What is income tax?
Almost all governments are funded, at least in part, by some form of taxation on their citizens. Most of these taxes are collected at the time of a sale or service, but others are collected at the end of a 12-month period called the tax year. One of these annual taxes is the dreaded income tax. This is essentially a federal and state government bill for individual earnings through wages and investment earnings. It is considered a progressive tax because the individual's financial obligation increases with the level of reportable income.
However, the United States has not always had an official income tax. After years of oppression under the control of robber barons and corrupt executives, Congressional leaders of the early 20th century created a national income tax law in 1914, primarily to force the richest and greediest to pay their taxes. Ultimately, this reform would hit the middle and lower working classes. While the tax remains progressive, many of the wealthiest companies and individuals benefit from various statutory exemptions.
Fortunately, income tax can only be applied to positive income, not a net loss. The basic tax structure allows people to earn a certain amount of non-taxable income. This is usually calculated by the standard deduction amount listed on federal and state tax forms. If an individual has not earned more than the standard deduction amount (usually a few thousand dollars), he owes nothing.
However, the problem that salary earners face is that the payroll department is required to deduct a set percentage of money from each salary for tax purposes. Federal and state income tax is deducted according to a specific calculation based on the employee's marital and dependency status. Other payroll deductions are also made to cover Social Security contributions (FICA), insurance, union contributions and any voluntary contributions. The amount collected is then reported on an official tax form called a W-2. Income without these tax deductions can be reported on another form called a 1099.
During tax season, from January to April 14, individuals must report all of their total income from wages and investment earnings. The standard deduction is subtracted from the total and the remainder is considered taxable income. A chart provided with the official 1040 tax forms reveals the actual amount owed to the government. If the amount withheld by the payroll department is greater than this number, the government will issue a refund for the difference. If the W-2 number is lower, the individual owes more income tax and must pay the IRS.
For most middle class taxpayers, income tax is around 15% of their gross income. Individuals and businesses can legally deduct many expenses related to their occupations, which can significantly reduce this amount. Charitable donations can also be used to offset income tax obligations.