Definition of "Income Tax"
A tax that governments impose on financial income generated by all entities within their jurisdiction. By law, businesses and individuals must file an income tax return every year to determine whether they owe any taxes or are eligible for a tax refund. Income tax is a key source of funds that the government uses to fund its activities and serve the public.
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Most countries employ a progressive income tax system in which higher income earners pay a higher tax rate compared to their lower earning counterparts.
The first income tax imposed in America was during the War of 1812. Its original purpose was to fund the repayment of a $100 million debt that was incurred through war-related expenses. After the war, the tax was repealed, but income tax became permanent during the early 20th century.
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Income tax is a levy many governments place on revenue of entities within their jurisdiction.
The first personal income tax laws in the US were passed in 1861 to help fund the American Civil War. Income tax was made permanent in 1913 with the ratification of the Sixteenth Amendment to the Constitution, which states that:
“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
In the US, income tax is a major source of the federal government’s tax revenue. Payroll taxes, such as Medicare and Social Security, can arguably be considered income taxes since they are a tax on payroll income. So in total, income tax accounts for about 80% of the government’s tax revenue.
The income tax system in the United States is a progressive tax system, which means that the tax rate rises as taxable income rises. This is considered fair, as higher earners presumably can afford to pay more tax than those of lesser means.
Before WWII, income tax was paid once a year with the filing of the annual income tax return. Now the tax is either paid at the source via payroll withholding, or in quarterly payments for those people and entities that do not have payroll withholding.
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Frequently Asked Questions About "Income Tax"
Why does the IRS withhold income taxes from employee paychecks?Answer:
In the midst of WWII, the U.S. government ran into trouble funding the war effort. The problem did not originate from citizens dodging taxes, but from the lack of regular flow of tax income. The massive expenditures required to fund war usually were financed with government debt, like war bonds.
Debts to citizens, as well as to nations, required maintenance, and other national expenses still required tax dollars. Instead of receiving a glut of cash at the end of each tax year, the government decided to withhold taxes before wages were paid, which required employers to become government tax collectors. As a result, the government had access to a regular flow of tax dollars to ease the ups and downs of war financing. Taxpayers' year-end filings became a way for the government to recover underpayments from some citizens, while refunding overpayments to others.
The idea to move to a yearly taxation method was formed by the treasury department during the early years of the war. The IRS was not thrilled about a pay-as-you-go tax, because it involved monthly paperwork and seemed more burdensome than the year-end filing method. Thus, the withholding system was adopted as a temporary measure for the duration of the war. However, when tax dollars started flowing in an uninterrupted stream, both the government and the IRS changed their tunes and continued to withhold at source.
Surprisingly, one of the architects of the pay-as-you-go method was none other than free market hero Milton Friedman.
(For more on this topic, read War's Influence On Wall Street and Common Tax Questions Answered.)
This question was answered by Andrew Beattie.
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Personal Income Tax Guide
If the sight of your W-4 has you in the doldrums, read on to learn how to beat the tax blues.
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