Income tax is an annual charge levied either on earned income wages, salaries, commission) and unearned income (dividends, interest, rents, trading gains).
There are two basic types of income tax. First listed is personal income tax, levied on incomes of individuals, households, partnerships and sole-proprietorships. The second type is corporation income tax, levied on profits net earnings of incorporated firms.
According to the law, businesses and individuals must declare an income tax return on annual basis to determine whether they owe any taxes or are eligible for a tax refund or not. Income tax is a key source of funds that the government uses to fund its activities and serve the public.
BREAKING DOWN Income Tax
Widely spread progressive tax system implies a higher tax rate for a high-income earners compared to a low-income individuals. Income tax first appeared in the United States in 1862, during the Civil War. At that time only about one percent of the population was required to pay the tax. A flat-rate income tax was imposed in 1867. The income tax was repealed in its entirety in 1872. Its original purpose was to fund the repayment of a $100 million debt that was incurred through war-related expenses. After the war, the tax was repealed, but income tax became permanent during the early 20th century.
In United States, the Internal Revenue Service (IRS) is tasked with collecting yearly income tax from working residents and businesses. Most citizens pay income tax to the agency annually, though in some cases, quarterly prepayments are required for freelancers and businesses that exceed a given income threshold. The IRS is part of the Department of the Treasury.
Individual Income Tax
An individual income tax is the tax levied on a person’s total income for a period of one year. This tax is regulated and collected by the government. With corrections made at the year end, adjustments to the taxes can result in either an additional tax payment owed to the government or a tax refund owed to the individual by the government.
Business Income Taxes
All businesses pay income tax on their earnings. According to IRS, corporations, partnerships, self-employed contractors and small businesses are considered to be businesses.
Regardless of the overall design of the income tax, it is common to provide special rules for taxing business or investment income. These rules primarily relate to the tax base, timing of the recognition of income and deductions, and collection of tax. By far the most important are the timing rules. Particularly in the business context, these rules must negotiate the difficult terrain that bridges financial accounting and taxation. While uniformity between tax and financial accounting may seem desirable, countries have adopted quite different approaches: some countries have achieved substantial uniformity; in others, tax and financial accounting are substantially independent.
State and Local Income Tax
Most individual U.S. states collect a state income tax in addition to federal income tax. The two are separate entities. Some local governments also impose an income tax, often based on state income tax calculations. Forty-three states and many localities in the United States may impose an income tax on individuals, only seven states do not levy income taxes on their citizens, and they include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee only collect income tax on earnings from dividends and investments. Forty-seven states and many localities impose a tax on the income of corporations.
Property Tax and Sales Tax
Property tax is a levy issued by a government on a person's real or personal property. The property is assessed to give it a value, and then that value is taxed. The amount of tax owed is determined by multiplying the fair market value of the property by the current tax rate. The amount taxed on a given property may change over time based on a reassessment of the property's value.
While sales tax is a consumption tax levied on goods and services purchased at the retail level, paid by the consumer and submitted by the retailer to the governing tax authority.