Income Taxes

Benjamin Franklin once said that nothing in this world is certain except death and taxes – and he was right.

In its earliest days, the U.S. government was supported by excise taxes on certain products and commodities and then by tariffs on imported goods. In 1862, President Abraham Lincoln created the Bureau of Internal Revenue to collect monies to pay for the Civil War, and the first income tax was levied. Over the next 50 years, the income tax was either supplemented or replaced by various sales, excise and other taxes.

It was not until 1913 that the 16th Amendment to the Constitution gave Congress the authority to pass legislation taxing the income of both individuals and corporations. In that same year, Congress enacted its first income tax law and issued the first 1040 tax form. A 1 percent tax was levied on net personal incomes above $3,000, with a 6 percent surcharge on incomes above $500,000.

Today the Internal Revenue Service (IRS), a bureau of the U.S. Treasury Department, collects federal income taxes and enforces the Internal Revenue Code. It collects more than $2.4 trillion from approximately 234 million individual and business tax returns a year.

Most American citizens are expected to file federal tax returns by April 15 each year. Self-employed individuals and businesses must file quarterly returns.

The process of filing a return can be as easy or complicated as your personal financial situation. The more ways you make money, the more ways you save for retirement, the more investments you have and the more you take advantage of tax credits and deductions, the more complex your tax return is likely to be.

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Filing Procedures and Deadlines for Federal Income Taxes

As April 15 approaches, taxpayers can choose how to file their returns. The oldest method is by mail. Forms and instructions can be obtained online at the IRS website, at a local IRS office or at places like a library or post office. After the forms are filled out properly, they can be mailed to the appropriate IRS address listed on the agency’s website or on the instruction booklet that accompanies the form.

However, fewer and fewer people mail their returns each year. In 2012, more than 100 million people filed their returns electronically. Electronic filing can be done from any computer or from the office of any authorized e-file provider, who can also help with the preparation of the return. While the IRS doesn’t require electronic filing, it recommends it. E-filing generally assures a quicker refund than filing by mail.

Individuals who have trouble meeting a filing deadline can apply for an extension. Both electronic and paper options to file an extension are available. Missed deadlines can incur severe penalties, including interest charges and late fees.

Individual income taxes are generally paid in three ways, each with its own deadline:
  • Withholding taxes: Money that is taken out of a person’s paycheck each pay period that must be paid to the government by an employer, on a quarterly basis.
  • Estimated tax payments: Money that must be paid quarterly, generally by self-employed individuals whose taxes are not withheld by an employer.
  • Income tax return: Money that must be paid by an individual by April 15 of each year, on income from the preceding year, along with the filing of all individual income tax return forms.

Taxpayers must indicate their filing status on their tax returns.

There are five different statuses that determine the amount of taxes owed, and which deductions and credits are applicable:
  • Single – a taxpayer who is unmarried or legally separated
  • Married Filing Jointly – all income, exemptions and deductions must be included for both spouses
  • Married Filing Separately – each spouse files a return, but they must both claim the standard deduction or both itemize deductions (this status has the highest tax rate)
  • Head of Household – the filer must be unmarried or living apart from a spouse for the last six months of the tax year; have paid more than half the cost of keeping up a home; and have a qualified person living in the home for more than half of the year
  • Qualifying Widow(er) with Dependent Child – the filer must: have been eligible to file a joint return with a spouse the year he/she died; can’t have remarried; be able to claim a child as an exemption; and paid more than half the cost of keeping up the home in which the child resides

Who Must File

In addition to one’s filing status, an individual’s age and income will determine if he or she must file a federal income tax return. Individuals older than 65 have lower income thresholds than younger taxpayers. Individuals whose gross income is below the threshold may not have to file a return.

Filing Status Age on Dec. 31, 2012 Gross Income
Single Under 65
65 or older
$9,750
$11,200
Married Filing Jointly Under 65(both)
65 or older(both)
Under 65(one)
$19,500
$21,800
$20,650
Married Filing Separately Any $3,800
Head of Household Under 65
65 or older
$12,500
$13,950
Qualifying Widow(er) Under 65
65 or older
$15,700
$16,850

If a taxpayer’s gross income falls below the applicable level, there are still reasons that may require the filing of a return, including: having a net self-employment income of more than $400; receiving distributions from a Health Savings Account; or earning more than $108.28 from a tax-exempt church organization, among other reasons.

In addition, an individual may want to file a return:
  • If taxes withheld from pay would result in a refund.
  • To claim a tax credit like the Earned Income Tax Credit (EITC) for low-income families or the American Opportunity Tax Credit for reimbursement of qualified education expenses.
  • To claim any tax overpayments that have been made.

Tax Brackets and Rates

The federal income tax is progressive: the higher your income, the greater percentage of that income must be paid in taxes. Because of the American Taxpayer Relief Act of 2012,  there are seven graduated tax brackets with rates ranging from a low of 10 percent to a high of 39.6 percent.

Each bracket comprises a range of “taxable income” – the amount of income from all sources minus all of the adjustments, exemptions and deductions that an individual taxpayer is allowed to take. For each bracket, the tax burden is different.

For instance:
  • A single person who earns $35,000 in taxable income is in the 15 percent bracket.
  • A single person who earns $50,000 is in the 25 percent bracket.
  • And a single person who earns $90,000 fits in the 28 percent bracket.

For the purposes of deductions, a taxpayer’s marginal rate is the bracket that contains the highest portion of taxable income. The actual rate paid, called the effective rate, always will be lower since the first portions of taxable income get taxed at the lower rates.

First-Time Filers

Most first-time filers will be able to use either the 1040A or 1040EZ form. Forms and instructions can be obtained from the IRS website or at a local IRS office.

Preparing a tax return is often made easier with the use of free or low-cost tax software. First-time filers can also visit a tax preparer to make sure that they have filled out the form(s) correctly. In addition, all filers can request help from the IRS either over the phone or in person at an IRS office.

Filing State and City Income Tax Returns

Forty-three states, and some cities, counties and other governmental units also impose taxes on various types of income, i.e. wages, interest and/or dividends. The 41 states that impose an income tax on wages require their employers to withhold income taxes from their workers, just as they withhold federal income taxes.

Some taxing authorities impose flat rates, while others have graduated rates, similar to the federal brackets, only much lower. It is up to the individual to determine which sources of income are reportable to a state or local government, how taxes are calculated, and where forms are to be sent. Information can usually be accessed by visiting a jurisdiction’s website or contacting the appropriate government office.

Generally, income taxes paid to states and localities offset the taxes due to the federal government. And like the federal government, states impose penalties for failing to file required tax returns and/or pay any owed taxes on a timely basis.

Taxes and Debt

Nobody likes paying taxes. But failure to pay them can result in fines and penalties, liens against property, and even prison. That is why it is important to make sure that your tax bill doesn’t force you into debt, or worse, deeper into debt.

If you are an employee, subject to withholding tax, make sure that your employer withholds the appropriate amount of income from each paycheck, so that when April 15comes around, you’re not hit with an unmanageable tax bill. You can do this by determining the correct sum on the W-4 form that you filled out when you first were hired. Increasing the amount of withheld taxes may shrink your paycheck somewhat, but it will keep you on par with what you ultimately will owe the government. Most taxpayers have more taxes withheld than they actually wind up owing, and receive a refund every year.

If you are self-employed, you need to make estimated tax payments quarterly. That means that you have to determine your likely income for the year and pay taxes every three months. The IRS will allow a certain discrepancy between what you’ve paid and what your final tax bill will be, but if you have underpaid by too much, you might incur a penalty.

Bill Fay

Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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