The democratically elected federal government of the United States imposes a progressive tax on the taxable income of individuals, partnerships, companies, corporations, trusts, decedents' estates, and certain bankruptcy estates. Some state and municipal governments also impose income taxes. The first Federal income tax was imposed (under Article I, section 8,clause 1 of the U.S. Constitution) during the Civil War, then again in the 1890s, and again after the Sixteenth Amendment was ratified in 1913. Current income taxes are imposed under these constitutional provisions and various sections of Subtitle A of the Internal Revenue Code of 1986, as amended, including 26 U.S.C. § 1 (imposing income tax on the taxable income of individuals, estates and trusts)and 26 U.S.C. § 11 (imposing income tax on the taxable income of corporations).
[pic] Income tax basics
While U.S. income tax law is very complex, the underlying idea is relatively easy to understand. Simplifying greatly, gross income is all income from all sources (§ 61) less any exclusions (§ 101 et seq.). An exclusion is something that Congress has effectively said a taxpayer need notinclude in his or her income for tax purposes, such as employer-paid health insurance (§ 106) or interest from tax-exempt bonds (§ 103). Exclusions, often referred to as deductions, are a matter of legislative grace; that is, taxpayers may not exclude, or deduct, from gross income any item which Congress has not specifically allowed.
For individuals, Adjusted Gross Income (AGI) is gross incomeless any above-the-line deductions (§ 62). Above-the-line deductions are listed in § 62 and include trade or business deductions, alimony (§ 215), and moving expenses (§ 217). Taxable income is AGI less (1) itemized deductions or the applicable standard deduction, whichever is greater, and (2) a deduction for any allowable personal exemptions for the taxpayer, the taxpayer's spouse (if filingjointly), and the taxpayer's dependents. (In certain cases involving higher income taxpayers, the allowed personal exemptions may be reduced or even eliminated.)
Non-itemizers take the standard deduction. Itemized deductions include any deduction not listed in § 62 such as charitable contributions (§ 170) and certain medical expenses (§ 213). Taxable income is then multiplied by the appropriate taxrate to arrive at the tax due. Tax credits such as the Earned Income Tax Credit (§ 32) or the Child Tax Credit (§ 24) lower the tax owed on a dollar-for-dollar basis. This means tax credits are more valuable than deductions of the same amount, because deductions are applied before the tax rate, while credits are applied after. For instance, with a 35% tax rate, a deduction of $100 would save only $35of taxes, while a $100 credit would save $100 worth of taxes.
Types of income
For tax purposes, income can be divided in a variety of ways. The first division is between ordinary income and capital gains. Ordinary income includes compensation for personal services such as wages and salaries, business profit, dividends from stock shares, and interest income from invested funds while capitalgain generally comes from the sale of investment property. Congress has typically shown a preference for long-term investment by having a capital gains tax rate lower than the ordinary income rate. However, only long-term capital gains get preferential treatment; short-term capital gains (from property held for one year or less) are taxed at the same rate as ordinary income. Added complications comefrom various distinctions within each category. For instance, qualified dividends, which were previously taxed at ordinary income rates (as non-qualified dividends currently are), can be currently taxed at long-term capital gain rates until 2011 under the Jobs and Growth Tax Relief Reconciliation Act of 2003, and within long-term capital gains, gains on certain real estate, collectibles, and...