Federal Income Tax Explained

What is the Federal Income Tax?

In the United States of America, a tax is enforced on income earned by the federal, most state, and the majority of local governments in the country. The income tax in the United States is determined by applying a tax rate, which takes the form of a progressive model. Typically, as income increases, the coordinating taxable rate increases, meaning those individuals or companies who generate higher incomes are subsequently taxed at higher rates.

Individuals and corporations in the United States are directly taxed and estates and trusts may be directly taxed on their undistributed income. Partnership formations are not taxed, but their partners are taxed on their proportionate shares of income.

The Federal income Tax is widely based off an individual’s earned income; however, there are several types of credits that reduce tax and many types of credits that will reduce one’s income to subsequently reduce their taxable rate.

The income that is being taxed under the Federal Income model refers only to the individual’s taxable income, meaning their total income less their allowable deductions. In this sense, income is broadly defined; the majority of business expenses, for example, are deductible which effectively reduces the particular entity’s taxable income. Furthermore, individuals may also deduct a personal allowance (known as an exemption) and certain personal expenses, including home mortgage interest, state taxes, contributions to charity, as well as many other items.

Additionally, capital gains are fully taxable while capital losses will effectively reduce taxable income only to the extent of that gains obtained. Individual taxpayers will currently pay a lower rate of tax on capital gains and certain types of corporate dividends.

Individual taxpayers will assess their particular tax standing by filing their Federal income Tax returns. Typically, when an individual files a Federal Income Tax return they will receive a rebate or tax refund in the form of direct deposit or a paper check sent by the United States Treasury Department. The majority of returns will be met with a refund because the amount of taxes withheld during taxable pay periods typically exceeds the total amount of taxes owed by an individual taxpayer.

The Federal Income Tax is levied based on net taxable income earned by individuals or entities within the United States. The Federal Income Tax is graduated, meaning the tax rates of higher incomes are increased, whereas those who earn less will have a mitigated taxable obligation.

The Federal Income Tax rates are divided into brackets; the brackets are established based on income thresholds. Each bracket has a tax rate attached to it that is delivered in a percentage form. For example, in 2009 the tax rates varied from 10% (attached to the lowest earners) to 35% (attached to those individuals who earned over $333,000 annually.

Federal taxable income is defined by the Internal Revenue Code and based off regulations issued by the Department of Treasury. The taxable income is the underlying payer’s gross income as adjusted less tax deductions. The majority of states and localities who impose the income tax will follow this definition, although some may incorporate adjustments to determine income taxed in that particular jurisdiction.

NEXT: Federal Tax