What are the basics of tax law?
At the federal level, the primary tax is the income tax. Most know this form of taxation by the completion of the annual 1040 form for the IRS. The income tax is a relatively new creation, having only been in existence for approximately a hundred years. The income tax is designed to tax anything that is referred to as income or what otherwise might be of as economic gain. That gain can come in the form of wages, profits from the sale of property and securities, earnings from gambling, or proceeds from winning the lottery.
Overall, the amount of tax that depends upon what tax bracket you are in. Currently there are several different tax brackets that are governed by your overall income level.
Whatever income you hove may be subject to certain deductions and also to a variety of different credits that may be available. A deduction reduces your adjusted gross income. Common deductions are the home mortgage interest deduction, the payment of state taxes, the payment of real estate taxes, and charitable deductions. These deductions do not reduce your tax burden dollar-for-dollar. They simply reduce the amount of income you have that is subject to tax at whatever your tax rate may be.
Deductions are contrasted with tax credits. A tax credit is a dollar-for-dollar reduction of your tax obligation. For instance, if your adjusted gross income is $100,000 and your total deductions are $40,000, then your taxable income is $60,000. At that level of income, your total obligation may be in the range of $20,000. !f you then have credits that you are entitled to, those credits will reduce that $20,000 obligation dollar-for-dollar. As such, if you have the entitlement to $5,000 in credits, then your actual tax burden will be only $15,000.
Income that you receive in some instances can be subject to double taxation. For instance, if you are a principal owner of a corporation and the corporation receives income, then the corporation may be taxed on that income. If you then distribute that income to yourself as compensation for being an officer or as shareholder dividends, then that income may be taxed a second time as your personal income. This double taxation can be avoided by designating your corporation as an S corporation. In an S corporation this tax liability is passed through to the individual owner or owners. In a C corporation the tax liability may exist both at the corporate level and at the individual level for the individual owners.
At the state level, taxes may come in several different forms. The state income tax that exists in most states is generally keyed to the federal income tax, in which information from your federal return is transferred directly to your state return forms. The tax at the state level for income is generally considerably less than at the federal level.
Other forms of state taxes include the sales tax, which is a tax on the sale of all goods. The sales tax is sometimes referred to as a regressive tax, meaning that it taxes lower income people disproportionately. That is, a 4% tax on sales of food and other necessities to someone earning $200,000 per year may not be a big bite on their budget, but a 4% tax on these sales for someone earning $20,000 is a big bite.
There may also be a number of different state licensing taxes. Those taxes may come in the form of licensing motor vehicles professional licenses, or occupational licenses. Many localities have what is referred to as a business license tax. This tax in some jurisdictions is called a gross receipts tax. Generally, the rate for this tax is fairly low, but it is a tax on essentially every dollar that business brings in the door, irrespective of how much actual income the owner of the business may derive from it. As such, a business may have gross receipts of $1,000,000 and also have expenses of $1,000,000, in which event there is no income generated. That business, however, is still going to pay a gross receipts tax on the $1,000,000 of gross receipts.
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