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Federal Income Taxation in the United States

An Overview of the Law and Process

Federal Income Tax LawU.S. federal income tax is a levy on the annual earnings of individuals and entities such as corporations, partnerships, and trusts. The federal income tax is collected on virtually all forms of receipts, broadly defined as “taxable income,” including, but not limited to, wages and salaries, bonuses and tips, commissions, interest, dividends, and capital gains.

A History of Federal Income Taxation in America

Income taxes are such an integral part of life in the United States that most people assume we’ve always had a system for the collection of revenues based on personal or business income. To the contrary, the first federal income tax in the United States was enacted by Congress in 1861 to fund the Northern effort in the American Civil War. That legislation also created the Bureau of Internal Revenue, now the Internal Revenue Service, which oversees the administration of the federal income tax system today.

Congress repealed that first law and passed a new law in 1894, establishing a two percent tax on all annual income over $4,000, but the law was ruled unconstitutional in 1895.

At the turn of the century, the concept of a federal income tax found new support. To address the potential unconstitutionality of such a law, proponents drafted and ratified the 16th Amendment, specifically granting Congress the power to tax personal income. The first Form 1040 was released in 1914, and two years later, Congress passed the Revenue Act of 1916, which included marginal tax rates from 2% to 25%. Today, the range of marginal tax rates is 10% to 37%.

Sources of American Federal Income Tax Law

The 16th Amendment to the Constitution states that “Congress shall have the power to lay and collect taxes on income….” The specific details governing the federal taxation of income in the United States are found in the Internal Revenue Code. Individual state codes include provisions for levying state income taxes.

What Is the Internal Revenue Service?

The Internal Revenue Service (IRS) is the U.S. federal agency responsible for the collection of a wide range of taxes. Part of the Department of the Treasury, the IRS also has federal tax law enforcement authority to require audits, assess penalties, and seize assets.

A Basic Overview of Federal Income Taxation in America

Under the most recent revisions to the Internal Revenue Code, enacted as part of the Tax Cuts and Jobs Act of 2017, there are seven tax brackets.

The marginal tax rates for taxpayers who are married and filing jointly are:

  • 10%–All taxable income under $19,750
  • 12%–All taxable income over $19,750, but under $80,251
  • 22%–All taxable income over $80,250, but under $171, 051
  • 24%–All taxable income over $171,050, but under $326,601
  • 32%–All taxable income over $326,600, but under $414,701
  • 35%–All taxable income over $414,700, but under $622,051
  • 37%–All taxable income over $622,050

The marginal tax rates for single filers are the same, but the amount of taxable income for each marginal tax bracket is half that of married persons filing jointly.

All individuals who make more than a certain amount of income must file a tax return for the year in which they receive the income. That amount varies, based on the type of income and status of the taxpayer. Tax returns are due on April 15 for the prior tax year, but taxpayers may get a six-month extension under certain circumstances. Returns may be filed electronically or by mail.

How Federal Income Tax is Calculated in the United States

The American federal income tax is a “progressive” tax, with the percentage of tax, known as the marginal tax rate, increasing as income goes up. Currently, the federal marginal tax rates range from 10% to 37%. To calculate the tax, a taxpayer must first determine his or her “taxable income,” which means gross income less allowable deductions. The tax rates are then applied to income in brackets, with the lowest rate applied to all income below a certain threshold, and any increasing rates applied only to income over that threshold. Once the tax is determined, a taxpayer may reduce their tax with any tax credits available to them.

What Is a Federal Income Tax Exemption?

A federal tax exemption is an amount that a taxpayer may exclude from their gross income. An exemption has an impact similar to a deduction but differs in a technical way. A deduction reduces taxable income when certain conditions are met, but an exemption refers to income that is not taxable in the first place. Prior to 2018, individual filers were allowed personal and dependent exemptions, but today, the primary application of federal income tax exemption is for organizations qualifying for tax-exempt status, such as charities.

What Are the Penalties for Violation of Federal Income Tax Laws?

Persons who violate the provisions of the Internal Revenue Code may be subject to both criminal and civil penalties. The IRS has significant authority to require audits, assess penalties, and seize assets, including bank accounts and investments. A person charged with tax fraud may face federal criminal prosecution, with penalties of up to $100,000 ($500,000 in the case of a corporation) and five years in prison. Civil fraud penalties up to 75% of any underpayment may also be added to the amount due.

Summary

In the United States, individuals are subject to taxation on income, though the amount of the tax assessed may be reduced through deductions or credits. The taxes levied are based on the amount of taxable income and are assessed in brackets ranging from 10% to 37%. Once the total tax is determined, credits may be used to reduce the tax due on a dollar-for-dollar basis. Violation of federal tax laws may result in both civil and criminal liability.

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