Kara Sears
The United States imposes tax on all citizens, including those who are residents of other countries, and on domestic corporations. Federal and most state income tax systems tax the worldwide income of citizens and residents. US tax laws are determined by Congress, which enacts federal tax law in the Internal Revenue Code of 1986 (IRC). The IRC is complex and its sections must be read in the context of the entire Code, the Treasury Regulations, and the court decisions that interpret it. Tax rates vary by state and locality and may be fixed or graduated. Most rates are the same for all types of income. State and local income taxes are imposed in addition to federal income tax.
| Characteristics | Values |
|---|---|
| Basis of tax laws | The Constitution gives Congress the power to tax. Congress enacts Federal tax law in the Internal Revenue Code of 1986 (IRC). |
| Tax law sources | Tier 1: Internal Revenue Code (IRC) (legislative authority, written by the United States Congress through legislation); Tier 2: Treaties (executive authority, written with other countries, subject to ratification in the US); Tier 3: Regulations and case law |
| Tax law interpretation | Treasury regulations (federal tax regulations) provide the official interpretation of the IRC by the US Department of the Treasury |
| Tax law publications | All regulatory documents are published in the Federal Register (FR) and republished in the Internal Revenue Bulletin |
| Tax law updates | The Internal Revenue Service (IRS) makes inflation-related adjustments to more than 60 tax provisions annually |
| Tax law challenges | There have been unsuccessful challenges to the applicability of tax laws, with promoters continuing to encourage non-compliance |
| Tax law evasion | Anti-tax law evasion schemes exist, presenting arguments in a pseudo-legal format |
| Tax law history | The Revenue Act of 1913 reinstated the federal income tax after the ratification of the Sixteenth Amendment |
| Tax law rates | Federal marginal tax rates vary from 10% to 37% of taxable income; State and local tax rates vary from 0% to 13.30% of income |
| Tax law deductions | Individuals can reduce taxable income by personal allowances and certain non-business expenses, including mortgage interest, state and local taxes, charitable contributions, and medical expenses |
| Tax law exemptions | Tax Expenditures allow special exclusions, exemptions, or deductions from gross income, providing alternatives to other policy instruments |
| Tax law on income | Income subject to tax is determined by tax accounting rules and includes almost all income, except large corporations are subject to a 15% minimum tax due to the Inflation Reduction Act of 2022 |
| Tax law on corporations | Most states impose a tax on corporate income, with rates varying by state and locality, and being fixed or graduated |
| Tax law on property | Property taxes are applied to real estate and business property, with the amount determined by the market value of each property |
| Tax law on foreign income | A federal foreign tax credit is granted for foreign income taxes, and individuals residing abroad may claim the foreign earned income exclusion |
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What You'll Learn
Federal and state income tax
Federal income tax laws are enacted by Congress in the Internal Revenue Code (IRC) of 1986, found in Title 26 of the United States Code. Treasury regulations, or federal tax regulations, provide the official interpretation of the IRC and direct taxpayers on compliance. These can be found in Title 26 of the Code of Federal Regulations. Regulatory documents related to taxation are published in the Federal Register and the Internal Revenue Bulletin.
State income tax laws often differ from federal rules in determining taxable income. Forty-three states and numerous localities impose income taxes on individuals, while 47 states and many localities tax corporate income. State and local tax rates vary, ranging from 0% to 13.30% of income, and may be fixed or graduated. Most states adopt federal definitions for income and business deductions but may have distinct rules.
Individuals can reduce taxable income through personal allowances, business expenses, and certain non-business expenses. These deductions may include home mortgage interest, state and local taxes (capped), charitable contributions, and medical expenses above specific income percentages. Federal tax credits are available for foreign income taxes, and residents abroad may claim the foreign earned income exclusion.
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Tax credits and deductions
In the United States, individuals and businesses can use tax credits and deductions to lower their tax bills or increase their refunds. Tax credits are a dollar-for-dollar amount subtracted from the tax owed, potentially resulting in a refund if the credit exceeds the tax owed. Some common tax credits include:
- Earned Income Tax Credit: A refundable credit targeted at moderate- and low-income taxpayers.
- Child Tax Credit: A non-refundable credit that reduces the taxpayer's liability and is applicable for children under 17 who are US citizens with a Social Security number and are claimed as dependents.
- American Opportunity Tax Credit: A partially refundable credit for qualified education expenses during the first four years of higher education, with a maximum annual credit of $2,500 per eligible student.
- Premium Tax Credit: A credit for individuals to help with healthcare expenses.
On the other hand, deductions reduce the amount of income that is subject to tax. Both individuals and businesses can deduct certain expenses from their income. For individuals, these may include personal allowances, home mortgage interest, state and local taxes, charitable contributions, and medical expenses above certain percentages of income. Businesses can deduct most types of expenses incurred, including the cost of goods sold.
Additionally, state income tax is deductible when computing federal income, but it is capped at $10,000 per household since the 2017 tax law. Taxpayers can refer to the IRS website and utilize tools like the Interactive Tax Assistant to determine their eligibility for various credits and deductions.
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Tax exemptions
The United States has a complex system of taxation, with federal and state income tax systems that levy taxes on the worldwide income of citizens, residents, and corporations. While the federal government sets the tax code, each state and locality has its own unique tax laws, resulting in variations in tax rates and rules across the country.
- Personal Exemptions: Individuals can claim personal exemptions for themselves, their spouses, and eligible dependents. Each exemption reduces the taxable income by a set amount, which typically changes annually. For example, in 2014, the exemption amount was $3,950.
- Dependency Exemptions: Taxpayers with dependents can claim dependency exemptions, further reducing their taxable income. Each dependent claimed results in a reduction in taxable income.
- Nonprofit Organisations: Qualifying nonprofits that meet specific requirements, such as those engaged in social welfare, charitable contributions, or religious education, can be granted tax-exempt status by the IRS. This means they are exempt from paying income tax.
- Foreign Income Exclusion: Individuals residing abroad may claim the foreign earned income exclusion, reducing their taxable income from foreign sources. Additionally, federal foreign tax credits are granted for foreign income taxes paid.
- State Tax Credits and Deductions: Many states offer tax credits or deductions for taxes paid to other states. These credits are typically limited to the amount of tax on income from other state sources. Additionally, state income tax can be deducted when computing federal income tax, but it is capped at a certain amount per household.
- Special Exclusions: Federal tax laws may also provide special exclusions or deductions from gross income, preferential tax rates, or deferrals of tax liability. These provisions are often viewed as alternatives to spending or regulatory programs and are detailed in the Tax Expenditure Budget.
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Tax treaties
The United States has tax treaties with dozens of different countries. These treaties are designed to eliminate double taxation. Under these treaties, residents of foreign countries may be taxed at a reduced rate or may be exempt from U.S. taxes on certain types of income they receive from sources within the United States. Similarly, U.S. residents and citizens may be taxed at a reduced rate or may be exempt from foreign taxes on certain types of income they receive from sources within foreign countries.
The specific terms of these treaties vary among countries and types of income. For example, the U.S.-Canada tax treaty allows Americans receiving Canadian pensions or annuities to apply tax-exempt treatment under Canadian law to their U.S. tax returns, meaning those portions would be exempt from U.S. taxes as well. Additionally, any Canadian social security benefits an American living in Canada receives are taxable only by Canada. The U.S.-Canada tax treaty also allows Americans living in Canada to deduct or exclude contributions to qualified Canadian retirement plans from their U.S. taxable income.
Most income tax treaties contain a "saving clause" which prevents U.S. citizens and residents from using the provisions of a tax treaty to avoid taxation of U.S. source income. If there is no treaty between the United States and a particular country, or if the treaty does not cover a particular type of income, then tax must be paid on that income in the same way and at the same rates as would otherwise apply. Some U.S. states do not honor the provisions of tax treaties, so it is important to consult the tax authorities of the relevant state to determine whether any state tax applies to your income.
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Tax compliance and evasion
The Internal Revenue Service (IRS) is responsible for collecting and processing tax returns in the USA. The IRS also investigates alleged federal tax crimes and employs special agents to detect and investigate tax evasion and fraud. The IRS is part of the Department of the Treasury, which provides the official interpretation of the Internal Revenue Code (IRC) in the form of Treasury Regulations. These regulations direct taxpayers on how to comply with the IRC's requirements.
The IRC is complex, and some individuals and groups have encouraged others not to comply with the tax laws. To address non-compliance by taxpayers using foreign accounts, Congress enacted the Foreign Account Tax Compliance Act (FATCA) in 2010. FATCA requires foreign financial institutions (FFIs) to report information about financial accounts held by US taxpayers to the IRS. It also requires US taxpayers holding financial assets outside the country to report those assets to the IRS. FFIs are encouraged to register directly with the IRS to comply with FATCA regulations.
In terms of tax evasion, the federal government aggressively investigates allegations of white-collar crimes, including tax fraud. Tax evasion occurs when an individual or business intentionally underpays or fails to pay their tax obligations. To prove a violation, the prosecutor must show the existence of a tax deficiency, an affirmative act constituting evasion, and willfulness. A conviction for tax evasion can result in up to five years in federal prison, a fine of up to $100,000 for an individual or $500,000 for a corporation, or both. The typical tax evader in the US is a male under 50 in a high tax bracket with a complicated return, and the most common means of evasion is the overstatement of charitable contributions. Despite the risks, some people continue to evade taxes by utilising jurisdictions with limited taxation, known as tax havens, which allow for legal tax avoidance and illegal tax evasion.
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Frequently asked questions
Federal marginal tax rates vary from 10% to 37% of taxable income. State and local tax rates vary widely by jurisdiction, from 0% to 13.30% of income, and many are graduated.
The US tax year for individuals starts on January 1 and ends on December 31.
The deadline for filing tax returns in the USA is April 15 of the year following the tax year.
The Internal Revenue Code of 1986 is the Federal tax law enacted by Congress. It can be found in Title 26 of the United States Code.
Federal income tax is imposed by the federal government, while state income tax is imposed by individual states. State income tax rules often differ from federal rules and state tax rates vary by state.
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