Income tax in the United States
In the United States, people have to pay income taxes to the United States government, most state governments, and many local governments. This means that people have to pay taxes to these governments, based on how much money they earn.
Introduction[change | change source]
Income taxes are based on what a person earns in one calendar year – between January 1 and December 31.
When it takes income taxes, the government takes a percentage of a person's income. This percentage is called an income tax rate. In other words, the income tax rate is the part, or portion, of a person's income that the government takes.
The United States government, and most states, use progressive tax rates. This means that as a person earns more income, their income tax rate gets higher. In other words, as a person earns more money, they have to pay more taxes.
Every year, the government divides incomes into categories. These categories are called tax brackets. Each tax bracket includes a range of incomes – the lowest and highest amounts a person could earn to be in that tax bracket.
Tax brackets are important because each one is taxed at a different tax rate. In other words, a person in a higher income category has to pay a larger percentage of their income in taxes. The tax rates for each different tax bracket are called marginal tax rates.
For example, in 2016, these are the tax brackets and marginal tax rates for single people:
|If a person earns this much income
(They are in this tax bracket):
|The government can take this percentage of their income|
(This is their marginal tax rate):
|$0 – $9,275||10%|
|$9,276 – $37,650||15%|
|$37,651 – $91,150||25%|
|$91,151 – $190,150||28%|
|$190,151 – $413,350||33%|
|$413,351 – $415,050||35%|
|$415,051 and above||39.6%|
Not all income is taxed at the same rate[change | change source]
However, this does not mean that a person making $415,051 is paying 39.6% of that entire $415,051 in income taxes. Tax rates in the United States are marginal. This means that different portions of a person's income get taxed at different rates.
For example, if a person earns $9,276 in a year, they do not have to pay 15% of that whole amount. The first $9,275 that they earned falls into the first tax bracket ($0 – $9275, which has a 10% tax rate). The person pays the 10% tax rate for all of their income that fell into that tax bracket. The person has only $1 left in income that falls into the next tax bracket ($9,276 – $37,650). They only have to pay that tax bracket's tax rate of 15% on that one dollar.
In other words, what the chart above really means is that in 2016, for a single person:
|A person will have to pay this tax rate:||For this part of their income ONLY:|
|10%||Anything between $0 – $9,275|
|15%||Anything above $9,275, up to $37,650|
|25%||Anything above $37,650, up to $91,150|
|28%||Anything above $91,150, up to $190,150|
|33%||Anything above $190,150, up to $413,350|
|35%||Anything above $413,350, up to $415,050|
|39.6%||Anything above $415,050|
Not all income is taxable[change | change source]
Usually, the government uses a person's gross income to decide how much they should be taxed. A person's gross income is every dollar they have earned in a year.
However, there are some types of income that the government cannot take as part of income taxes.
Deductions[change | change source]
Deductions are certain kinds of costs that the government does not tax. The government will decrease (or "deduct") these costs from a person's gross income. This means the government will be taxing the person on less income.
There are many kinds of deductions. There are some deductions that anyone who pays taxes can take. For example, if a person has paid to move, paid into a retirement fund, or paid student loan interest, they can take these costs off their gross income. The government will not tax these costs.
The federal government also gives a standard deduction to most people who are paying income taxes. For example, in 2015, the standard deduction for a single person was $6,300. The government does not tax this amount.
Personal exemptions[change | change source]
The federal government allows each person who files taxes to take a tax deduction called a "personal exemption." When the United States Congress created tax rules in 1954, they thought a certain amount of money should not be taxed so that a person could spend that money on food, housing, and other basic needs. In 2015, the personal exemption for one person was $4,000. Most people can take another exemption for their spouse, and another for each child in their home.
State deductions[change | change source]
Many states have their own deductions. For example, if a person in Massachusetts pays rent to a landlord, they can deduct half of their rent (up to $3,000) from the amount of income the government can tax them on.
Credits[change | change source]
The federal government also offers tax credits. This means that if a person spends money on certain things, and meets all the rules of the credit program, the credit can be up to 35 percent of your qualifying expenses, depending upon your adjusted gross income. For example, the Child and Dependent Care Credit is for parents who work, but have to pay over $3,000 a year for someone to take care of their children while they are working. Each credit has many different rules that people must meet. However, if they do meet them, the federal government will take $3,000 off of their taxes, to help the parents continue to work.
Filing taxes[change | change source]
Every year, most people in the United States must file a report of their income from the year, their deductions, credits, and any other special tax issues. This report is called a tax return. The tax return helps work out what a person might owe the government in taxes. On the other hand, if a person has been paying their taxes bit by bit, the government may owe them money. This is called a tax refund.
Filing status[change | change source]
There are a five different ways that a person, or a couple, can file their tax returns:
- Single: People file this way if they are not married and do not fit under any of the other five categories
- Married Filing Jointly: A married couple can file just one tax return if they want to. Both people put their income and other information on the same tax form. This is usually called a "joint return."
- Married Filing Separately: A married couple can file two different tax returns, one for each person, if they want to pay their taxes separately
- Head of Household: A person can file this way if they are not married; they pay most of the costs for their home; and a certain type of relative lived with them for more than half of the past year
- Qualified Widower with Dependent Child: If a person's spouse died during the tax year, the person can still file a joint return, as if their spouse was still alive. A widower can only do this in the year that their spouse died.
Sometimes a person fits into more than one of these categories. If this happens, they are allowed to file their taxes using the category that will let them pay the least amount of taxes.
Importance[change | change source]
Filing status is important because many things change based on what filing status a person files their taxes under. For example:
- Tax brackets and marginal income tax rates are different for every filing status
- The standard deduction is different for different filing statuses
- People in some tax brackets may not be eligible for certain deductions and tax credits
- A person's filing status may affect whether they have to file a tax return at all
Example of a tax calculation[change | change source]
Here is a basic example of how a person would work out what they have to pay in taxes, based on their income, filing status, and deductions.
- Gross (total) income: $20,000
- Filing Status: Single
- Deductions: Standard deduction ($6,300) and one personal exemption ($4,000)
First the person needs to work out their taxable income. This is the amount of income the government can tax. It does not include deductions, since the government does not tax those. So, to get their taxable income, the person needs to subtract their deductions from their gross income. In other words:
$20,000 (gross income) – $6,300 (standard deduction) – $4,000 (personal exemption) = $9,700 taxable income
Now the person can use lists of tax brackets and marginal tax rates to figure out what they owe in taxes. Here are the tax brackets and marginal tax rates that apply to this person:
|Tax bracket||Marginal tax rate||Which means...||A person will have to pay this tax rate:||For this part of their income ONLY:|
|$0 – $9,275||10%||10%||Anything between $0 – $9,275|
|$9,276 – $37,650||15%||15%||Anything above $9,275, up to $37,650|
- Out of $9,700 in taxable income:
- The first $9,275 will always be taxed at 10%. $9,275 x 10% = $927.50.
- The person has $425 of income above $9,275. This $425 will be taxed at 15%. $425 x 15% = $63.75
- Total income tax is $927.50 + $63.75 = $991.25
This person is paying only 4.9% of their gross (total) income to the government in income taxes.
What federal income taxes pay for[change | change source]
|Spent On||For Example|
|27.49%[b]||Health care||Medicare and Medicaid (help paying medical costs for elderly ex-workers and for very poor, often disabled people|
|23.91%||National defense||Defending the country; paying soldiers' salaries; paying for new weapons for the U.S. military|
|18.17%||Job and family security||Programs to give free food, tax credits, and other help poor families|
|9.07%||Net interest||The total amount of interest the U.S. had to pay to other countries who have given the U.S. loans|
|5.93%||Veterans' benefits||Pays for health care, home loans, pensions, education, and help with disabilities for veterans|
|3.59%||Education and job training||Financial aid (which helps students pay for university); job training programs; special education|
|2.00%||Immigration, law enforcement, and administration of justice||Making the borders secure, paying for lawsuits, other court-related costs|
|1.85%||International affairs||Spending on humanitarian aid for other countries; spending on U.S. Embassies across the world|
|1.64%||Natural resources, energy, and environment||Controlling pollution, making energy, making the environment cleaner|
|1.13%||Science, space, and technology programs||Spending on science, scientific research, and the space program|
|0.97%||Agriculture||Money paid to farmers to help them grow crops; agricultural research; crop insurance|
|0.43%||Community, area, and regional development||Spending on things to make communities stronger, like building housing and community centers|
|0.39%||Responding to natural disasters||Costs of helping Americans (and American businesses) who have survived a major natural disaster|
|3.42%||Other government programs||All other government programs, like controlling trade and making the government work|
Federal income taxes help pay for poor children to get health care through Medicaid
What state and local income taxes pay for[change | change source]
Every state gets to decide where to spend the income tax it collects (its income tax revenue). Different states use this money for different things, at different times.
Education and health care[change | change source]
In 2015, a report looked at what every state spent its income tax revenue on. It found that most of state income tax dollars went to pay for education and health care.
Specifically, states spent over half of their income tax revenues on three different things:
- Public elementary and secondary schools. Together, state and local governments have to pay 90% of public school costs.[d] These include things like paying teachers, buying books, and paying for all the other things schools need. On average, the states paid one-fourth of their income tax revenues toward public education.
- Higher education. States paid about 13% of their income tax revenues to support community colleges, state (public) universities, and vocational schools.
- Health care. The states have to help the federal government pay for some health care programs, like Medicaid. These programs help pay for health care for poor people, the elderly, and people with disabilities. States spent about 16% of their income tax revenues on these programs.
Other things[change | change source]
The 2015 report found that the states spent the other half of their income tax revenues on many different things. Here are some examples.
- Building roads, highways, and bridges
- Making sure roads and bridges are safe, and fixing them
- Public transportation
- Cleaning snow and ice off the roads during the winter to make them safe to drive on
States spend about 4% of their income tax revenue on corrections. These income taxes pay for things like:
- Prisons (including paying guards, and paying the costs of keeping prisoners locked up safely)
- Treatment programs in prison (for example, for people with addictions)
- Educational and job training programs in prison
- Programs for children who commit crimes
Other "public services"[change | change source]
- Public safety
- Trash collection and street lighting
- Free public libraries and public parks
- Paying the costs needed to keep the state government working, including paying the salaries of government workers
Graphs[change | change source]
Notes[change | change source]
- Examples of allowed deductions include:
- Things a person has to pay for their job, that nobody pays them back for
- Things a person pays for medical costs, like medications and hospital visits, that nobody pays them back for
- Interest for a mortgage
- The amount of money or property that a person has donated to a nonprofit organization
- The value of property that a person has lost in a natural disaster
- This means that for every dollar a person paid in taxes in 2014, 27.49 cents went to pay for health care.
- The United States Environmental Protection Agency (EPA) had to clean up this pond so the pollution would not spread to Great Salt Lake, the largest salt-water lake in the Western Hemisphere.
- The federal government pays the other 10%.
- The bars in purple are corporate income taxes – income taxes paid by corporations. The bars in green are personal income taxes – income taxes paid by individual people and families.
- These states are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
References[change | change source]
- "What are Income Tax Rates? Updated for Tax Year 2015". TurboTax: Taxes 101. Intuit. Retrieved April 15, 2016.
- Bernard, Tara Siegel (January 21, 2009). "Income Taxes: What You Need to Know". The New York Times. The New York Times Company. Retrieved April 15, 2016.
- "CNBC Explains: What Is the Marginal Tax Rate?". CNBC. CNBC LLC. November 20, 2012. Retrieved April 15, 2016.
- "Table 20.1. Standard Deduction Chart for Most People". Publication 17 (2015), Your Federal Income Tax: For Individuals. United States Internal Revenue Service. 2015. Retrieved April 15, 2016.
- "Part Five – Standard Deduction and Itemized Deductions". Publication 17 (2015), Your Federal Income Tax: For Individuals. United States Internal Revenue Service. 2015. Retrieved April 15, 2016.
- "Standard Deduction vs. Itemized Deductions". H&R Block. HRB Digital LLC. 2015. Retrieved April 15, 2016.
- "3. Personal Exemptions and Deductions". Publication 17 (2015), Your Federal Income Tax: For Individuals. United States Internal Revenue Service. 2015. Retrieved April 15, 2016.
- "Guide to Personal Income Tax: Rent Paid". Massachusetts Department of Revenue. Commonwealth of Massachusetts. 2016. Retrieved April 15, 2016.
- "32. Child and Dependent Care Credit". Publication 17 (2015), Your Federal Income Tax: For Individuals. United States Internal Revenue Service. 2015. Retrieved April 15, 2016.
- Terrell, Ellen (2012). "History of the US Income Tax". Business Reference Services. United States Library of Congress. Retrieved April 15, 2016.
- "2. Filing Status". Publication 17 (2015), Your Federal Income Tax: For Individuals. United States Internal Revenue Service. 2015. Retrieved April 15, 2016.
- "Your 2004 Taxpayer Receipt: Want to know how your federal tax dollars are being spent?". WhiteHouse.gov. Government of the United States. 2015. Retrieved April 15, 2016.
- "Great Salt Lake." Encyclopædia Britannica Online. Encyclopædia Britannica Inc. 2016. Retrieved April 15, 2016.
- "Policy Basics: Where Do Our State Tax Dollars Go?". Center on Budget and Policy Priorities. April 14, 2015. Retrieved April 15, 2016.
- "State and Local Taxes". United States Department of the Treasury. December 5, 2010. Retrieved April 15, 2016.
- Schiller, Zach (March 2012). Ohio needs a strong income tax (PDF) (Report). Policy Matters Ohio. pp. 1–3. Retrieved April 15, 2016. Cite has empty unknown parameter:
- Feldman, Andy (April 14, 2012). "What do our state taxes pay for?". Milwaukee-Wisconsin Journal Sentinel. The Milwaukee Journal Sentinel. Retrieved April 15, 2016.
- Brennan, Linda Crotta (2015). Understanding Taxes. Real World Math: Personal Finance. Cherry Lake. p. 9. ISBN 978-1633627574.