Overview of Federal Income Tax

The federal income tax is the main way that the federal government raises revenue to pay for its expenditures. Besides raising revenue, the federal income tax serves a social function by allocating resources, subsidizing some persons or activities, encouraging certain kinds of economic and social behavior, redistributing wealth, stimulating economic growth and addressing specific social problems such as pollution and urban decay. While all US citizens and residents, including corporations, trusts and estates, are potentially subject to income tax, this article focuses on individual income tax.

Income tax is a progressive tax, with the tax rate increasing as the net taxable income of a taxpayer increases. Individuals must file a federal tax return if their gross income exceeds a certain amount, which varies based on age, marital status and residency status. Generally speaking, all income is subject to federal tax; however, the Internal Revenue Code (IRC) does not specifically define income. Under the IRC, gross income is defined as all income from whatever source derived, including:

  • Wages, fees and commissions
  • Interest,
  • Dividends
  • Gains on the sale of assets
  • Rent payments
  • Business income
  • Income from trusts or estates
  • Discharge of a debt
  • Gambling winnings
  • Court awards or damages
  • Alimony or spousal maintenance
  • Income from life insurance
  • Royalties

Several things are specifically excluded from gross income under the IRC, including: contributions to corporate capital, employer-provided coverage under accident and health plans, the value of meals or lodging provided by employers to employees for the employers' convenience and certain fringe benefits provided to employees.

Once gross income is calculated, certain allowable deductions are applied to determine adjusted gross income. There are deductions available for eligible retirement-account contributions, student-loan interest, medical-savings-account contributions, qualified moving expenses, one-half of any self-employment tax paid and alimony paid.

Adjusted gross income is then reduced by either the standard deduction or itemized deductions, and by any personal exemptions. The amount of the standard deduction depends on the taxpayer's filing status. If the taxpayer opts to itemize deductions instead of taking the standard deduction, there are deductions available for:

  • State and local income taxes paid
  • Real-property taxes paid
  • Home-mortgage interest
  • Investment interest
  • Charitable contributions
  • Medical expenses, casualty losses and employee business expenses that exceed a certain percentage of adjusted gross income.

A taxpayer may also claim a personal exemption amount for the taxpayer plus an exemption for a spouse and each dependent child, if applicable. The taxpayer can claim other relatives, such as elderly parents, as dependents in certain circumstances. Itemized deductions and personal exemption amounts are phased out for higher-income taxpayers.

After these subtractions, what remains is taxable income, which is the income on which the taxpayer must pay taxes. Tax tables or tax-rate schedules are applied to the taxable income amount to calculate the amount of tax due. Once the tax is computed, certain credits may reduce the amount of tax due dollar for dollar. Typical credits include childcare credits, dependent-care credits, foreign tax credits, credits for the elderly, education credits, earned-income credits and adoption credits.

Individual income tax returns are due on April 15 in the year subsequent to the tax year. Taxpayers can file for an extension of time in which to file their return (until as late as October 15). The Internal Revenue Service can impose penalties and interest for failure to pay the taxes due by April 15 or failure to file a return by the due date (April 15 or the extended date).

Preparing for a Meeting with Your Tax Attorney

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Preparing for a Meeting with your Tax Attorney

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