What is Income Tax?

Once a person starts to earn an income, they may wonder, “What is an income tax?” Local, state and federal government have the authority to levy a tax on the earned income of an individual or a business. Understanding what this tax is, who has to pay it and how to go about filing a tax return are essential to an individual’s or business’s compliance with the law.

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What the Tax on Income Is

Income taxes are levied on earned income from employment. That earned income could be from self-employment, such as people who operate an in-home daycare center for four children or people who work as freelance writers. People who are contract workers or work for an employer must also pay these taxes. Students who receive a stipend as a part of their financial aid package may have to pay tax on the stipend portion of their financial aid.

Who Has to Pay a Tax on Income

Not all people end up owing a tax on their income, but everyone does have to file a return on their income taxes. According to the 2018 tax rates, anyone filing individually who earned less than $9,750 would not owe a tax on their income. If one was deducted from their pay, they would get it refunded after filing their tax return. Deductions for dependents could raise that threshold of income that a person can earn without owing a tax. However, employers are obligated to deduct the tax from the paycheck, then the person files a return in order to get back money they are owed or to pay more if their employer did not withhold enough.

How Much Taxes Have to Be Paid

The tax rates vary year by year in accordance with the laws passed by a city council, state legislature or the United States House of Representatives. The amount of tax that a person or business has to pay on their earned income will vary based on the law and how much money they earned. According to the Tax Policy Center, the 2018 federal marginal income tax rates ranged from 10 to 37 percent. Filing taxes can be a complicated process because of deductions, credits, itemizing, dependents and other factors.

Where the Income Taxes Go

Governments use income taxes to fund a wide variety of programs and services. At the local level, they are used to fund police, road construction and emergency services. At the state level, income taxes are used for funding health departments, repairing bridges and paying educators. At the federal level, income taxes are used to pay for national defense, interstate maintenance and veterans’ services, among thousands of other programs. Just like there are laws about the tax rates, there are also laws passed on how the funds must be used.

Many people feel frustrated about losing some of their hard-earned money to the local, state or federal income taxes they have to pay. Understanding the tax, its rates and the political processes that go into setting the tax rates and rules could help a person take action and contact their political representatives if they do not like their tax situation. Knowing “What is income tax?” also helps a person understand what all of the deductions are when they receive their earnings statements from their employer.

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