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An Overview to Income Taxes

Income Taxes Overview

The tax revenue stream for local, state and federal government is vital to provide certain services for taxpayers within those tax jurisdictions. The manner in which tax revenue is accumulated can vary. For example, sales taxes are a regressive tax, which means that taxpayers with a lower salary are responsible for a higher tax burden as a percentage of their salary.

There are taxes that can be imposed in a more progressive manner, which means that the tax burden would be equally distributed as a percentage of each taxpayers salary. If Income tax were accessed as a flat rate of each taxpayers salary, the tax would be progressive. On the same token, taxes can be income elastic or income inelastic.

Taxes that could be considered income elastic, are taxes that depend on an individuals salary, or overall income. For example, the capital gains tax and the income tax are both income elastic. There are taxes that do not depend on an individuals salary, such as property taxes. Those taxes are not imposed as a percentage of salary, but as percentage of the value of some piece of property.

It could be argued that property taxes are income elastic because the wealthy can afford more expensive property, which results in a higher tax based on their income. Overall however, the property tax is accessed on the value of the property and an individuals salary has no bearing over that determination.

Taxes can be imposed in a number of ways. First, many taxes are imposed in a cyclical manner. For example, payroll taxes are taken out on a cyclical schedule, or every pay period. Cyclical taxes are simply those that are imposed on a regular basis, or according to some set schedule. There are also taxes that are non-cyclical, such as sales taxes, which are imposed at the point of purchase, as a percentage of the sales price.

Individuals may shop on a fairly typical schedule, but the sales taxes are imposed as a random pattern, controlled by the shopper. Taxes can be imposed in a pattern, without a pattern or in opposition of the state of the economy. Taxes that are countercyclical, work in oppositions of the economy. For example, in a bad economy, a countercyclical tax would be raised. In a good economy, a countercyclical tax would be lowered.

In order for taxes to be constitutional, they must adhere to the substantial nexus,fair appointment, non-discrimination and relationship to service rules. In essence, the taxes must be imposed when there is a direct relationship between the taxable item, the tax jurisdiction and the individual making the purchase. The taxes cannot be imposed unfairly and must apply to all equally, as not to discriminate against certain groups of people, or certain types of businesses.

Income Taxes:

Income taxes are imposed against any salary in the United States. Each employee's paycheck is subject to the tax on a cyclical basis. Income taxes must be taken out of each paycheck, according to law. Those taxes are an estimate of each employees income tax burden, based on their overall salary. Income taxes are the responsibility of all employed Americans.

At the end of the tax year, the taxpayer may find that they have overpaid their taxes, but only after they have taken all allowable deductions. In that case, the taxpayer will receive a refund from the government which includes any over payments.

If however, the taxpayer owes money for their income taxes, they must make that payment by the tax filing deadline, generally April 15th. If they are unable to make a payment at that time, the amount owed will be subjected to an interest payment, in addition to possible late fees.

Exemptions for income taxes include deductions for dependents. For example, a parent that has three children under the age of eighteen, may take four deductions, including themselves.Personal income taxes have different allowable deductions and exemptions, than those that are allowed for corporate income taxes.

Personal deductions include those that apply to that individual taxpayer. Whereas corporate deductions are those allowed for a business. Business deductions include losses, especially if the company had no profit that tax year.

Income taxes are estimated according totax brackets as set out by each tax jurisdiction. For example, the Federal government has a tax bracket which allows employers to estimate each employees income tax burden based on their salary.

Although their actual tax burden may differ from that listed on the bracket, it helps to establish a set amount of taxes to be deducted form their paycheck. Each state will also have income tax brackets which work in the same manner. Taxpayers must calculate their actual income tax burden at years end, so that they can file taxes, and pay the government if they owe addition taxes. In addition, taxpayers that are due a refund from the government, should file their taxes promptly so that they can receive their refund.

Income taxes are imposed on a wide variety of income types. Individuals must pay income taxes on any profit made during that tax year, regardless of where the income cam from. For example, individuals that have a garage sale, would be required to pay a capital gains tax on any profit from that sale. There are many that question the legal validity of income taxes.

However, when the Sixteenth Amendment was ratified, it gave Congress the right to impose taxes. In fact, Congress has the ability to impose taxes, or to overturn taxes imposed by state and local jurisdictions. Although income taxes have continuously been challenged as unconstitutional, they have been held legally valid in every case.
Capital Gains Tax:

The capital gains tax is a tax which is imposed on any income other than a taxpayer's regular salary. For example, investments which have a positive return, are subjected to the capitals gains tax. If the investor holds that investment for more than one year after the date of purchase, that would be a long term capital gain. If however, they were to sell that investment for profit, after less than a year has passed after the date of purchase, they would be subject to a short term capital gain tax. A short term capital gain is taxed at a higher rate than a long term capital gain tax.

There are many strategies a taxpayer can utilize to defer their capital gains tax burden. Taxpayers may pay a lower tax on capital gains if they donate some of their proceeds to charity, which is an excellent deferment strategy. Taxpayers can also subtract capital losses indefinitely. In other words, a loss can be deducted up to the amount of actual capital gains in that tax year. Left over losses can be carried over into proceeding tax years and subtracted until the full loss has been deducted, regardless of how many years have passed since the original loss.

Taxpayers may be able to avoid paying a capital gains tax if their losses matched or exceeded their gains in that tax year. In fact, capital losses can be deducted indefinitely, until the total loss is totally deducted from capital gains and other income. Capital gains taxes may also be deferred in real estate sales, if the person making the profit makes a similar purchase with the profit from the sale of the original real estate.

However, this can sometimes be difficult, as it is not always easy to find a property that is similar in price and type. In order to take advantage of this tax deferment, their can be no money left over from the profit, after they have purchased the new property.

There have been many criticisms of the capital gains tax. First, it is assumed that the tax discourages investments. Taxpayers may forgo investments in favor of simple interest bearing accounts, simply to avoid being taxed at the higher rate. Conversely, capital gains are a source of income, which means that the capital gains tax is simply an extension of income taxes.

Payroll Tax:

A payroll tax is applied to any Americana's salary. The payroll tax is cyclical, which means that each pay period, a certain percentage of a salary is taken out to meet the individuals payroll tax burden. However, employees share the tax burden with their employers. Once the total tax burden has been calculated as a percentage of an employees total salary, the tax burden is equally split between the employee and the employer.

The payroll tax is utilized to cover such things as Social Security and Medicare taxes. Social Security taxes are taxed at a percentage of an employees salary and those payments are capped. In other words, no taxpayer contributes more then the maximum Social Security payment in a given year. If they do, because they switch employers, they can add the overpayment as a deduction from the income tax. Medicare payments however, continue to be taxed as a percentage of salary, with no maximum threshold.

Medicare payments continue as a percentage of a salary, no matter how high the salary is. Medicare taxes are currently imposed at a rate of about one and one half percent of each taxpayers salary. That means that both the employee and the employer each contribute that percentage, for a total of about three percent of an individuals salary being contributed to Medicare with no maximum contribution.

The total Social Security tax rate is about thirteen percent, divided between the employee and the employer. The amount of Social Security payments that a retired American in entitled to collect, is directly correlated with the amount of their lifetime contribution.

Payroll taxes are also imposed in order to fund unemployment benefits and Disability insurance. The percentage of money taken out of each employees paycheck in order to fund unemployment benefits, will vary according the unique and specific laws in each state. In any case, the employer and the employee both contribute to unemployment insurance through a payroll tax. Regular employees payroll tax is divided between their employers and themselves. However, self employed individuals, must pay the payroll taxes on their own.

The payroll taxes originated because of the consequences of the Great Depression. When the economy crashed, it meant that many Americans were unable to support themselves. American citizens were unable to find jobs, afford health insurance, or financially survive after retirement. Payroll taxes are part of a measure that is meant to prevent that from happening again. When each taxpayer contributes to the payroll tax, they are assured that they will be entitled to the benefits which are funded through those taxes.

Estate Tax:

An estate tax is imposed against the value of an estate, which the benefactor has left behind after passing away. The estate tax is assessed on the total value of the estate. Whereas, an inheritance tax is imposed on the value of property inherited by each benefactor.The Estate tax is imposed on the estate of an individual that passes away, separate form any inheritance tax imposed within that tax jurisdiction. An estate tax can be imposed on both the federal and state level. The tax is imposed on the total vale of the estate on the day that the benefactor passes away.

The value of the gross estate is reduced according to several factors before the estate tax is actually applied. First, the cost of the funeral of the benefactor, is deducted from the value of the estate. In addition, any debt incurred when the benefactor was alive, must be paid off before the estate can be distributed to the beneficiaries. There are some other deductions that may be taken against an estate tax.

For example, close relatives, such as children and spouses of the deceased, may be exempt from the estate tax, on inheritance valued up to a certain threshold. In fact, the Federal government allows the children of benefactors to inherit up to one million dollars tax free.

The manner in which inheritance tax is imposed, will depend on the jurisdiction that imposes the tax. There is a Federal estate tax and some states also impose a state estate tax and an inheritance tax. If the tentative tax is used to determine the amount of estate tax, there is a formula used. First, the amount of inheritance will fall within some range on the inheritance tax bracket.

Within each range, there is a flat rate of tax imposed. However, any amount over the minimum threshold, will also have a tax at a percentage of that amount over the threshold. For example, an inheritance valued at one and a half million dollars, may fall within the range of one million dollars. That amount will receive the flat tax rate in that range. Then, the remainder of one half million dollars, will be taxed at the percentage which applies to that range.

There are credits available for inheritance tax. On the Federal level, their are lifetime credits, with a maximum allowable estate value per benefactor or beneficiary. For example, there is a lifetime credit available for children to inherit up to million dollars tax free, from either parent, in their lifetime. Yet, that credit may not currently apply because the Federal inheritance tax rate for 2010 is zero.

The rates set to go into effect in 2011, will revert back to those found almost a decade ago. In fact, the rates will increase and the exemptions will decrease from what they were in 2009. Yet, the inheritance and estate tax for this tax year are zero, as a result of a loophole to tax laws that currently applies. Yet, many suspect that the government will impose next years tax rate retroactively, which means it could apply to estates and inheritance from 2010.

Estate taxes generally have to be filed within nine months of the death of the benefactor. If however, the beneficiaries are not yet able to pay the taxes, they can get an extension. However, they will likely have to pay penalties and interest on those taxes. There are many that criticize the estate tax as unfair, especially to the wealthy.

In fact, the higher the value of the estate, the more tentative tax which will be applied. In addition, many claim that the estate tax discourages entrepreneurship because families know that when they pass away, a majority of their estate will be pad to the Federal and state government in the form of taxes. Conversely, many argue that no one is entitled to the money which resulted for the hard work of another, even when they are family.

Inheritance Tax:

Like an estate tax, an inheritance tax is imposed when a benefactor passes away. However, the inheritance tax is imposed differently than the estate tax. The estate tax is imposed on the value of the estate, or the gross estate value, on the day that the benefactor passes away. However, there are some allowable deductions, such as the cost of the benefactor's funeral, before the estate tax is actually applied. The inheritance tax is separately imposed as a percentage of the value of inheritance for each beneficiary. In some states, there is no inheritance tax. In states that do impose an inheritance tax, there are differing rules and tax rates.

Like the estate tax, there are often allowable deductions for the inheritance tax. In some tax jurisdictions, beneficiaries may be exempt form the inheritance tax, if they are a descendant of, or a spouse of the benefactor. Somestate's tax jurisdictions do not take that factor into consideration at all. Spouses may be able to avoid the inheritance tax if any of the property involved, was jointly owned before the benefactor passed away. On the Federal level, children may inherit up to one million dollars tax free, during their lifetime.

Taxes on Legalized Gambling:

Taxes on legalize gambling apply on the state and Federal level, in most cases. There are only a few states that prohibit all forms of legalized gambling, including the lottery. In contrast, there are states that allow legalized gambling, but do not tax winnings. For example, Florida does not tax winnings on the lottery in that state.

However, other states tax winnings at different percentage rates, even changing that percentage depending on the type of gambling. In New Jersey, there is a twenty five percent tax withheld on casino gambling, when the winners have won above a certain amount. However, New Jersey only taxes lottery at eleven percent, although eleven percent is one of the highest lottery taxes in the nation.

On the Federal level, amounts of winnings that are subjected to the automatic tax withholding, have an automatic withholding of that percent before the winner receives any monies. For slot machines, the threshold at which the twenty five percent is automatically withheld, is one thousand and two hundred dollars. For card games, the amount subject to automatic gambling tax with holdings, is five thousand dollars.

In all gambling winnings that meet the federally set threshold standards, twenty five percent is withheld. That percentage may vary if winners can not verify their identity, or are not United States Citizens. The automatic withholding is not necessarily indicative of that persons total tax burden. The actual tax on that amount may be higher or lower, depending on other factors unique to each taxpayer.

In addition, gambling winnings are subject to a deduction based on losses, including the wager that was necessary for those winnings. In most cases, gamblers will need to have proof of loses, such as losing lottery tickets. However, if they have no proof, or if their losses fall below the standard allowable tax deduction, they should utilize the standard loss deduction.

Gamblers that have winnings that are not subjected to an automatic withholding, are required to report all winnings on their taxes, no matter how small their winnings are. Tax revenue from legalized gambling is vital to many economies that allow gambling. In fact, the tax revenue from legalized gambling in Atlantic city provides millions of dollars in tax revenue to New Jersey and to the Federal government.

Yet, there is still a lot of controversy surrounding legalized gambling. There have been studies that suggest an increase in organized crime in locations that allow legalized gambling. In addition, gambling may promote unhealthy and addicting behavior for individuals that take part in gambling.

Yet, in cities like Atlantic city, the job growth in the area has amounted to thirty five thousand new jobs. Those jobs have included total salaries of billions of dollars each tax year. That means there is also an increase in income tax revenue for the state and Federal government. This debate rages in regards to online gambling.

Currently, online gambling is not technically legal in the United States. However, online gambling does represent an added source of tax revenue, which could total in the billions of dollars, based on estimates from previous online gambling. While online gambling may not present as many job opportunities as casinos, the tax revenue would far exceed tax revenues from casino gambling an lottery gambling.

Consumption Taxes:

Consumption taxes are imposed on a myriad of merchandise and services. There are sales taxes which are imposed as a flat percentage of the price of merchandise. There is currently no Federal sales tax in place, except the one imposed on indoor tanning. However, many in the economic sector have proposed the VAT, or value added tax, which would be the federal equivalent of a state sales tax. That tax would be imposed on purchases across the country, and would be added to the tax already imposed within each tax jurisdiction.

There are several types of consumption taxes. For example, there is a gross receipts tax which is imposed against the profit of businesses. That tax is unique, in that it is the sole responsibility of the business owner. Hawaii imposes no sales tax on consumers, and instead imposes the gross receipts tax on business owners. In turn, business owners generally do pass on that tax to consumers, by increasing the price of items sold in their store. Yet, consumers may be unaware that the price of an item includes the addition of the gross receipts tax passed on by the business owner.

There are also excise taxes, which are imposed at a flat amount on items, as a measure of their volume. For example, the excise tax on gasoline is imposed on a per gallon basis. Consumers may may pay an excise tax which is imposed by the federal, state and local governments, as each has the ability to impose the excise tax. Consumers do not generally see the amount of tax when they make a purchase.

Instead, they are given the total price of an item, based on volume. Consumers may also be subjected to use tax on items they purchase outside of their tax jurisdiction, which would normally be taxed in their jurisdiction. For example, individuals that buy cigarettes out of state to save money, are responsible for reporting that purchase and paying a use tax to their tax jurisdiction.

The use tax is imposed on items used, consumed, or stored, in the taxpayers jurisdiction, when they were purchased in another tax jurisdiction. In some cases, states impose a use tax as a percentage of a taxpayers salary. In other states, taxpayers are expected to report their out of state purchases.

Sales Tax:

General sales taxes can be applied to the purchase of merchandise and services. Each state applies its own tax rate to unique and specific merchandise in each state. In addition, each local tax jurisdiction may add an additional tax to items purchased within that jurisdiction. Some states tax items that other states do not tax.
In fact, some states do not even apply a sales tax directly to the consumer at all. In Hawaii, the merchants pay a gross receipts tax which is based on a percentage of their sales. In most cases, however, merchants do pass that tax onto their customers in the form of adding to the price of the merchandise available in their stores. Some states apply a sales tax to provided services, such as landscaping, while others do not.

In states that do apply a sales tax directly to the consumer, the tax is consideredregressive. Sales taxes are applied as a flat percentage of the cost of an item. In essence, those with lower salaries end up shouldering more of the tax burden, as based as a percentage of their salary. The wealthy pay a lower percentage of their salary towards the tax. There is currently no general Federal sales tax on most merchandise or services.

Each tax jurisdiction authorizes there own sales tax, as a percentage of the sales price. Each state and local government many apply sales taxes to whatever merchandise and services they choose, as long at the tax complies with Federal law. In most cases, it is the merchants responsibility to collect sales tax directly form the consumer when they make a purchase. At the end of the year, the merchant pays those taxes to the government. While each state authorizes merchants to collect the sales tax, the state is authorized to do so through Congress.

Taxes may be imposed on the purchase of regular merchandise, when consumers make a purchase in a store. Yet, online purchases can also be subjected to a sales tax. However, online purchases may not automatically be taxed by the merchant. Usually, the merchant only taxes individuals that receive delivery of an item, in a state where that company has an office or warehouse.

Consumers that are not taxed, are expected to submit a use tax to their state of residence, if the item purchased would normally be taxed in their state. In some states, there is a tax on provided services, such as mechanics. In fact, economists suggest that tax jurisdictions that do not impose the tax on services, lose out on copious amounts of tax revenue each year.

There are also special sales taxes imposed on specific items. Like all taxes, these excise taxes can be applied on the local, state and federal level. Often times, these taxes are imposed on all three levels. For example,a cigarette excise tax is impose don the federal level, by New York State and also by New York City. In fact, a pack of cigarettes purchased in New York City, is one of the most expensive around the nation.

Special excise taxes are generally imposed on items which the government wishes to discourage the purchase or use of. For example, it is widely know that cigarettes are bad for the users health and for the health of those around them. In fact, the added cost associated with health care and other smoker related issues, far outweighs the cost of a pack of cigarettes. The same dangers seen in smoking, can also be seen in those that abuse or excessively use, alcohol.

The alcohol excise tax is imposed as a flat amount, on the volume of alcohol purchased. In addition, certain types of alcohol are taxed at a higher amount than others. The tax revenue form cigarettes and alcohol, is often used for public educational campaigns, as well as for the additional health care necessary for those that become ill form the effects of use, abuse or simple exposure. The motor fuel excise tax is imposed in the hopes of discouraging excessive gasoline consumption.
Special Sales (Excise) Tax:

There are several types of special sales taxes which can be imposed upon the purchase of certain items. The types of products which incur the special excise tax, are those which the government hopes to discourage consumption of. In the absence of being able to prevent consumption of such products, the excise tax is utilized to fund public education campaigns and other beneficial programs.

The tax revenue is also used to help those that want to quit, or avoid using certain substances. For example, New York offers free nicotine patches or nicotine gum to citizens that wish to quit smoking. Those programs are often funded through the excise tax revenue from cigarette taxes. Many states also offer alcohol abuse prevention, and support groups, for individuals experiencing difficulties associated with alcohol abuse.

Some states also utilize the tax revenue to prevent drunk driving, and other offenses that result form alcohol consumption. The alcohol excise tax is used in a variety of ways, that greatly benefit the public through prevention and support groups. The motor fuel tax is slightly different. Although the fuel tax is imposed on a measure of the item, the tax revenue is utilized in several different ways. Many states use the fuel tax revenue to protect the environment and to encourage alternate means of travel. Each state is authorized to impose any type of excise tax, as long as it complies with all applicable Federal and states law.

Other State and Local Taxes:

There are several types of state and local taxes. In some states, there is an entertainment tax imposed on events such as concerts, or movies. The tax is generally imposed on events that have a main purpose of entertainment. If an event is considered educational, or a fund raiser, even when entertainment is involved, the entertainment tax would not likely apply. There are also taxes that are state specific, or specific to local government.

For example, there is a tax on stocks purchased on the New York Stock Exchange. The tax is imposed at a flat rate, per stock, as opposed to a percentage of the value of the stock. Although the stock tax is currently in effect, the tax has been directly refunded to investors since 1981. There is great controversy surrounding the issue of the stock tax. In fact, if the tax remains in effect, even when in theory, it is possible that the state may halt refunding the tax to investors. In the absence of stopping the stock tax refund, it is likely that the tax will be removed from the books. Some states also impose a severance tax.

That tax is applied to natural resources harvested in that tax jurisdiction, but only when the resources are used in another state. In general, the severance tax only applies to non renewable resources. Most states also impose an estate tax or a gift tax. The estate tax is imposed on the value of an estate, on the day that the benefactor passes away. Each state that imposes the tax, does so at differing rates and with varying allowable exemptions and deductions. Gift taxes apply when the benefactor is still alive, and gives a gift, of some financial value, to family or friends.

Gifts to family, are often tax exempt if they fall below a certain threshold. Almost every state also imposeslicense taxes and fees for various licenses. For example, liquor licenses often have fees and taxes associated with their purchase.

NEXT: Corporate Income Tax at a Glance

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