Wednesday, May 04, 2011

Federal Income Tax on Individuals

Constitution of the United States, Amendment XVI

“Section 1 Taxes on Income

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Amendment XVI, allowing for a federal income tax, was ratified February 3, 1913, almost one hundred years ago.

The purpose of a government tax is to provide the revenue necessary for the operation of government and to carry out the powers of the government. Originally, a federal government tax was not for the purpose of redistributing money to select groups within the population. Originally, a federal government tax was not for the purpose of benefiting one group over another group. Originally, a federal government tax was not for the purpose of punishing one group as opposed to another. Early on, the U.S. Supreme Court ruled that the power to tax is the power to destroy. Thus, one governmental entity could not tax another governmental entity.

In fiscal year 2009 (which began on October 1, 2008, and ended on September 30, 2009), federal income was $2.105 trillion and outlays were $3.518 trillion, leaving a deficit of $1.413 trillion.

Income Outlays

1) Borrowing to cover deficit 40%

Amount borrowed: $1,413,000,000,000 = one trillion, four hundred thirteen billion dollars

2) Personal income taxes 26%

Amount from personal income tax: $914,680,000,000 = nine hundred fourteen billion, six hundred eighty million dollars

3) Social security, Medicare, and unemployment and other retirement taxes 25%

Social security, etc. taxes: $879,500,000,000 = eight hundred seventy nine billion, five hundred million dollars

4) Excise, customs, estate, gift, and miscellaneous taxes 5%

Excise, etc. taxes: $175,900,000,000 = one hundred seventy five billion, nine hundred million dollars

5) Corporate income taxes 4%

Corporate income taxes: $140,720,000,000 = one hundred forty billion, seven hundred twenty million dollars

Total taxes collected: $2,110,800,000,000 = two trillion, one hundred ten billion, eight hundred million dollars (Difference due to rounding.)

According to the above, the largest source of income for the federal government is from government borrowing which accounts for 40% of all federal money spent. 40%!!! The second largest source of revenue for the federal government is from the personal income tax which accounts for 26% of all revenue spent.

Even though originally the federal government income tax was not for the purpose of benefiting one group over another group, that is not the case today. The federal income tax system is burdened with rewards for certain behavior over other behavior. Most of these rewards are designed to and/or impact demand in one way or another.

A sampling of such rewards would include:

A) Credits: Some credits may be used to lower the amount of tax owed down to zero and then they end. Other credits may be refunded even if no taxes are owed. The result is that some people pay zero taxes and then make money by simply filing a federal tax return. The last information I have heard on this is that in the last filing period where the results are known, 40% of those who filed made money through the federal income tax system while paying no taxes. An additional 7% did not make any money but also did not pay any federal income tax. Only 53% of all filers paid any federal income tax!!! Some of these credits include:

Note: I’ve tried to simplify the explanations for brevity.

01) Earned Income Credit: This is complicated. In my tax booklet, the table that is used to determine how much money a person or married couple receives is 17 pages long!!! The lowest credit possible allows a person to earn $1 and receive $2 from the government! A married couple filing jointly with three children can earn at least $48,350 but less than $48,362 and receive $1 from the federal government. This is the highest amount that can be earned and still receive some money from the government. The most money that can be received from the government from this program is $5,666. To receive this amount, a filer must have three qualifying children and earn at least $12,550. This amount received is just over 45% of the amount earned if $12,550 is earned.

02) Child Tax Credit: a filer with a qualified child receives $1000. A filer may have up to three qualifying children and thus received a $3000 credit. The credit is first used to lower taxes to zero. If the tax is lowered to zero, any remaining credit may then be used to receive money from the federal government with some qualifications. To receive money back a filer must file a specific tax form (Form 8812) to determine how much, if any, is returned.

Additional credits that may be used to lower taxes owed to zero:

03) Foreign Tax Credit: a complicated form that gives credit for taxes paid to a foreign government(s) (Filers have a choice between taking this credit or deducting the taxes paid to a foreign government as an itemized deduction on Schedule A)

04) Child and Dependent Care Expenses Credit: Most often used for daycare for dependent children. Limits based upon amount of money earned and per child care expenses. Also, limited to a maximum of two children.

05) Education Credits: A filer has a choice between two different credits in this area depending upon established criteria. There is also a third choice that allows for a deduction (called an adjustment of gross income) for tuition and fee expenses. Only one of the three may be used and not all filers qualify.

06) Retirement Savings Contributions Credit: Designed to encourage low income filers to contribute to retirement accounts.

07) Residential Energy Credits: An attempt to prevent “global warming!?”

08) The General Business Credit: Believe me, you don’t want to know. A compellation of different, possible business (partnerships and sole proprietors) credits (at least, 25 different credits) based upon specific criteria. If there was no business income tax, these credits would not be needed. Are they needed now? An example of a business credit includes the Railroad Track Maintenance Credit.

09) AMT Tax Credit from Regular Tax: If a filer had paid an Alternative Minimum Tax in a previous tax year, the filer may qualify for a credit for that payment in the current tax year.

Additional credits that may allow a filer to be paid money by the federal government:

10) Making Work Pay Credit: A married couple may receive a credit up to $800. A single filer up to $400.

11) American Opportunity Credit: The Education Credits used to reduce taxes to zero may also allow for this credit to give money to the filer. I wanted to list it separately because the title is different and so, so patriot. Who can be against opportunity in America?

12) First-time Homebuyer Credit: The federal government helps to buy a principle residence under specific criteria. This is suppose to have ended in 2010.

13) Credit for Federal Tax on Fuels: A business use credit for gasoline or special fuels.

14) Tax Credits from Mutual Funds: If the mutual fund paid taxes on capital gains and then the filers pays taxes on the same capital gains, the filer gets a credit to avoid double taxation. (If no business income tax, this credit would not be necessary.)

15) Adoption Credit: A credit up to $13,170 for qualified expenses paid in relation to adopting a child under age 18.

16) AMT Tax Credit from Regular Tax: See #09 above. Can also be used to receive money back if owe no taxes in the current tax year. (I’ve never done this form. I’m guessing the credit is first used to get taxes to zero and then any remainder under certain criteria is used as a refundable credit.)

17) Health Coverage Credit: Basically, an employee has lost his job to foreign competition and is receiving Trade Adjustment Assistance benefits.

B) Deductions: Deductions are generally not as desirable as are credits. However, deductions reduce the amount of taxes owed by millions/billions of dollars every year. Most deductions occur either on Schedule A for those who do not take the standard deduction or above-the-line deductions also known as Adjusted Gross Income deductions

01) Standard Deduction: Everyone who has taxable income qualifies for some type of standard deduction.

Schedule A deductions are usually used to increase the dollar amount of deductions above the allowed standard deduction. I am just going to list some of the Schedule A deductions without explanation:

02) Medical and Dental Expenses
03) State and Local Income Taxes or General Sales Tax
04) Real Estate Taxes
05) Personal Property Tax—auto license taxes based upon the value of the car
06) Foreign Tax—could be a credit; can’t be both
07) Home Mortgage Interest and Reported Points
08) Home Mortgage Interest Not Reported
09) Points Not Reported
10) Investment Interest
11) Charitable Donations in Cash
12) Charitable Donations in Products
13) Charitable Donations Carryover from Previous Years
14) Casualty or theft Loss(es)
15) Unreimbursed Employee Expenses
16) Tax Preparation Fees
17) Other Expenses
18) Other Miscellaneous Deductions: This section includes gambling losses.

Adjusted Gross Income Deductions: Again, I am listing some deductions without explanation.

19) Educator Expenses
20) Certain Business Expenses of Reservists, ….
21) Health Savings Account Deduction
22) Moving Expenses
23) One-half of Self-employment Tax
24) Self-employed SEP, ….
25) Self-employed Health Insurance Deduction
26) Penalty on Early Withdrawal of Savings
27) Alimony Paid
28) IRA Deduction
29) Student Loan Interest Deduction
30) Tuition and Fees
31) Domestic Production Activities Deduction

C) Exemptions: $3,650 is deducted from taxable income for each accepted family member.

The federal personal income tax system at present can be complicated and convoluted. Tomorrow, a simplified system that is designed to collect revenue for the operation of the government without rewarding selected economic activity.