What is Federal Income Tax?

Definition:

Federal income tax is the tax based on a person’s or business’s income that’s paid to the Internal Revenue Service (IRS), an agent of the United States government.

🤔 Understanding Federal Income Tax

Federal income tax is a financial charge/levy that the United States government imposes upon people and businesses based on their level of income. The U.S. doesn’t have a flat tax for everyone but uses a sliding tax scale known as a progressive tax. Your tax bill may increase or decrease from one year to the next according to the changes in your income and deductions. The 2020 tax rates for individuals and couples range from 10% of your income to 37%, depending on your status. The federal government collects income taxes through the Internal Revenue Service (IRS).

Example

Imagine Martha is finishing her senior year of college. Her coursework leaves her little time to hold down a job, so she settles for the occasional house-sitting gig. The work doesn’t pay well. Martha’s earnings are so low that she’s exempt from paying any federal income tax. Although, she may be liable for self-employment tax, depending on how much she makes. The next year Martha is gainfully employed and earning well over six figures. She’ll have to pay a percentage of her income in federal taxes. How much she owes will depend on her taxable income and which federal income tax brackets she falls under.

Takeaway

The federal income tax is like the item that you’re asked to bring to a neighborhood block party…

Suppose the hostess asks each neighbor to bring something according to their financial ability to help contribute to the party. She asks the wealthy guy down the block to bring several bottles of excellent wine and a few award-winning craft beers. However, she asks the financially struggling college student living over a garage to bring only a bag of ice. Similarly, the federal government asks people to submit taxes that are related to their annual income to help contribute to society.

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What is the federal income tax?

The Federal income tax is what the United States government requires individuals, businesses, and other entities to pay in proportion to their level of income. The U.S. uses a progressive tax system so that, in theory, wealthier people will pay a more substantial amount of tax than the average person.

There are numerous tax credits, deductions, and exclusions that may potentially dramatically reduce a person’s tax obligation. The U.S. first used an income tax in 1861 to raise money for military spending during the American Civil War. The government required persons making over $800 a year to pay 3% of their income in tax. But a few years after the war, Congress repealed the tax law.

It wasn’t until the 20th century that income tax became a regular part of American life. In 1901, Congress passed the 16th Amendment to the U.S. Constitution, which established the federal government’s authority to impose income tax on individuals and businesses throughout the country. The Amendment received enough votes from the states for ratification in 1913. Later that same year, Congress passed the Revenue Act, which reinstituted a federal income tax.

Congress uses the Internal Revenue Service (IRS) as the agency to enforce federal tax laws and collect payments. However, the IRS didn’t officially come into existence until 1952. The IRS is a reorganization of what was known as the Bureau of Internal Revenue. The Office of the Commissioner of Internal Revenue dates to 1862.

What is the purpose of federal income tax?

The federal income tax has become the largest source of revenue for the U.S. government. Income tax revenue is even greater than the revenue from payroll taxes. According to government records, for the tax year of 2018, the IRS collected $1.68T in personal income tax and another $204.7B in corporate income tax.

Overall, a large portion of tax money goes toward the nation’s health. Programs like Medicare and Medicaid are funded through separate payroll taxes rather than income taxes. However, a sizable portion of income tax revenue is devoted to health care and public health. Money pays to prevent the spread of disease and to promote food safety. A significant portion of the tax revenue goes toward defense spending for the U.S. Army, Navy, Air Force, Marines, and defense intelligence along with joint defense projects.

The U.S. government allocates some of its revenue to help those who are most financially vulnerable, including the poor, the retired, and children. Income tax helps provide retirement benefits to former government workers and food to those who can’t afford meals.

Your federal income tax also goes toward paying the country’s debt. For 2018, $325M helped pay the interest on the national debt.

State governments shoulder most of the financial responsibility of running public school systems, but the federal government plays a major role in supplementing the states. Federal funding helps states and local communities with a variety of educational needs, including free lunches, assistance for accommodating students with disabilities, and school libraries. Federal dollars also support advanced education through college financial aid programs. Plus, tax revenue pays for specific federal job training programs that are available to the public, including those with disabilities.

Federal courts and the nation’s top law enforcement agencies such as the Federal Bureau of Investigation and the Bureau of Alcohol, Tobacco, Firearms, and Explosives depend on your taxes. Immigration services also receive tax revenue.

The U.S. uses a part of its revenue to maintain the country’s scenic beauty and natural resources. Taxes fund the agencies responsible for overseeing the nation’s federally protected lands and bodies of water. The country’s diplomatic outposts in foreign lands need ongoing maintenance as well as protection. Your tax dollars help meet their costs. Scientific discovery and exploration require ongoing funding, too — Tax revenue pays for federal research laboratories. The most famous recipient of U.S. scientific funding is the National Aeronautics and Space Administration (NASA).

What types of income are subject to federal taxes?

Unless the IRS clearly identifies certain income as exempt, there’s a good chance that it's subject to taxes.

Payments that are made available to you count as income even if you don’t have the money in your hand or in the bank. For example, suppose your boss handed out bonuses at the end of the year, but you forgot to stop by his office to pick up your check. The funds still count as part of your income for that current tax year.

Fringe benefits can also be income — such as bonuses, employer-provided life insurance, or personal use of a company car.

If you operate a for-profit side business that rents property or equipment, the proceeds are taxable. Likewise, you’re going to pay taxes on any royalties you receive from patents and copyrights. Also taxable are royalties produced by properties containing gas, oil, or minerals. Less common forms of income are also subject to tax. Profits from investments in Cryptocurrency such as Bitcoin can be subject to taxation. If you swap and receive an item or service as part of an exchange, you may need to report the fair market value of the item you receive.

Tax Exclusions

Some items aren’t considered part of your income, so there may be no need to list them on your tax return. The following list is representative but not exhaustive. Always verify which items are on the most up-to-date list of exclusions, or work with your tax professional.

  • Some death benefits from a life insurance policy
  • The value of gifted or inherited property
  • Funds received from sources such as insurance, workers’ compensation, disability, and court cases that compensate you for illness or injury
  • Funds contributed by your employer to your accident or health insurance plans
  • Some scholarships
  • Payments received from a foster agency for fostering a child
  • Some military benefits
  • Disaster relief payments
  • Federal subsidies

How do you calculate federal income tax?

To calculate your federal income taxes, you will need to add up all your sources of income and account for anything that may lower your federal income tax liability. Fortunately, the government allows certain deductions and credits that can lower your tax liability. The amounts permitted tend to change each year to keep pace with inflation.

Tax deductions

There are standard deductions and itemized deductions. You can opt to deduct the standard amount from your income or choose to list all of your tax-deductible expenses. Some taxpayers would rather not go to the trouble of itemizing their expenses while others find that it gives them a sizable deduction. Itemized deductions might include such things as interest on student loans, costs related to your employment, and donations to charity. There are various standard deductions depending upon the tax filer’s specific situation, but the general filing statuses are as follows:

  • Single individuals: $12,400
  • Married couples filing jointly: $24,800
  • Head of household: $18,650

Once you’ve deducted all your allowable expenses from your gross income, the remainder of your income is typically your adjusted gross income. To determine how much tax you must pay, you need to know your tax bracket and filing status, as well as some other factors.

Federal income tax brackets

The federal income tax has seven tax rates, often called brackets. The lowest bracket is 10%. The rates then increase to 12%, 22%, 24%, 32%, 35%, and 37%. The United States has a marginal tax rate system. This means that each rate of taxation only applies to the income that falls into that bracket.

Tax filing status

You can file your taxes as an individual, as the head of a household, jointly as part of a married couple, or married filing separately. Your status will affect your tax bracket, your available deductions, and other aspects of your tax situation.

The intent of the variation in tax filing statuses is to not financially penalize anyone for their marital or family status.

Other factors

Other factors may impact your tax bill as well. This includes payments already made, eligible tax credits, and more.

It’s important not to confuse tax deductions and tax credits. Tax deductions reduce how much of your income is subject to federal income tax. Tax credits directly reduce the amount of tax you owe — they are not applied until after you calculate your tax liability.

Your actual tax return may be quite complex, depending on your personal situation. If you’re unsure how to calculate your federal taxes owing, it’s best to consult with a financial advisor or tax expert.

What is the federal income tax for 2018? 2019? 2020?

The nation’s tax laws are together called the Internal Revenue Code. Congress writes the code, which includes all the tax laws written since the late 1700s. Congress routinely alters the tax code to keep pace with the government’s changing needs and the country’s evolving economic situation.

The largest impact on federal income tax in recent years has come from the Tax Cuts and Jobs Act, which first affected taxes filed for 2018. The legislation lowered the tax rates for most income brackets through 2025.

Notice below the reduction in tax rates for five of the seven brackets.

Rates prior to 20182018 – Current Marginal Rates
10%10%
15%12%
25%22%
28%24%
33%32%
35%35%
39.6%37%

However, the act removed the personal exemption which everyone had been able to use as long as they weren’t a dependent on someone else’s tax return.

Additional changes in the new law include:

  • Standard deduction increased for individuals.
  • Standard deduction increased for joint returns of married couples.
  • Contributions allowed to retirement accounts increased.
  • The state and local tax (SALT) deduction was capped at $10,000. (There was no limit prior to 2018.)

The one thing that you can count on is that the tax code will continue to change. A brief glimpse at the federal income tax rates and brackets for 2018, 2019, and 2020 will illustrate how the nation’s tax requirements can undergo minor but regular readjustment.

2019 Tax Rate Schedule

2020 Tax Rate Schedule

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