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What is income tax?
What’s important to know it?
In this article, I will break down the meaning of Income Tax so you know all there is to know about it!
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What Is Income Tax
Income tax generally refers to the tax that individuals and businesses are required to pay on their revenues to the tax authorities.
The term “income tax” is a broad term referring to the tax applicable to all sources of income you generate in a given year.
The government imposes taxes on income to fund government services and pay for their ongoing operations.
Generally, every person and company is required to file an income tax return every year to report how much they earned in income and pay the applicable taxes.
Employees are required to pay income tax on their salary and wages whereas businesses are required to pay income tax on their business revenues.
The United States imposes progressive tax rates which means that taxpayers will pay progressively more taxes the more their earnings.
Why Pay Income Taxes
Paying income tax is essential for the government to be able to properly function and provide the necessary public services to every citizen.
In the United States, individuals and businesses pay their income taxes to the Internal Revenue Service (IRS) who is responsible for collecting taxes and enforcing the tax laws.
The IRS will then remit the funds to the government who will finance programs such as Social Security, Medicare, national security, infrastructure projects, and so on.
Historically, the US government imposed income taxes for the first time in 1862 to help fund the Civil War.
Following the war, the income tax requirement was abolished.
However, it was reinstated in 1913 with the ratification of the 16th Amendment allowing the government provides more and better services to a growing nation.
Today, income taxes represent the largest source of tax revenue in the United States.
Types of Income Tax
To better understand what are income taxes, let’s look at the different types of income taxes that are levied by the tax authorities.
The first type of income tax is the personal income tax.
Personal income tax is a tax that is paid by individuals on their salaries, wages, and earnings.
The tax laws allow individuals to take advantage of certain tax credits or exemptions depending on their circumstances.
When an individual files an income tax return, he or she will have to pay income taxes on the taxable income which is generally lower than the individual’s gross income.
Another type of income tax is the business income tax.
A business income tax is the taxes that businesses, legal entities, partnerships, LLCs, self-employed individuals, and other business owners pay to the government.
Typically, companies pay taxes on their net income which is their total revenues less the expenses incurred to generate those revenues.
You also have state and local income taxes that are levied by state and local governments.
Most states levy state income taxes on their residents except for Alaska, Florida, Nevada, South Dakota, Texas, Tennessee, Washington, and Wyoming.
Income Tax Calculation Example
Let’s look at an example of how income taxes are charged.
Let’s assume that a married couple files their taxes together and together earned $150,000 ($75,000 each).
In this case, they will be taxed at a rate of 22% based on the 2021 Federal Income Tax Brackets and Rates for Taxable Income.
This means that they both will have to pay $33,000 in income taxes leaving them with $117,000.
Now let’s assume that a company has an income of $150,000.
The federal corporate tax rate is a flat 21% which means that the company will have to pay $31,500 in taxes leaving it with $118,500.
What Is Income Tax FAQ
What income is taxed?
Individuals and businesses must pay taxes on the money they made in a given year.
Individuals pay taxes based on the adjusted gross income or AGI as the starting point for their income taxes.
The adjusted gross income represents an employee’s total income less certain deductions such as individual retirement account contributions and student loan interest.
Businesses pay income taxes on their net income which is their revenue from all sources less all their expenses.
How much does the IRS collect in income taxes?
Taxes levied on taxpayers’ income represents the largest source of revenue for the US government.
In 2020, the IRS collected $1.8 trillion in individual income taxes and $263.6 billion in business income taxes.
As you can see, the US government has made over $2 trillion in individual and business income taxes in 2020.
How does income taxes work?
Considering the US tax system is progressive, the more income you have, the more income tax you will pay.
The way it works is that the government imposes different tax rates applicable to different income ranges (or tax brackets).
For instance, in 2021, a single filer earning less than $9,950 would pay 10% in income taxes whereas a single filer making more than $523,600 would pay 37%.
What is an income tax return?
An income tax return is a form used to provide information relating to your income to the tax authorities allowing them to assess your tax liability.
Based on the income that you declare on your income tax return, the tax authorities will determine how much income taxes you will need to pay.
So there you have it folks!
What does “income tax” mean?
In a nutshell, income tax refers to the amount of taxes individuals pay on their wages and businesses pay on their earnings.
In the United States, income tax is imposed on individuals and businesses on their revenues and earnings.
The purpose of paying income taxes is to help fund the government’s operations, projects, and services.
The government needs to build roads, bridges, fund schools, Medicare, Social Security, and many other programs that people can benefit from.
Every taxpayer’s tax situation is different where they may be subject to different income tax rates, have the option to make certain tax deductions, or use certain tax credits.
In the end, every person earning a salary or wage and every business generating revenues are required to pay their share of income taxes.
Now that you know what income tax means and how it works, good luck with your research!
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