What is Federal Income Tax?
Federal income tax is paid to the IRS based on the annual income of an individual or company.
It can be incurred based on earnings from a variety of sources and includes employment wages, capital gains from investments, and business profits.
Taxes are essential to keeping the government running and supporting all the services that help a society function. US federal income taxes are owed to the government of the United States.
Depending on where they live, an individual may also incur state and local taxes to fund local services such as schools and police departments.
Calculating Income Taxes
The US tax system is notoriously complex, with many rules, tax loopholes, and exceptions.
While it is advisable to hire an accountant if you have a complex tax situation, there are a few basic concepts that everyone should know about how income taxes work.
Federal income taxes are progressive, which means the more taxable income you have, the higher your tax rate is.
The table below shows the different tax rates for different levels of taxable income; each level is referred to as a tax bracket.
Tax rates also vary based on tax filing status, which basically means that tax rates for single people are different than for married people filing taxes jointly.
A Deeper Look
Applying numbers makes it easier to understand tax rates and brackets.
According to the table above, if you are an unmarried individual, the tax rate for your first $9,700 of income is 10%.
The tax rate on your income from $9,700 to $39,475 is 12%.
Therefore, if you make $30,000 in taxable income, your tax liability is $3,406.
This is calculated by multiplying the 10% tax rate by the first $9,700 of income, which equals $970.
Then multiply the 12% tax rate by the next bracket of income, $20,300 ($30,000 in total income minus $9,700 of income already taxed) which equals $2,436.
Adding $970 and $2,436 gives you $3,406, which are the total taxes owed.
What would the tax liability be for a married couple earning $150,000 in total income?
Here is how that was calculated (referencing the tax bracket table above):
10% tax rate on the first $19,400 of income = $1,940
12% tax rate on the next $59,550 of income ($78,950 minus $19,400) = $7,146
22% tax rate on the last $71,050 of income ($150,000 minus $59,550 minus $19,400) = $15,631
Adding up $1,940 plus $7,146 plus $15,631 = $24,717
Factors to Consider
However, calculating income taxes isn’t this straightforward because there are several loopholes and exceptions to take into consideration.
Individuals and families may qualify for certain tax credits and tax deductions which can reduce taxable income. It’s important to know all the rules and laws to know what you qualify for.
That’s why using tax software is a must and hiring a tax accountant may be a good idea.
Don’t get too liberal with adjusting taxable income for tax deductions. If you break the rules and underpay your taxes, the IRS will levy a tax penalty on you if they find out. The IRS conducts tax audits on random people as well as suspicious tax filings.
People who qualify for many tax deductions that substantially reduce their taxes owed may be required to pay the alternative minimum tax.
This is the minimum tax required for certain levels of income. It is calculated using a different tax table and is designed to ensure everyone pays their fair share.
How Income Taxes are Collected
In the United States, federal income taxes are collected throughout the year based on estimates of what people will likely owe.
When an employee receives their paycheck, a portion is withheld for estimated taxes owed. Businesses are generally required to pay taxes on a quarterly basis based on their estimated profits.
After a year has ended, individuals and businesses calculate what their taxes should be based on what they actually earned during the year.
They put this information into their annual tax filing, which is generally due on April 15. If a person or business withheld more in taxes than they actually were liable to pay, the IRS will issue a tax refund for the difference.
If they withheld too little during the year, they will need to pay an additional amount to cover their full tax liability.