What’s income tax?

Governments levy an “income tax” on enterprises and individuals in their jurisdiction. Taxpayers must file an annual revenue tax return to calculate their tax liabilities by law.

Governments get revenue from such taxes. They fund public services, government commitments, and citizen goods. Yet, many states and municipalities levy income taxes in addition to the federal government. This type of tax may not apply to certain assets, such as housing authority bonds.

How does it work?

The IRS enforces and collects taxes in the United States. The IRS has extensive rules on reportable and taxable income, deductions, credits, etc. The agency taxes wages, salaries, commissions, investments, and company revenues.

The government collects personal earnings tax for programs and services, including Social Security, national security, schools, and roads.

History of Income Taxes

The first U.S. revenue tax was enacted in 1862 to fund the Civil War. The Revenue Act of 1913 reintroduced the tax after the war. In the same year, Form 1040 was launched.

Interestingly, most countries, including the U.S., have a progressive earning tax system where higher-income workers pay higher taxes than lower-income earners. A progressive tax assumes that high-earners can pay more. In 2023 and 2024, federal revenue tax rates vary from 10% to 37%.

Types of Income Tax

Personal

Personal earnings tax is the individual revenue charge. This revenue tax applies to wages, salaries, and other income. This is usually a state tax.

Therefore, due to exemptions, deductions, and credits, most people do not pay taxes on all their income. The IRS provides revenue tax deductions and credits to lower taxable income. So, tax deductions cut taxable income and tax rates, whereas tax credits lower earning tax obligations. Healthcare, investment, and education expenses are tax-deductible by the IRS. So, if a taxpayer earns $100,000 and receives $20,000 in deductions, their taxable income is reduced to $80,000.

Tax credits lower the taxpayer’s tax liability. They were designed for middle- and low-income families. Suppose a person owes $20,000 in taxes but receives $4,500 in credits. Their tax obligation drops to $15,500. Your taxable income is your AGI minus any itemized or standard deductions.

Firm

Corporations, partnerships, self-employed contractors, and small enterprises pay revenue taxes to the IRS.Depending on the business structure, the corporation, owners, or shareholders report business income and deduct operating and capital expenses.

In addition, the difference between business income and operating and capital expenses is typically called taxable business income.

Local and State Earning Tax

Most U.S. states tax personal income. Eight states, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming, do not impose personal earning taxes on inhabitants. Tennessee eliminated its dividend and interest tax, the Hall tax, on January 1, 2021.

While New Hampshire does not tax income, residents must pay 5% on profits and interest. In 2018, the state passed a law to phase down the 5% interest and dividend tax on January 1, 2024. Nine states will have no income tax by 2024.

However, living in a state without revenue taxes may not be cheaper. States often compensate for lost revenue with other taxes or fewer services.

Additionally, factors such as healthcare, cost of living, and career possibilities impact the affordability of residing there. Tennessee has a 7% sales tax, while Florida has 6%.

If your tax position is simple, a tax calculator can estimate your earning tax liability.

To make matters worse, governments tweak their tax systems in big and tiny ways, making it impossible to estimate future tax burdens.

Which percentage of income is taxed?

Your earnings tax percentage depends on your income and filing status. In theory, earning more means paying more. Federal revenue charges are 10%–37%.

How do I calculate income tax?

To compute earning tax, sum all taxable income from a tax year. Next, calculate your adjusted gross income (AGI). After this, subtract eligible deductions from your AGI.

States Without Tax on Earnings?

Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not collect state-earning taxes—New Hampshire taxes interest and profits but not wages.

Surprisingly, after 2023, New Hampshire will phase out these taxes, and all personal income will be tax-free by 2027.

Conclusion

• Businesses and people pay revenue taxes to governments.
• This tax funds public services, government commitments, and citizen goods.
• The federal government, numerous states, and localities tax income.
• Personal tax applies to wages, salaries, and other income.
• The self-employed, companies, partnerships, and small firms pay business taxes.