Personal Income Tax Information

  1. Income Tax Basics
  2. What Is Taxed and Who Must File
  3. What Is AGI (Adjusted Gross Income)?
  4. What Is MAGI (Modified Adjusted Gross Income)?
  5. What Is Taxable Income?
  6. Choosing Your Filing Status
  7. Marginal Income Tax Brackets
  8. 2010 Individual Income Tax Rates
  9. 2011 Individual Income Tax Rates
  10. Federal Income Tax vs. State Income Tax

1. Income Tax Basics

While everyone knows that individual income taxes are paid to the IRS (Internal Revenue Service) each year, the process of taxation itself can be confusing to many. There are various factors that affect how personal income is taxed and how much you end up paying to the government (or receiving as a tax refund).

Both individuals and companies are required to pay a portion of their income to the federal government. There are very few who are exempt from paying income taxes altogether.

While the federal government is responsible for constructing and implementing tax laws, the IRS is in charge of enforcing those tax laws to make sure that everybody is paying the proper amount. Tax forms are available for download online, or paper forms may be requested by mail or picked-up at your local public library (near tax filing time). The IRS also provides assistance to taxpayers who have questions, concerns, or issues with their tax situation.

The amount of tax that you owe each year is based on your income level. Your adjusted gross income (AGI) determines which marginal tax bracket you fall into, and thus, which tax rate applies to you.

Currently, the United States has a progressive income tax system. That basically means that individuals who earn more money generally pay more in taxes. That being said, the IRS allows people to reduce their tax liability using various tax credits, tax deductions, tax exclusions, and other tax benefits.

The majority of individuals are subject to the “Pay-As-You-Go” system, which means that income tax is deducted from each paycheck and sent to the IRS (also known as withholding taxes). If more money was withheld from your wages than you owe in taxes that year, you will receive the overpayment as a tax refund. On the other hand, if too little was withheld from your wages, you will owe more to the IRS on April 15th (or April 15th for the 2012 filing season).

If you are self-employed, or expect to owe above a certain amount of tax for the year, the IRS requires you to pay Estimated Income Tax on a quarterly basis (typically in equal installments every 3 months). At the end of the year, if your payments were not enough to cover the total income tax due, you must pay the remaining balance to the IRS. Conversely, if you paid too much over the course of the year (more than what you owe in income tax), the IRS will send back your excess payment in the form of a tax refund.

It’s important to note that you are mostly likely subject to Federal income tax as well as State income taxes. This will require you to file 2 tax returns ― one to the IRS, and one to your State’s Department of Revenue or Tax Commissioner.

While it’s always recommended that you have your financial records organized and handy, you may elect to request a tax extension if you need additional time to file your return. Remember that a tax extension does not extend the time you have to pay, and any tax owed for that year must be remitted to the IRS by the original filing deadline (typically April 15th). Also keep in mind that filing and/or paying your taxes late will result in penalties and interest charges.

2. What Is Taxed and Who Must File

What Is Subject to Income Tax?

The IRS defines “income” as any money that you receive during the given tax year.

Gross income refers to all income that you received in the form of money, goods, property, and services that is not exempt from tax. This can include any income from sources outside of the United States, as well as income from the sale of your home.

Taxable income, generally speaking, is the gross income of an individual or corporation, less any allowable tax deductions. Your taxable income is, in other words, the amount of your income that is subject to income tax. [What qualifies as “taxable income” is defined in Section 63 of the Internal Revenue Code, and “gross income” is defined in Section 61 of the Internal Revenue Code.]

It’s important to realize that taxable income can encompass more than just your annual salary.  Taxable income can include profits from stocks or real estate sales, as well as winnings from the lottery, betting on horse races, or any casino (domestic or abroad). Even the cash value of bartered items is considered taxable income.

Types of Income

The following categories represent types of income, which may be subject to Federal/State income tax, as set forth by the IRS:

  1. Wages and salaries
  2. Interest received
  3. Dividends
  4. Business income
  5. Capital gains and losses
  6. Pensions and annuities
  7. Lump-sum distributions
  8. Rollovers from retirement plans
  9. Rental income and expenses
  10. Farming and fishing income
  11. Earning for Clergy
  12. Unemployment compensation
  13. Gambling income and losses
  14. Bartering income
  15. Scholarship and Fellowship grants
  16. Social Security and equivalent Railroad Retirement Benefits
  17. 401(k) plans
  18. Passive activities (losses and credits)
  19. Stock options
  20. Exchange of Policyholder Interest for stock
  21. Canceled debt
  22. Alimony and child support

Income That Is Taxable

Wages, Salaries, and Other Job-Related Earnings ― This may include advance commissions, back pays, bonuses, awards, cash gifts from your employer, fringe benefits, unemployment compensation, and childcare services.

Taxable Interest Income ― According to the IRS, taxable interest is defined as “any interest you receive that is credited to your account and can be withdrawn.” This may include interest from bank accounts, investment accounts, time deposits, loans you made to others, savings bonds, and debt instruments sold at a discount.

Miscellaneous Income ― This may include income from bartering, canceled debts, life insurance proceeds, survivor benefits, recoveries, welfare, and other public assistance benefits.

Other types of taxable income may include: investment dividends income, interest on bonds, alimony, unemployment benefits, Social Security benefits, retirement plan distributions, jury pay, election worker pay, rental income, royalties, notary fees, and certain scholarships, fellowships, and grants.

Income That Is NOT Taxable

Types of income that are not subject to Federal tax may include the following:

  1. Gifts and inheritances
  2. Life insurance proceeds
  3. Child support
  4. Certain Veteran’s benefits
  5. Insurance reimbursements for medical expenses not previously deducted
  6. Some welfare payments
  7. Compensatory damages for personal physical injury or illness
  8. Workers’ compensation
  9. Some qualified pension distributions for Public Safety Officers

For more information, please see IRS Publication 525, Taxable and Nontaxable Income.

Who Must File Income Taxes?

In general, you must file a Federal income tax return according to the following table (based on your filing status, age, and income level):

  • If your filing status is SINGLE and at the end of 2011 you were UNDER 65 then file a return if your gross income was at least $9,500.
  • If your filing status is SINGLE and at the end of 2011 you were 65 OR OLDER then file a return if your gross income was at least $10,950.
  • If your filing status is MARRIED FILING JOINTLY and at the end of 2011 you were UNDER 65 (BOTH SPOUSES) then file a return if your gross income was at least $19,000.
  • If your filing status is MARRIED FILING JOINTLY and at the end of 2011 you were 65 OR OLDER (ONE SPOUSE) then file a return if your gross income was at least $20,150.
  • If your filing status is MARRIED FILING JOINTLY and at the end of 2011 you were 65 OR OLDER (BOTH SPOUSES) then file a return if your gross income was at least $21,300.
  • If your filing status is MARRIED FILING SEPARATELY and at the end of 2011 you were ANY AGE then file a return if your gross income was at least $3,700.
  • If your filing status is HEAD OF HOUSEHOLD and at the end of 2011 you were UNDER 65 then file a return if your gross income was at least $12,200.
  • If your filing status is HEAD OF HOUSEHOLD and at the end of 2011 you were 65 OR OLDER then file a return if your gross income was at least $13,650.
  • If your filing status is QUALIFYING WIDOW(ER) WITH DEPENDENT CHILD and at the end of 2011 you were UNDER 65 then file a return if your gross income was at least $15,300.
  • If your filing status is QUALIFYING WIDOW(ER) WITH DEPENDENT CHILD and at the end of 2011 you were 65 OR OLDER then file a return if your gross income was at least $16,450.

If any of the following situations apply to you, you will most likely need to file a Federal income tax return (based on information provided by the IRS):

  1. You had Federal taxes withheld from your wages and/or pension for the tax year, and you wish to get a tax refund back
  2. You are entitled to the Earned Income Tax Credit (EITC), or you received Advance Earned Income Credit for the tax year
  3. You are self-employed with earnings of more than $400.00
  4. You sold your home
  5. You owe any special tax on a qualified retirement plan (including individual retirement accounts (IRAs) and medical savings accounts (MSAs)) –- you may need to file if you received an early distribution from a qualified plan; you made excess contributions to your IRA or MSA; you were born before July 1, 1939 and didn’t take the minimum required distribution from your retirement plan; you received a distribution in the excess of $160,000 from your retirement plan
  6. You owe Social Security tax and Medicare tax on tips that you did not report to your employer
  7. You owe uncollected Social Security and Medicare tax, or Railroad Retirement (RRTA) tax on tips you reported to your employer
  8. You are subject to the Alternative Minimum Tax (AMT)
  9. You owe recapture tax
  10. You are a church employee with wages of $108.28 or more (from a church or qualified church-controlled organization that is exempt from employer Social Security or Medicare taxes)

Even if you do not otherwise have to file a Federal income tax return, it’s recommended that you file one if you are eligible for any of the following tax credits:

  • “Making Work Pay” Tax Credit
  • Earned Income Tax Credit
  • Additional Child Tax Credit
  • American Opportunity Tax Credit
  • First-Time Homebuyer Tax Credit
  • Credit for Federal Tax on Fuels
  • Adoption Tax Credit
  • Refundable Tax Credit for prior year minimum tax
  • Health Coverage Tax Credit

3. What Is AGI (Adjusted Gross Income)?

Adjusted Gross Income (AGI)

Your Adjusted Gross Income (or AGI) is defined as your gross income from all taxable sources, minus certain allowable tax deductions. These “allowable deductions” (also known as “above-the-line deductions”) may include unreimbursed business expenses, medical expenses, alimony, moving expenses, or deductible retirement plan contributions.

Your AGI is important when determining your overall tax liability because it can affect your tax bracket, how much you can contribute to qualified retirement accounts, and which tax credits you may qualify for.

Gross Income

Gross income refers to all income that you received in the form of money, goods, property, and services that is not exempt from tax. This can include any income from sources outside of the United States, as well as income from the sale of your home.

Above-the-Line Deductions

These deductions are taken before your Adjusted Gross Income (AGI) is calculated -- instead of after, like other tax deductions. Because of this, many believe this type of deduction to be more advantageous to taxpayers. Above-the-line deductions are subtracted from your gross income, and the resulting number is your AGI. These above-the-line deductions apply whether you itemize or not. These deductions are designed to help protect your personal exemptions and itemized deductions from phaseouts.

Some above-the-line deductions include the following:

  • Student loan interest
  • Business mileage
  • Moving expenses
  • Alimony
  • Contributions to qualified retirement accounts
  • Early withdrawal penalties

Reporting AGI on Your Tax Return

Your AGI is figured on Page 1 of your Federal income tax return (IRS Tax Form 1040).

4. What Is MAGI (Modified Adjusted Gross Income)?

Your Modified Adjusted Gross Income (MAGI) is calculated by adding back certain items (above-the-line deductions) to your Adjusted Gross Income (AGI), after your AGI has been determined. Your MAGI is used to determine if you are eligible to claim/report particular tax credits, tax deductions, qualified retirement plans, etc.

Some of the items that you may need to “add-in” for calculation of your MAGI include the following:

  • Student Loan Interest Tax Deduction
  • Tuition and Fees Tax Deduction
  • Lifetime Learning Tax Credit
  • Hope Scholarship Tax Credit
  • Qualified Contributions to a Traditional IRA or Roth IRA
  • Interest from Savings Bonds
  • Foreign Earned Income Exclusion
  • Foreign Housing Exclusion or Deduction
  • Deductions for Domestic Production Activities
  • Employer-Provided Adoption Benefits

5. What Is Taxable Income?

The IRS defines “income” as any money that you receive during the given tax year.

Taxable income, generally speaking, is the gross income of an individual or corporation, less any allowable tax deductions.

It’s important to realize that taxable income can encompass more than just your annual salary.  Taxable income can include profits from stocks or real estate sales, as well as winnings from the lottery, betting on horse races, or any casino (domestic or abroad). Even the cash value of bartered items is considered taxable income.

Income that may be part of your gross income but is not identified as “taxable income” would include: child support, proceeds from life insurance policies, inheritances, Workers Compensation payments, Welfare benefits, compensation awarded as a result of physical injury, education scholarships or grants, and income paid to your retirement account (either a 401k or IRA, up to a certain amount).

Overall, taxable income is that portion of your gross income which is subject to taxation by the governing authority, minus any allowable itemized or standardized deductions. Your taxable income is basically the amount of your income that is subject to income tax. [What qualifies as “taxable income” is defined in Section 63 of the Internal Revenue Code, and “gross income” is defined in Section 61 of the Internal Revenue Code.]

Items That Can Reduce Your Taxable Income

Itemized deductions that can minimize your taxable income can include: medical expenses and health insurance, as well as the cost of prescriptions, and the mileage to/from your doctor’s appointments.  Itemized deductions may also include the mortgage interest paid on a home loan, personal losses due to theft or accident, state and local income or sales taxes, property taxes (on real estate as well as personal property), charitable contributions to churches and other qualified nonprofit organizations, gambling losses  (provided they are offset by gambling winnings), and home office expenses.

The standard deduction, on the other hand, reduces your taxable income based on your filing status. It’s important to remember that the standard deduction amount usually changes from year to year, depending on inflation.  There is a higher standard deduction for individuals who are blind, and those aged 65 or older.  In addition to the standard deduction, you may claim tax deductions for real estate taxes, (net) loss sustained as a result of a Federally Declared Disaster, and taxes on federally-sponsored programs (which may include energy-efficient vehicle purchases, appliances, etc.).

Note that you cannot reduce your taxable income with the standard deduction if you itemize your deductions.

Types of Income Subject to Tax

The following categories represent types of income, which may be subject to Federal/State income tax, as set forth by the IRS:

  1. Wages and salaries
  2. Interest received
  3. Dividends
  4. Business income
  5. Capital gains and losses
  6. Pensions and annuities
  7. Lump-sum distributions
  8. Rollovers from retirement plans
  9. Rental income and expenses
  10. Farming and fishing income
  11. Earning for Clergy
  12. Unemployment compensation
  13. Gambling income and losses
  14. Bartering income
  15. Scholarship and Fellowship grants
  16. Social Security and equivalent Railroad Retirement Benefits
  17. 401(k) plans
  18. Passive activities (losses and credits)
  19. Stock options
  20. Exchange of Policyholder Interest for stock
  21. Canceled debt
  22. Alimony and child support

6. Choosing Your Filing Status

Choosing a tax filing status may seem like a basic decision. However, it can become unexpectedly difficult ― especially for taxpayers who are in a complex financial situation, having financial or legal troubles, or on the brink of divorce. For example, if you get married, have a child, or take on responsibility for an elderly parent, your filing status can suddenly change.

The following filing statuses are recognized by the IRS and must be reported on your personal income tax return (Form 1040). Review each status carefully, as one may offer you more tax benefits than another, depending on your specific situation.

Single

A taxpayer may file as “single” is he/she is unmarried, divorced, legally separated, or widowed as of the last day of the calendar year (December 31st). Individuals who have dependents, but who were not the primary caregiver for more than half of the year, must also use this filing status. The IRS generally requires taxpayers to file as “single” if they do not meet the criteria for the other filing statuses.

Married Filing Jointly

Married couples who file under this status must turn one shared/combined tax return and jointly take responsibility for the income reported and taxes owed. To qualify, the couple must be legally married as of the last day of the applicable tax year. Widow(er)s whose spouse died in the past did and who did not remarry may also use this status. The majority of couples file jointly because it offers them more benefits, such as lower tax liability, than if they had filed separately.

Married Filing Separately

Married couples who files under this status generally have separate high income and/or large itemized deductions (e.g., from charitable contributions or medical expenses). However, if a couple files separately and one spouse itemizes deductions, the other spouse cannot claim the standard deduction. Also, certain tax breaks (such as student loan deductions and child tax credits) cannot be claimed, or are reduced, for separate filers. In terms of tax benefits, this status is usually considered less advantageous because it can result in a higher overall tax for a married couple. It is highly recommended that spouses compute their tax liability under both “joint” and “separate” statuses to see which will work best for them.

Head of Household

A taxpayer may file as “head of household” if he/she is unmarried as of the last day of the year (December 31st). To qualify, the head of household must also be paying for over half the costs of maintain his/her home and have a qualifying dependent (e.g., child or relative) who has lived in the home with them for at least 6 months ― special exceptions may apply to dependent parents). This status is generally used by single parents who have custody of their children. Head of household offers more benefits than the “single” or “married filing separately” statuses, including lower tax rates and higher standard deductions.

Qualifying Widow/Widower with Dependent Child

This status can only be used by a widow(er) who lives with a dependent child and has not remarried. It may apply for the year in which their spouse passed away, and it can be used for up to 2 years after their spouse’s death. A qualifying widow(er) must have been entitled to file a joint return with their spouse in the year that he/she passed, regardless of whether that return was actually filed. This filing status allows individuals to use the same tax rates as those who are “married filing jointly” as well as the highest standard deduction (provided they do not itemize deductions).

7. Marginal Income Tax Brackets

Many people do not understand marginal income tax and how it affects them. In turn, they can end up making financial decisions that are actually less beneficial in the long run. One of the most common misconceptions is that moving into a higher tax bracket (e.g., from a salary increase) has a negative impact for the taxpayer because more tax is due.

For example, if you move from the 25% tax bracket to the 28% tax bracket, you may think that all of your income is taxed at that higher rate. However, only the money that you earn within the 28% bracket is taxed at that rate.

The marginal income tax rate system is known as a “gradual tax schedule.” That basically means: as you make more money, you pay more tax.

There are currently 6 marginal income tax brackets for each filing status:

  • 10 %, 15 %, 25 %, 28 %, 33 %, and 35 %

Your marginal tax bracket is the highest tax rate that you will pay on your income.

Minimizing Your Tax Liability

If you understand marginal tax brackets and how they work, you can use this knowledge to help save money on your income taxes. If you are close to one of the marginal tax bracket limits, you can intentionally avoid moving into the next tier by controlling the amount of income that you earn. However, it’s recommended that you run the numbers and consider your particular situation before implementing a tax strategy, because owing less tax means earning less income.

For example, let’s consider a married couple filing a joint income tax return. If that couple earns between $16,751 and $68,000 during the tax year, they fall into the 15% tax bracket (i.e. their income is taxed at 15%). But, if the couple earns more than $68,000 that year, the amount of income that exceeds $68,000 is taxed at 25%, which is the next tax bracket. This means that if the couple earns $70,000 during the year, only $2,000 (i.e. the amount over $68,000) is taxed at 25%.

While it is the goal of many taxpayers to keep their income in the lower tax bracket, the gradual tax schedule ensures that not all of your income is taxed at a higher rate.

8. 2010 Individual Income Tax Rates

Every year, the federal individual income tax rates adjust. While the adjustments are sometimes subtle, it is important that you understand any rate changes and how they will affect you.

Listed below are the 2010 individual income tax rates (as of July 2010), organized by federal filing status.

Single (Rate Schedule X)

  • Taxable income between $0 and $8,375 ― 10% tax rate
  • Taxable income between $8,376 and $34,000 ― 15% tax rate
  • Taxable income between $34,001 and $82,400 ― 25% tax rate
  • Taxable income between $82,401 and $171,850 ― 28% tax rate
  • Taxable income between $171,851 and $373,650 ― 33% tax rate
  • Taxable income of $373,651 or more ― 35% tax rate

Married Filing Jointly or Qualifying Widow/er (Rate Schedule Y-1)

  • Taxable income between $0 and $16,750 ― 10% tax rate
  • Taxable income between $16,751 and $68,000 ― 15% tax rate
  • Taxable income between $68,001 and $137,300 ― 25% tax rate
  • Taxable income between $137,300 and $209,250 ― 28% tax rate
  • Taxable income between $209,251 and $373,650 ― 33% tax rate
  • Taxable income of $373,651 or more ― 35% tax rate

Married Filing Separately (Rate Schedule Y-2)

  • Taxable income between $0 and $8,375 ― 10% tax rate
  • Taxable income between $8,376 and $34,000 ― 15% tax rate
  • Taxable income between $34,001 and $68,650 ― 25% tax rate
  • Taxable income between $68,651 and $104,625 ― 28% tax rate
  • Taxable income between $104,626 and $186,825 ― 33% tax rate
  • Taxable income of $186,826 or more ― 35% tax rate

Head of Household (Rate Schedule Z)

  • Taxable income between $0 and $11,950 ― 10% tax rate
  • Taxable income between $11,951 and $45,550 ― 15% tax rate
  • Taxable income between $45,551 and $117,650 ― 25% tax rate
  • Taxable income between $117,651 and $190,550 ― 28% tax rate
  • Taxable income between $190,551 and $373,650 ― 33% tax rate
  • Taxable income of $373,651 or more ― 35% tax rate

Federal Tax Filing Statuses

To file an individual income tax return you must determine your filing status. It is essential that you consider all your filing options to ensure that you make the best decision. The filing status that you choose establishes your tax bracket and standard deduction, which eventually determines how much income tax you owe (or how much you will receive as a tax refund).

Here are some facts about federal income tax filing statuses:

  • Your marital status on the last day of the tax year determines your filing status for the entire tax year. That means if you are legally married as of December 31, 2010, you must state your status as “married filing jointly” or “married filing separately” on your 2010 federal income tax return.
  • There are many taxpayers who qualify for more than one filing status. If you are eligible for different filing statuses (such as “married filing jointly” and “married filing separately”), you should choose the one that offers you the most tax benefits. For most couples, filing a joint return will result in lower income tax liability.
  • To qualify for the “single” filing status, you must be unmarried, legally separated, or divorced (as of the last day of the tax year).

9. 2011 Individual Income Tax Rates

Every year, the federal individual income tax rates adjust. While the adjustments are sometimes subtle, it is important that you understand any rate changes and how they will affect you.

Listed below are the 2011 individual income tax rates (as of July 2010), organized by federal filing status.

Single

  • Taxable income between $0 and $8,500 ― 10% tax rate
  • Taxable income between $8,501 and $34,500 ― 15% tax rate
  • Taxable income between $34,501 and $83,600 ― 25% tax rate
  • Taxable income between $83,601 and $174,400 ― 28% tax rate
  • Taxable income between $174,401 and $379,150 ― 33% tax rate
  • Taxable income of $379,151 or more ― 35% tax rate

Married Filing Jointly or Qualifying Widow/er

  • Taxable income between $0 and $17,000 ― 10% tax rate
  • Taxable income between $17,001 and $69,000 ― 15% tax rate
  • Taxable income between $69,901 and $139,350 ― 25% tax rate
  • Taxable income between $139,351 and $212,300 ― 28% tax rate
  • Taxable income between $212,301 and $379,150 ― 33% tax rate
  • Taxable income of $379,151 or more ― 35% tax rate

Married Filing Separately

  • Taxable income between $0 and $8,500 ― 10% tax rate
  • Taxable income between $8,501 and $34,500 ― 15% tax rate
  • Taxable income between $34,501 and $69,675 ― 25% tax rate
  • Taxable income between $69,676 and $106,150 ― 28% tax rate
  • Taxable income between $106,151 and $189,575 ― 33% tax rate
  • Taxable income of $189,576 or more ― 35% tax rate

Head of Household

  • Taxable income between $0 and $12,150 ― 10% tax rate
  • Taxable income between $12,151 and $46,250 ― 15% tax rate
  • Taxable income between $46,251 and $119,400 ― 25% tax rate
  • Taxable income between $119,401 and $193,350 ― 28% tax rate
  • Taxable income between $193,351 and $379,150 ― 33% tax rate
  • Taxable income of $379,151 or more ― 35% tax rate

10. Federal Income Tax vs. State Income Tax

It is important to understand the difference between state income taxes and federal income taxes. If you don’t, you could end up underpaying or overpaying on your tax returns ― mistakes that can cost you time and money. Although it may sound confusing at first, once you are familiar with some facts about both state taxes and federal taxes, you can manage your tax strategies much more efficiently and even lower your tax liability.

Federal income tax is paid by citizens of the United States, regardless of the state or county in which they live. If you make your home in one of the 50 states, you will owe income tax to the federal government. Along with this, it is important to know that federal income tax is paid to the IRS (Internal Revenue Service).

On the other hand, state income taxes are levied by each individual state government ― there is no system that encompasses these taxes for all 50 states. For this reason, state taxes vary based on where you live, shop, invest, etc. State taxes may be administered by a department of revenue, department of taxation, state treasurer, or state comptroller.

Just as with the federal income tax system, the majority of states use a progressive tax system. This basically means that you pay more in tax as your income increases. Some states, such as Pennsylvania, have a flat tax ― which means you are taxed at the same rate regardless of your income level.

State income taxes are due every year, usually by April 15th (similar to federal income tax). However, just because you pay the IRS in-full and on-time does not mean that you can be careless when it comes to preparing and paying your state income tax. The state government is a separate entity and will charge penalties if you neglect to file and pay your taxes.

As you can see, there are several key differences between state income taxes and the federal income tax. Overall, while federal tax applies equally to all American taxpayers, your state tax system is more unique to where you live.

Federal Income Tax

Both individuals and companies are required to pay a portion of their income to the federal government. There are very few who are exempt from paying federal income taxes. While the federal government is responsible for constructing and implementing tax laws, the IRS is in charge of enforcing those tax laws to make sure that everybody is paying the proper amount.

The amount of tax that you owe each year is based on your income level ― hence the name, income tax ― as well as your filing status. Your adjusted gross income (AGI) determines which marginal tax bracket you fall into, and thus, which tax rate applies to you.

The majority of individuals are subject to the “Pay-As-You-Go” system, which means that income tax is deducted from each paycheck and sent to the IRS ― also called withholding tax. If more money was withheld from your wages than you owe in taxes that year, you will receive the overpayment as a tax refund. On the other hand, if too little was withheld from your wages, you will owe more to the IRS on April 15th (or April 17th for the 2012 filing season).

IRS Tax forms are available for download online, or paper forms may be requested/picked-up. The IRS also provides assistance to taxpayers who have questions, concerns, or issues with their tax situation.

State Income Tax

In addition to the various rules and guidelines surrounding federal tax laws (which are often incomprehensible enough), American taxpayers must also be concerned with their state taxes. Depending on the state, full-time residents (as well as part-time residents and nonresidents) may be subject to personal income taxes, corporate income taxes, sales taxes, use taxes, and/or property taxes.

State income taxes are levied in addition to federal income tax, although they generally have lower rates. The state income tax may be a “progressive” tax (the more you earn, the higher your tax rate) or a “flat” tax (all filers are taxed at the same rate, regardless of income).

The majority of states have a progressive income tax system, in which higher-income filers are subject to higher tax rates. In Missouri, the tax rate starts at 1.5% and goes up 0.5% for every $1,000 of taxable income (up to $9,000). Iowa taxpayers with annual income over $63,315 are taxed at 8.98%, but those earning $1,407 or less are only taxed at 0.36%. Hawaii has the highest income tax out of any state, with a top rate of 11% for income over $200,000.

Other states may have a flat income tax system, in which all income is taxed at the same rate. Illinois has the lowest flat tax rate of any state at 3%, followed by Pennsylvania at 3.07%, and Indiana at 3.4%.

Here are some other state income tax facts:

  1. Taxpayers in North Dakota and Oregon may deduct health care costs from their state taxes.
  2. 27 states (and Washington, D.C.) allow a tax deduction for Social Security Benefits. They are Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Ohio, Oklahoma, Oregon, Pennsylvania, Massachusetts, Michigan, Mississippi, New Jersey, New York, Alabama, Arizona, Arkansas, California, North Carolina, South Carolina, Wisconsin, and Virginia.
  3. 26 states (including Michigan, Texas, New York and Florida) allow retired veterans to deduct their pay from state taxes.
  4. 10 states do not tax federal, military, or in-state pension income. They are: Kansas, Massachusetts, Illinois, Louisiana, New York, Mississippi, Michigan, Alabama, Hawaii, and Pennsylvania.
  5. Some states offer additional tax deductions for retirees. In Mississippi and Illinois, you can deduct all income from qualified retirement plans. In Louisiana, you can deduct up to $6,000 of income from qualified retirement plans. The State of New York allows up to a $20,000 deduction, and Michigan allows a maximum deduction of $34,920.

The income tax rate(s) in a given state may affect your decision to live there. But keep in mind there are other state taxes ― including business taxes, sales taxes, and property taxes ― which you should also take into consideration.

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