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What is Income Tax?

Income tax is paid to the government based on the amount of income earned. There are federal income taxes, and some states have their own income taxes, too.

As an employee for a company, income taxes will be withheld from paychecks using the company’s best estimation of your annual earnings. At the end of the year it may turn out that they withheld too much, and the government may give you a tax refund for what was overpaid.

Income can come from sources other than an individual’s main occupation, such as real estate income and dividends from stocks and bonds. Income taxes are levied on all reported income for which the individual does not file exclusions, deductions, and tax credits.

In the United States, income tax is a progressive tax, meaning the rate of taxation increases the more income is brought in. Some people misunderstand how a progressive tax works.

Let’s say you make $500,000 in taxable income one year and the tax in that bracket is 40%, just for illustrative purposes. The entire $500,000 is not going to be taxed at 40%.

There are tiers for the tax rates leading up to that bracket, and whatever amount of money falls into each tier will be taxed at the rate which applies to it. Lower amounts of income are taxed at lower rates, so the effective tax rate for the person making $500,000 a year will be less than 40%, ignoring any other taxes like state taxes, social security taxes and Medicare taxes.

Self employed people must file their own quarterly income tax returns, but companies withhold income tax on behalf of their employees. Sometimes it turns out at the end of the year that due to deductions or an irregularity in income that the person may owe more or less income tax than has already been withheld. If it is more, and it is not paid for a while, the IRS can garnish wages or put liens on property.

If it is less, the person will receive an income tax refund in the form of a check. Tax rates may change year to year and along with the political environment, so check the IRS website for current tables.

What are Federal Tax Brackets?
What is Federal Income Tax?
What is Income Tax Payable?

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