratification procedures) *''Tier 2'' ** Agency interpretative regulations (executive authority, written by the (IRS) and ), including: *** Final, Temporary and Proposed Regulations promulgated under IRC § 7805 or other specific statutory authority; *** Treasury Notices and Announcements; *** Executive agreements with other countries; ** Public Administrative Rulings (IRS Revenue Rulings, which provide informal guidance on specific questions and are binding on all taxpayers) *''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.''Id.'' 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.
Basic conceptsA tax is imposed on net 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 on higher amounts of income are higher than on lower amounts
Federal income tax rates for individualsFederal income brackets and tax rates for individuals are adjusted annually for inflation. The (IRS) accounts for changes to the and publishes the new rates as " Tax Rate Schedules".
Marginal tax rates
Marginal tax rates before 2018Beginning in 2013, an additional tax of 3.8% applies to net investment income in excess of certain thresholds.
Marginal tax rates for 2018
Marginal tax rates for 2019An individual pays tax at a given bracket only for each dollar within that 's range. The top marginal rate does not apply in certain years to certain types of income. Significantly lower rates apply after 2003 to capital gains and qualifying dividends (see below).
Example of a tax computationIncome tax for year 2017: Single taxpayer making $40,000 gross income, no children, under 65 and not blind, taking standard deduction; * $40,000 gross income – $6,350 – $4,050 = $29,600 taxable income ** amount in the first income bracket = $9,325; taxation of the amount in the first income bracket = $9,325 × 10% = $932.50 ** amount in the second income bracket = $29,600 – $9,325 = $20,275.00; taxation of the amount in the second income bracket = $20,275.00 × 15% = $3,041.25 * Total income tax is $932.50 + $3,041.25 = $3,973.75 (~9.93% ) Note, however, that taxpayers with taxable income of less than $100,000 must use IRS provided tax tables. Under that table for 2016, the income tax in the above example would be $3,980.00. In addition to income tax, a wage earner would also have to pay (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 = $3,973.75 + $3,060.00 = $7,033.75 (~17.58% 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 = $3,973.75 + $3,060.00 + $3,060.00 = $10,093.75 (~25.23% of income)
Effective income tax ratesEffective 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 $118,500 of someone's income is subject to social insurance (Social Security) taxes in 2016. The table below also does not reflect changes, effective 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 near the lowest levels since 1979.
Taxable incomeIncome tax is imposed as a tax rate times taxable income. Taxable income is defined as less allowable . Taxable income as determined for federal tax purposes may be modified for state tax purposes.
Gross incomeThe states that "gross income means all income from whatever source derived," and gives specific examples.26 USC 61
Business deductionsMost business deductions are allowed regardless of the form in which the business is conducted. Therefore, 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 to make a profit. Only a few business-related deductions are unique to a particular form of business-doing. 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 accounting rules, not financial accounting ones. Tax rules are based on principles similar in many ways to accounting rules, but there are significant differences. Federal deductions for most meals and entertainment costs are limited to 50% of the costs (with an exception for tax year 2021, allowing a 100% deduction for meals purchased in a restaurant). Costs of starting 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 likely to produce future benefits must be capitalized. The capitalized costs are then deductible as depreciation (see ) 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. That 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. Business deductions allowed for federal income tax are almost always allowed in determining state income tax. Only some states, however, 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, deductions for losses from passive activities may be deferred to the extent they exceed 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).
Personal deductionsPrior to 2018, individuals were allowed a special deduction called a for dependents. This wa
Retirement savings and fringe benefit plansEmployers 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 , 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 ( ), *Profit sharing plans ( ), * (ESOPs), *Stock purchase plans, *Health insurance plans, *Employee benefit plans, * s. 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 s (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
Capital gainsTaxable income includes . However, individuals are taxed at a lower rate on long term capital gains and qualifying dividends (see below). A capital gain is the excess of the sales price over the (usually, the cost) of capital assets, generally those assets not held for sale to customers in the ordinary course of business. 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 for individuals 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 , 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 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 fo
Accounting periods and methodsThe US tax system allows individuals and entities to choose their . 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 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 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.
Other taxable and tax exempt entities
Partnerships and LLCsBusiness entities treated as ar
CorporationsCorporate tax is imposed in the U.S. 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, as an . Corporate income tax is based on , which is defined similarly to individual taxable income. Shareholders (including other corporations) of corporations (other than S Corporations) are taxed on 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 at the federal and some state levels with their common parent.
Corporate tax ratesFederal corporate income tax is imposed a
Deductions for corporationsMost expenses of corporations are deductible, subject to limitations also applicable to other taxpayers. See relevant deductions for details. In addition, regular U.S. corporations are allowed a deduction o
Estates and trustsEstates and trusts may b
Tax-exempt entitiesU.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 . Exempt organizations are still taxed on any business income. An organization which participates in , ing, or certain other activities may lose its exempt status. Special taxes apply to prohibited transactions and activities of tax-exempt entities.
Other tax items
CreditsThe federal and state systems offer numerous for individuals and businesses. Among the key federal credits for individuals are: * Child credit: For 2017, a credit up to $1,000 per qualifying child. For 2018–2025, the credit rose to $2,000 per qualifying child but made having a (SSN) a condition of eligibility for each child. For 2021, the credit was temporarily raised to $3,000 per child aged 6–17 and $3,600 per qualifying child aged 0–5 and was made fully refundable. * Child and dependent care credit: a credit up to $2,100, 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 2015, the maximum credit was $6,422. *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 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 taxTaxpayers 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 for 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.
Special taxesThere 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 * provisions.
Special industriesTax 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:
State, local and territorial income taxesIncome tax is also levied by most s 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 on payment of wages. also imposes its own taxation laws; however, unlike in the states, only some residents there pay federal income taxes (though everyone must pay all other federal 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) (Se
International aspectsThe United States imposes tax on all citizens of the United States, including those who are residents of other countries, all individuals who are residents for tax purposes, and domestic corporations, defined as corporations created or organized in the United States or under Federal or state law. Federal income tax is imposed on citizens, residents, and domestic corporations based on their worldwide income. To mitigate double taxation, a credit is allowed for foreign income taxes. This is limited to that part of current year tax attributable to foreign source income. Determining such part involves determining the source of income and allocating and apportioning deductions to that income. Many (but not all) tax resident individuals and corporations on their worldwide income, but few allow a credit for foreign taxes. In addition, federal income tax may be imposed on non-resident non-citizens as well as foreign corporations on U.S. source income. Federal tax applies to interest, dividends, royalties, and certain other income of nonresident aliens and foreign corporations not effectively connected with a U.S. trade or business at a flat rate of 30%. This rate is often reduced under . Foreign persons are taxed on income effectively connected with a U.S. business and gains on U.S. realty 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. The United States has income wit
Tax collection and examinations
Tax returnsIndividuals (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 15Publication 509: Tax Calendars for use in 2017
Tax collectionTaxpayers are required to pay all taxes owed based on the self-assessed tax returns, as adjusted. The IR
Withholding of taxPersons paying wages or making certain payments to foreign persons are required to withhold income tax from such payments. Income tax withholding on wages is based o
Statute of limitationsThe IRS is precluded from assessing additional tax after a certain period of time. In the case of federal income tax, this period is generally 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, or in the case of failure to file a return.
PenaltiesTaxpayers 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 .
ConstitutionalArticle I, Section 8, Clause 1 of the United States Constitution (the " "), specifies '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 es and es (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 under the . 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 taxesThe first income tax suggested in the United States was during the . 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 , Congress imposed the first federal income tax in U.S. history through passage of the . The act created a flat tax of three percent on incomes above $800 ($ in current dollar terms). This taxation of income reflected the increasing amount of wealth held in stocks and bonds rather than property, which the federal government had taxed in the past. The established the first national and added a ation structure to the federal income tax, implementing a tax of five percent on incomes above $10,000. Congress later further raised taxes, and by the end of the war, the income tax constituted about one-fifth of the revenue of the federal government. To collect these taxes, Congress created the Office of the within the Treasury Department. The federal income tax would remain in effect until its repeal in 1872. In 1894, s in Congress passed the Wilson-Gorman tariff, which imposed the first peacetime income tax. The rate was 2% on income over $4,000, 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 , 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 s from real estate, on income from personal property and other income from personal property (which includes 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).
Progressive EraFor several years, the issue of an income tax lay unaddressed. In 1906, President revived the idea in his Sixth Annual Message to Congress.Origins of the Modern Income Tax, 1894–1913
There is every reason why, when next our system of taxation is revised, the National Government should impose a graduated inheritance tax, and, if possible, a graduated income tax.During the speech he cited the ''Pollock'' case without naming it specifically. The income tax became an issue again in Roosevelt's later speeches, including the 1907 State of the Union, and during the 1912 election campaign. Roosevelt's successor, William Howard Taft, also took up the issue of the income tax. Like Roosevelt, Taft cited the ''Pollock'' decision and gave a major speech in June 1909 regarding the Income Tax.June 16, 1909: Message Regarding Income Tax
Ratification of the Sixteenth AmendmentIn response, Congress proposed the Sixteenth Amendment to the United States Constitution, Sixteenth Amendment (ratified by the requisite number of states in 1913), which states:
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 of the United States, Supreme Court in ''Brushaber v. Union Pacific Railroad,'' , 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 protester (United States), tax protesters and others opposed to income taxes cite what they contend is evidence that the Sixteenth Amendment was never properly ratification, ratified, based in large part on materials sold by William J. Benson. In December 2007, Benson's "The Law that Never Was, 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 incomesThe modern interpretation of the Sixteenth Amendment taxation power can be found in ''Commissioner v. Glenshaw Glass Co.'' . 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 , under the Internal Revenue Code, 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.348 U.S.(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 (law), Codification). In ''Central Illinois Public Service Co. v. United States'', , 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 (equivalent to $ in 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 (equivalent to $ in 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 (equivalent to $ in 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 (equivalent to $ in dollars). During 1944 and 1945, the top rate was its all-time high at 94% applied to income above $200,000 (equivalent to $ in dollars). * The highest marginal tax rate for individuals for U.S. federal income tax purposes for tax years 1952 and 1953 was 92%. * From 1964 to 2013, the threshold for paying top income tax rate has generally been between $200,000 and $400,000 (unadjusted for inflation). The one exception is the period from 1982 to 1992 when the topmost income tax brackets were removed. From 1981 until 1986 the top marginal rate was lowered to 50% on $86,000 and up (equivalent to $ in dollars). From 1988 to 1990, the threshold for paying the top rate was even lower, with incomes above $29,750 (equivalent to $ in 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%.
Federal income tax ratesFederal 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. These income numbers are not the amounts used in the tax laws at the time.
The complexity of the U.S. income tax lawsUnited 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, and the 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.
Proposals for changes of income taxationProposals have been made frequently to change tax laws, often with the backing of specific interest groups. Organizations making such proposals include 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.
AlternativesProponents 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 statesSome 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.
Tax protestorsNumerous 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 litigation, frivolous.
DistributionIn the United States, a progressive tax, 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 were not 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 Organisation for Economic Co-operation and Development, 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. In 2008, overall income tax rates for the US were below the OECD average.
Effects on income inequalityAccording 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.
Social insurance taxes (Social Security tax and Medicare tax, or FICA)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. The maximum amount of wages subject to the tax for 2020 was $137,700. 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%) is imposed on self-employed persons.
See also* ''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: * Capital gains tax in the United States * Corporate tax in the United States US State taxes: * Sales taxes in the United States * State income tax * State tax levels Politics: * FairTax * Tax protester (United States) General: * Taxation in the United States * Federal tax revenue by state
Further readingGovernment sources: *IR