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Tags: finance, income tax, principles of the income tax system
 Income tax is a levy on the income of persons, and corporate entities and of 3 types-progressive, proportional, or regressive. A progressive type has different levy levels based on your earnings bracket. If you earned $30,000, the first $10,000 could be taxed at 5%, the next $10,000 at 10%, and the rest at 20%.
The flat type levies the same percentage rate regardless of earnings bracket. If you made $30,000 or $100,000 you're taxed at a 20% rate. Lastly, the regressive type only levies up to a certain amount, say up to the first $100,000 earned. In the United States we use a progressive levy on individuals, partnerships, companies, corporations, trusts, decedent’s estates, and bankruptcy estates.
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While the different types of income tax includes personal or individual income tax, corporate income tax, payroll, inheritance, and capital gains taxes, we will focus specifically on the personal or individual income tax in our discussion. While our country’s tax laws are a tad complicated (OK very complicated), understanding the principles of the income tax system is relatively simple.
We start with what we call our gross income, which is basically all receivables or financial inflows regardless of how or where it was made less any allowable exclusion (or those things that our government allows us not to include). For tax purposes this can be divided into ordinary receivables and capital gains.
Capital gains we discussed in my prior article “Understanding the Capital Gains Tax—Beyond the Basics,” (April 6, 2009), but as a refresher it is simply defined as any gain from the sale or exchange of a capital asset. As for those receivables or inflows falling under the ordinary category it can be defined as the sum of all the wages, salaries, profits, interest payments, rents and other forms of earnings received in a given period of time.
The other forms of earnings can include but are not limited to, tips, commissions, bonuses, and other types of compensation from employment, dividends, or net from a sole proprietorship, partnership or LLC. Rent receivables and royalties, less allowable allowances, as well as gambling winnings also falls under the ordinary category.
Short term capital gains, or gains on the sale of an asset held for less than one year is also taxed as ordinary. Once we have gotten our gross we subtract from it any and all allowable above the line deductions to get at our Adjusted Gross Income or AGI.
Above the line deductions are those deductions that the Internal Revenue Service (IRS) allows taxpayers to subtract from the gross such as certain expenses of performing artists, certain expenses for books and supplies incurred by teachers, losses from the sale of property, alimony payments, moving expenses, and higher education expenses to name a few.
AGI less your standard deductions or itemized deductions whichever is greater equals you taxable income. A standard deduction is the amount that non-itemized users subtract from their AGI and is based upon filing status. So if your filing status for 2008 is single then your standard deduction is $5,450. This amount can be higher if for example you are over 65 years of age or legally blind.
An itemized deduction can be used in lieu of the standard deduction and most taxpayers are given this option. The choice of whether to use the standard or itemized deductions hinges on whether the taxpayer is a citizen or resident alien or not since non-resident aliens are not eligible to use the standard deduction.
If taxpayer is married but filing separately and the spouse itemizes, he or she must also itemize. Once the deductions are taken, the resulting taxable amount is then multiplied by the tax rate to get the income tax due. As long as you have the needed information, filing you income tax return will be easier.
About the author
The author of this article Rick Goldfeller is a successful underground Financial Analyst who has been advising and coaching individuals for many years. Rick recently published a book on how to manage your money and attract Wealth and Financial Freedom. More info on his Finance Planning course is available HERE.
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