What Is Income Tax?

By Taylor Bell

February 25, 2021

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Although you might cringe at the thought of paying taxes on your hard-earned income, taxes are what keep the federal government in business, paying for the services you rely on. For the U.S. federal government, a majority of the revenue comes from income taxes. To understand what income tax is and how it works, take a look at this breakdown. Even though you have to pay taxes, there are ways to reduce your tax bill by thousands of dollars.

What Is Income Tax?

Income tax is a tax imposed by the IRS on the annual earnings of individuals, corporations, trusts and other legal entities. That means anyone — person or business — with a form of income is subject to pay a piece of what they made over the prior year to the government. Even if you win the lottery, or win big on your favorite game show, the government takes a portion of that as income tax.

And what are federal taxes used for exactly? The government uses all that money to pay for big federal programs including Social Security, defense and security, and major health programs such as Medicare and Medicaid.

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The History of U.S. Federal Income Taxes

The federal income tax history goes all the way back to the Civil War. In the 1860s, Congress was short on money to fund Civil War expenses and thus imposed an income tax, which was later repealed. In 1894, a flat rate federal income tax was enacted, but it was later ruled unconstitutional. As a result, in 1913 Congress passed the 16th Amendment, which legally gave the government the power to collect taxes on incomes “from whatever source derived.”

Who Pays Income Taxes?

Although the government imposes an income tax, not everyone pays this tax equally, or even at all.

If you want to know what is the income tax rate, take a look at your tax bracket, which is the range of earnings to which a particular tax rate applies. The tax is progressive, so your tax rate increases as your earnings increase.

As note above, the amount of taxes you pay is based on your income bracket. For instance, if you are an unmarried individual and have an income up to $9,875, your tax rate is 10%. If you make between $9,875 and $40,125, your tax rate is 12%, but because the tax is progressive, you won’t pay 12% on all your earnings. You’ll pay 10% on the first $9,875 and 12% on income between $9,875 and $40,125.

State Income Taxes

If you live in some select states, you won’t have to pay state income taxes on top of your federal income taxes. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming don’t impose income taxes. Only South Dakota and Wyoming don’t impose corporate income or gross receipts taxes.

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Income Tax Deductions

The IRS allows you to subtract qualified tax deductions from your taxable income. For instance, if you itemize deductions, you can potentially deduct for work-related expenses, charitable contributions, home mortgage interest and real estate tax. Make sure to take advantage of these commonly missed tax deductions.

You can also elect to take the standard deduction. The standard deduction is a flat amount the federal government allows you to deduct based on your filing status. The 2019 standard deduction increases for 2020.

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Daria Uhlig contributed to the reporting for this article. 

Last updated: Feb. 25, 2021

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