Income tax definition

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What is Income Tax?

An income tax is a government tax on the taxable profit earned by an individual or corporation. The resulting revenue is usually one of the chief sources of cash for a government entity. It is considered one of the more fair forms of taxation, since it is only imposed if a person or business has been successful enough to generate taxable income. Thus, its impact on the poor or unprofitable is minor to nonexistent.

Types of Income Taxes

There are several variants on the basic income tax concept. Here are the most common types of income taxes:

  • Individual income tax. This is a tax levied on the wages, salaries, investments, and other income earned by individuals. It’s usually collected by federal, state, and sometimes local governments, with rates that can be progressive (higher rates for higher income levels).

  • Corporate income tax. This tax is imposed on the profits of corporations. After accounting for expenses, deductions, and credits, corporations pay a percentage of their taxable income to the government.

  • Capital gains tax. Applied to the profit made from selling assets like stocks, real estate, or investments. Short-term gains (held less than a year) are usually taxed at a higher rate than long-term gains (held more than a year).

  • Alternative minimum tax (AMT). This is a parallel tax system designed to ensure high-income earners can’t avoid taxes through deductions and loopholes. Taxpayers must calculate both regular tax and AMT and pay the higher amount.

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Progressive Income Taxes

Most tax rates are progressive, which means that the tax rate increases as the level of income increases. The reasoning behind this tax structure is that the poor are less able to pay taxes, while the rich have more excess cash with which to pay taxes. Some jurisdictions offer a flat income tax rate in order to attract wealthier residents, who can save substantial amounts by avoiding progressive income taxes. These jurisdictions typically make up the lost income taxes by imposing other taxes instead, such as property taxes.

Income Tax Deductions

The amount of income tax paid can be reduced by a number of deductions, which are allowed as the result of legislation by the relevant government entity. These deductions are usually intended to foster certain types of behavior by taxpayers. For example, the research and development credit was used to foster more R&D expenditures within the United States.