Federal Income Tax

October 13, 2010by EconomyWatch


The Federal Government of the United States of America is the administrative head for imposition of taxes in the country. Various states and municipalities also have the function of setting tax rates. The Federal Income Tax system can be characterized as progressive in the case of the USA whereby taxes increase with the income levels. That is to say, the tax rates or the proportion of taxes as part of their disposable income will consequently increase with rising income levels.

Federal Income Tax or taxes on incomes of legal entities can be levied on individuals, corporations, trusts, estates of deceaseds and certain bankruptcy estates. The first Federal income tax was imposed during the 1860’s in time of the American Civil War. It was included in clause 1 of Sec 8 under Article I of the US constitution. It was again implemented in the 1890’s and again when the Sixteenth Amendment to the US constitution was ratified in 1913. Current income taxes are however, legalized under these provisions and various provisions of Subtitle A of the Internal Revenue Code of 1986.

The Federal Income Tax structure recognizes the taxable income of the individual which is the Adjusted Gross Income (AGI) less the itemized or standard deductions like charitable donations and medical expenses, which may be tax exemptions accounting to the taxpayer or his spouse (if filing the tax return jointly) or tax exemptions accruing to a family dependent. The AGI is in turn, an above-the-line deduction from the Gross Income of the individual which again does not take into account the employer’s paid health insurance or income from tax-exempted bonds.

The taxable income is then multiplied by the tax rate to give the tax due. It should be noted that while tax deductions can lower your tax by bringing down the taxable income, tax credits, such as Earned Income Tax Credit and Child Tax Credit, applied after the tax deductions can lower your liabilities much on a dollar-to-dollar basis.

The tax rates on income generally can be divided into ordinary income tax rates and capital gains tax rates.

Federal income taxes are charged according to which bracket the individual belongs. The salaries of individuals are divided into several brackets and differential tax rates are levied for each of them.

The income brackets decreased from 15 in 1979 to 6 in the period of 2003-06 with income tax rates ranging from 10%-35% as against 14%-70% in the year 1979. This implies that tax rates have been homogenized to a much larger extent in the recent years. Surprisingly, income taxes are not imposed in the state of Texas in the USA.

As mentioned, Federal Tax Rates are progressive in nature and people only pay taxes according to every dollar they earn within a tax bracket. For example, if a person earns $10,000 a month, he will pay 10% for the first $7500 and a 15% income tax rate on the remaining $2500. On the contrary, against a flat rate of 15% imposed for a wide range of income in most countries with progressive taxation, they will have to dole out a higher amount of tax amounting to $1500 rather than in this case where they only have to let out $1122.50 as income taxes. Thus, it can be said that the more a person earns in the pre-tax period, the more he can earn in the post-tax era as well in this scheme of progressive taxation.

In terms of tax computation, if the AGI is $40,000 then in taxes, the individual will have to pay,

$7550 x 10% + $(30, 650-7550) x 15% + $(40,000-30,650) x 25% =$6557.50 or 16.39% of income.

The Federal Income Tax structure for the US economy can be depicted as follows (in case of a single person filing tax returns):

Tax rates

Income in dollars












336,550 and above

From the above example, one can see the efficacy of the US income tax system. Being the most progressive in the world, it removes the popular misconception that being pushed into a higher tax bracket reduces the after-tax income.


blog comments powered by Disqus