Income tax
Taxes based on income are imposed at the federal, most state, and some local levels within the United States. The tax systems within each jurisdiction may define taxable income separately. Many states refer to some extent to federal concepts for determining taxable income.
History of the income tax.
The first Income tax in the United States was implemented with the Revenue Act of 1861 by Abraham Lincoln during the Civil War. In 1895 the Supreme Court ruled that the U.S. federal income tax on interest income, dividend income and rental income was unconstitutional in Pollock v Farmers' Loan & Trust Co., because it was a direct tax. The Pollock decision was overruled by the ratification of the Sixteenth Amendment to the United States Constitution in 1913, and by subsequent U.S. Supreme Court decisions including Graves v New York ex rel. O'Keefe, South Carolina v Baker, and Brushaber v Union Pacific Railroad Co.
Basic concepts.
The U.S. income tax system imposes a tax based on income on individuals, corporations, estates, and trusts. The tax is taxable income, as defined, times a specified tax rate. This tax may be reduced by credits, some of which may be refunded if they exceed the tax calculated. Taxable income may differ from income for other purposes (such as for financial reporting). The definition of taxable income for federal purposes is used by many, but far from all states. Income and deductions are recognized under tax rules, and there are variations within the rules among the states. Book and tax income may differ. Income is divided into "capital gains", which are taxed at a lower rate and only when the taxpayer chooses to "realize" them, and "ordinary income", which is taxed at higher rates and on an annual basis. Because of this distinction, capital is taxed much more lightly than labor.
Under the U.S. system, individuals, corporations, estates, and trusts are subject to income tax. Partnerships are not taxed; rather, their partners are subject to income tax on their shares of income and deductions and take their shares of credits. Some types of business entities may elect to be treated as corporations or as partnerships.
Taxpayers are required to file tax returns and self-assess tax. Tax may be withheld from payments of income (for example, withholding of tax from wages). To the extent taxes are not covered by withholdings, taxpayers must make estimated tax payments, generally quarterly. Tax returns are subject to review and adjustment by taxing authorities, though far fewer than all returns are reviewed.
Taxable income is gross income less exemptions, deductions, and personal exemptions. Gross income includes "all income from whatever source". Certain income, however, is subject to tax exemption at the federal or state levels. This income is reduced by tax deductions including most business and some nonbusiness expenses. Individuals are also allowed a deduction for personal exemptions, a fixed dollar allowance. The allowance of some nonbusiness deductions is phased out at higher income levels.
The U.S. federal and most state income tax systems tax the worldwide income of citizens and residents. A federal foreign tax credit is granted for foreign income taxes. Individuals residing abroad may also claim the foreign earned income exclusion. Individuals may be a citizen or resident of the United States but not a resident of a state. Many states grant a similar credit for taxes paid to other states. These credits are generally limited to the amount of tax on income from foreign (or other state) sources.