What Is an Income Tax?

What Is an Income Tax?

An income tax is a tax imposed by state and federal governments for people and businesses residing within their jurisdictions, explain authors at Investopedia.

In the United States, income tax is collected from individuals and businesses. Income tax is the primary source of funding for government projects, including transportation and public works. A personal income tax is based on the amount of money a person earns each year. Similarly, corporate revenue is taxed according to how much revenue the business generates during the course of a year. Income for both types is adjusted according to revenue, notes Investopedia. Those earning a higher income pay more in taxes each year than people and entities that make less money. Across the country, the income tax system is controlled and regulated by the Internal Revenue Service (IRS). The IRS is responsible for establishing a series of rules and regulations that determine how much money people and companies pay yearly as well as what credits or deductions they may be eligible for.

State and Federal Taxes
A person's annual income tax is based on several factors. Base salary is the primary tax base but other income from royalties, dividends and earnings from lottery tickets and rental properties. These taxes are paid at the federal level, and many states also have their own taxes. At present, there are only seven states in the country that do not have their own taxes, explains Turbo Tax. These states are Florida, Nevada, South Dakota, Washington, Texas, Alaska and Wyoming. Otherwise, all states have some sort of tax charge for those with a "significant interest" in the state, elaborates Turbo Tax. This can mean living full time in the state or having a residence there, such as an apartment or second home. State income tax functions much like a federal tax in the sense that it is designed to help state government fund projects and public works programs. State governments collect taxes through property taxes, sales taxes and federal taxes.

Purpose of Taxes
Income tax, particularly tax collected from individuals, is the federal government's primary source of income. In 2008, revenue collected from individual income tax was reported to amount to nearly $1.15 trillion, according to the Congressional Budget Office. Income taxes paid by corporations, in comparison, were about $305 billion. These figures amount to about 45 percent of government revenue and 12 percent of federal revenue, respectively. The tax system is monitored so that at the end of the year, individuals and businesses that overpay and underpay their taxes will be treated accordingly. People who owe money at the end of the year are subject to additional taxes while those who paid too much in taxes during the previous year receive a credit, explains Investopedia. Some deductions that people might be eligible for through the IRS are medical bills and dental bills (or parts thereof), interest earned on mortgages and educational expenses.

At the state level, sales and property taxes are the two main sources of tax revenue. Property tax is imposed on homeowners for their homes, which are taxed based on their annual assessed value. The owner of the property (such as a landlord or business) is responsible for paying the taxes owed for the property in question. In the U.S., the tax system is voluntary but not optional.