Individual Income Tax

Most citizen have the obligation to pay their taxes. This section discusses topics and issues related to the individual income tax.

Federal Individual Income Tax

Most of the federal government’s budget comes from the federal tax income. The taxes that are paid to the federal government are used to finance federal government expenditures such as infrastructure, economic activities, defense and social services. For individuals who pay federal income tax, the tax is progressive; meaning a certain percentage of tax increase applies as the net taxable income of the taxpayer increases.

Gross Income

Gross income is the amount of all the income an individual receives, regardless of the source. It includes salaries, interests, gains, dividends, alimony, compensations, winnings from gambling, etc.

There is a certain amount of gross income that would make an individual subject to pay federal income tax. There are certain bases for this threshold amount such as an individual’s age, marital status and residency status.

“Adjusted” Gross Income

The adjusted gross income is the gross income minus the adjustments related to certain retirement account contributions, medical savings account contributions, student loan interest, self-employment tax, qualified moving expenses, paid alimony, etc.

Deductions and Exemptions

After the adjusted gross income, there are other deductions that can be utilized. Deductions vary depending on the individual’s filing status. There are the itemized deductions and personal exemption.

The itemized deductions are subtracted from the adjusted gross income, which will now determine the net income that is subject to tax.

The following are the most common itemized deductions:

  • state and local income taxes
  • personal property taxes
  • investment interest
  • real property taxes
  • home mortgage interest
  • charitable contributions

Certain itemized deductions are only deductible to the extent that they exceed a certain percentage of the adjusted gross income. Some of these include:

  • medical expenses
  • employee business expenses
  • casualty losses
  • miscellaneous deductions

Taxpayers can claim a personal exemption amount for themselves plus the same amount for a spouse and each dependent child if applicable. Taxpayers can also claim other relatives as dependents in certain limited circumstances.

Itemized deductions and personal exemption amounts are phased out for higher income taxpayers.

Determining Taxable Income

The personal exemption and itemized tax deductions are subtracted from the adjusted gross income to get the amount of taxable income.

Taxable Income = Adjusted Gross Income(Personal Exemption + Itemized Tax Deductions)

Tax tables or tax rate schedules are applied to the taxable income amount to calculate the amount of tax due. Once the tax is computed, certain credits may apply that will reduce the amount of tax due dollar for dollar.

Typical credits include:

  • childcare credits
  • adoption credits
  • foreign tax credits
  • dependent care credits
  • credit for the elderly
  • earned income credits
  • education credits

Additional Taxes

Additional taxes that may apply to the individual income tax:

  • self-employment taxes
  • tax on early distributions from retirement plans
  • household employment taxes
  • alternative minimum tax

The most common is the alternative minimum tax, which applies when a taxpayer’s alternative tax is beyond the amount of the regular tax. Recomputing the taxes based on the alternative system is required to ensure that the taxpayer is paying the least amount in taxes. This is done by adding back the itemized deductions and other favorable tax preference items. It is similar to a flat-rate tax in the sense that the tax is applied on the total income with limited adjustments.

Capital Gains

The long-term capital gains, in which special favorable rules are applied, depend on the payer’s tax bracket. To qualify, the capital asset that was sold must have been held for more than a year. A capital asset includes everything that was owned for personal or investment purposes. If there is a loss on the sale of a capital asset, the taxpayer can deduct the loss against any capital gains.

When to File Individual Income Tax Returns

The deadline for filing income tax returns is April 15 and the taxpayer can request for an extension for until October 15 of the same year. There are certain penalties and interests imposed if taxes are not paid by April 15, or if returns are not filed by April 15, or the extension date if applicable.

State Income Tax

Individual income tax is also collected in most states. The taxpayer could be subject to income tax on their state of residence and the state where they work or their real property is locates. State income tax is determined in almost the same manner as the federal income tax.

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