Cecily Zamora
Tax laws are the laws that guide how taxes are calculated and collected. In the United States, taxes are imposed at the federal, state, and local levels, and can be levied on income, payroll, property, sales, capital gains, dividends, imports, estates, and gifts, among other things. The authority for tax rules and procedures comes from different sources, with the Constitution granting Congress the power to tax. Congress typically enacts federal tax law in the Internal Revenue Code (IRC), which falls under Title 26 of the United States Code. The IRC covers various types of federal taxes, including income, estate, gift, and excise taxes, and sets out procedural and administrative rules for both taxpayers and the Internal Revenue Service (IRS). The IRS is responsible for administering federal income tax and other aspects of the US tax system, such as assessing and collecting estate, gift, and employment taxes. While federal tax laws provide a framework, state and local governments also play a role in adjusting property tax rates and enacting other tax policies.
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Federal income tax laws
The IRC covers various aspects of taxation, including income tax, which is imposed on individuals, corporations, estates, and trusts. The federal income tax was first enacted in 1913 with the passage of the Sixteenth Amendment, which overturned a previous Supreme Court ruling that deemed an income tax of 2% on income over $4,000 as unconstitutional. The Revenue Act of 1913, passed after the amendment's ratification, reinstated the federal income tax.
The federal income tax rate is progressive, meaning it increases with higher income levels. In 2020, the average federal income tax rate on adjusted gross income was 13.6%. The bottom 50% of taxpayers paid less than 5% of the total individual federal income taxes, while the top 1% paid 42%.
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State income tax laws
The history of state income tax laws in the United States dates back to the early 20th century. Wisconsin implemented the first modern state income tax in 1911, followed by Virginia in 1926. During the Great Depression, several states, including Oregon and Washington, introduced individual income taxes to cope with the economic crisis. However, these taxes faced legal challenges and were sometimes found to be unconstitutional.
Today, 42 states impose a state income tax, while eight states have no income tax at all: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. These tax-free states have become attractive destinations for individuals and companies looking to minimise their tax obligations. Nevada, for instance, offers high levels of privacy as it does not have an information-sharing agreement with the IRS.
State income tax rates can vary, with some states implementing flat rates and others using progressive tax structures. For instance, Colorado's individual and corporate income tax rates were temporarily reduced to 4.25% in 2024 due to fiscal surplus, but they reverted to the standard rate of 4.4% in 2025. On the other hand, Utah's individual and corporate income tax rates were lowered from 4.65% to 4.55% in 2024 due to legislative changes.
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Local tax laws
The United States has separate federal, state, and local governments, each with their own tax laws. Local tax laws in the US vary across different states and local jurisdictions. For instance, in Texas, the state sales and use tax rate is 6.25%, but local jurisdictions (cities, counties, special-purpose districts, and transit authorities) can impose additional sales and use taxes of up to 2%, resulting in a maximum combined rate of 8.25%. Local sales tax is based on the seller's place of business, while local use tax is based on where the customer first uses or consumes the item. Telecommunications services are subject to state sales tax but not always to local sales tax, depending on the jurisdiction.
Some states in the US are considered tax havens due to their favourable tax laws. For example, Nevada has no state income tax, personal income tax, inheritance tax, or franchise tax. Similarly, Delaware attracts financial companies with its business-friendly usury laws, high secrecy levels, and predictable judiciary rulings. South Dakota is also a popular tax haven due to its favourable laws regarding hereditary estates and trusts.
It is important to note that local tax laws can vary significantly across different countries and regions. While this provides an overview of local tax laws in the US, the specifics may differ in other parts of the world.
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Tax evasion
In the United States, tax laws are enacted by Congress in the Internal Revenue Code (IRC) of 1986, with sections found in Title 26 of the United States Code. Federal income tax rates have been modified frequently, with changes made in 34 of the 97 years between 1913 and 2010. The US also has state and local governments that impose taxes, with varying rates of VAT or sales tax.
The level of income tax evasion is influenced by factors such as tax rates, unemployment rates, income levels, and dissatisfaction with the government. Studies suggest that evasion increases with wealth, and the risk of evasion is influenced by the likelihood of detection and the severity of punishment.
Customs duties are another area where evasion occurs, with importers using under-invoicing and misdeclaration of quantity or product description to reduce their tax liability. Smuggling is also a means of evading customs duties and importing or exporting contraband.
To prove tax evasion, prosecutors must establish an unpaid tax liability, an affirmative act to evade taxes, and the specific intent to evade a known legal duty to pay.
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Tax avoidance
There are various methods of tax avoidance, including claiming permissible deductions and credits, making strategic investment choices, and utilising tax shelters or havens. For example, taxpayers can take advantage of tax credits, deductions, and exclusions provided in the tax code, such as the Child Tax Credit or retirement savings accounts. Additionally, businesses may establish subsidiaries in offshore jurisdictions with favourable tax policies.
The United States, despite not being considered a tax haven as a whole, has certain states like Nevada, South Dakota, and Delaware that offer favourable tax policies and high levels of secrecy, attracting individuals and companies seeking to minimise their tax obligations.
Anti-avoidance measures exist to prevent the reduction of tax liabilities through legal loopholes. These include General Anti-Avoidance Rules (GAAR) and Specific Anti-Avoidance Rules (SAAR), which aim to curb practices that exploit loopholes in the law. Courts play a crucial role in developing these measures, guided by principles such as the business purpose rule and substance over form rule.
According to Joseph Stiglitz, there are three key principles of tax avoidance: postponement of taxes, tax arbitrage across individuals in different tax brackets, and tax arbitrage across income streams with different treatments. These principles can result in complex tax strategies that reduce tax liabilities.
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Frequently asked questions
The Constitution gives Congress the power to create tax laws. Congress typically enacts Federal tax law in the Internal Revenue Code of 1986 (IRC).
Federal taxes include income tax, estate tax, gift tax, employment tax, and excise tax.
State taxes include income tax, property tax, sales tax, and capital gains tax.
