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Income Tax

Understanding the difference between tax deductions and credits is crucial, as the tax strategies that you adopt now can favor one over the other and yield substantially different tax savings.


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.



Investopedia Explains "Income Tax"

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 After the war, the tax was repealed, but income tax became permanent during the early 20th century.



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Tax Deductions Vs. Tax Credits

Understanding the difference between tax deductions and credits is crucial, as the tax strategies that you adopt now can favor one over the other and yield substantially different tax savings.

Understanding the difference between tax deductions and credits is crucial, as the tax strategies that you adopt now can favor one over the other and yield substantially ...
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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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