how income tax works
the internal revenue service irs collects taxes and enforces tax laws in the united states the irs employs a complex set of rules and regulations regarding reportable and taxable income deductions credits etc the agency collects taxes on all forms of income such as wages salaries commissions investments and business earnings the personal income tax that the government collects can help fund government programs and services such as social security national security schools and roads history of income taxthe united states imposed the nation s first income tax in 1862 to help finance the civil war after the war the tax was repealed but it was reinstated after the passage of the revenue act of 1913 that same year form 1040 was introduced 1most countries including the u s employ a progressive income tax system in which higher income earners pay a higher tax rate compared with their lower income counterparts the idea behind progressive tax is that those who earn high incomes can afford to pay more tax for 2023 and 2024 federal income tax rates range from 10 to 37 23types of income taxindividual income tax is also referred to as personal income tax this type of income tax is levied on an individual s wages salaries and other types of income this tax is usually a tax that the state imposes because of exemptions deductions and credits most individuals do not pay taxes on all of their income the irs offers a series of income tax deductions and tax credits taxpayers can use to reduce their taxable income while a deduction can lower your taxable income and the tax rate used to calculate your tax a tax credit reduces your income tax obligation the irs offers tax deductions for healthcare expenses investments and certain education expenses for example if a taxpayer earns 100 000 in income and qualifies for 20 000 in deductions the taxable income reduces to 80 000 100 000 20 000 80 000 tax credits help reduce the taxpayer s tax obligation or amount owed they were created primarily for middle income and lower income households to illustrate if an individual owes 20 000 in taxes but qualifies for 4 500 in credits their tax obligation reduces to 15 500 20 000 4 500 15 500 4taxable income is your adjusted gross income agi minus any itemized deductions or your standard deduction 5businesses also pay income taxes on their earnings the irs taxes income from corporations partnerships self employed contractors and small businesses 6depending on the business structure the corporation its owners or shareholders report their business income and then deduct their operating and capital expenses generally the difference between their business income and their operating and capital expenses is considered their taxable business income 78all but nine u s states impose personal income taxes on their residents the ones that don t are alaska florida nevada new hampshire south dakota tennessee texas washington and wyoming 9keep in mind though that it may not necessarily be cheaper to live in a state that does not levy income taxes this is because states often make up the lost revenue with other taxes or reduced services 