USA Income Tax: A helpful guide of the individuals income tax in US, and how is working the taxation system in the United States
Every United States business operating in the global economy must be aware of the differences between international and U.S. accounting practices. All businesses around the globe need to accurately report their assets, liabilities, and expenditures in order for potential investors, creditors, and other stakeholders to assess their financial health.
A summary of the income tax, and taxation system in the US
In 2021, 41 states and the District of Columbia imposed a broad-based USA income tax on individuals. New Hampshire taxes interest and dividends only. Individual income is not subject to tax in Alaska, Florida, and Nevada, South Dakota. Tennessee, Texas. Washington, Wyoming, and South Dakota. Tennessee had previously taxed stock dividends and bond interest, but this tax was eliminated in 2021.
US income taxes represent a significant source of revenue, but local governments receive relatively low revenues from them. Because only 12 states allowed local governments to impose an individual US income tax or payroll tax, the percentage of local government revenue from individual income taxes in 2018 is limited. The percentage of local income tax revenue from individual income varied between 0.1 percent in Oregon and 17 percent in Maryland.
In Indiana, Iowa, and Maryland, localities levy an income tax that piggybacks on state income taxes. These states have local taxpayers who file their local tax on state tax returns. They also use state exemptions and deductions to pay the local tax.
Localities in Alabama and Kansas, Kentucky, Missouri. Ohio. Oregon, Pennsylvania, and Ohio levy a payroll or earnings tax. These taxes are not included in the state USA income tax.
Payroll taxes and earnings are usually calculated as a percentage of wages.
They are withheld by the employer, but paid by the employee, and paid by people who live in the taxing area, even if they do not reside in the same city. Kansas taxes only interest and dividends and not wages.
The federal USA income tax was enacted by the United States in 1913 when they ratified the 16th Amendment. It is not the same tax that it was in 1913. The actual form and directions were only four pages long in 1913. Today, they are 106 pages. Like most laws, the tax law grows as legislators use it for pork.
A brief history of the federal USA income tax rates.
- During World War I: Congress passed the 1916 Revenue Act and the War Revenue Act of 1917 to finance U.S. involvement in World War One. The highest USA income tax rate increased from 15% in 1916 to 67% in 1917 to 77% in 1918. War is costly. Federal USA income tax rates dropped to 25% between 1925 and 1931 after the war.
- During the Depression: During the Great Depression, Congress increased taxes by 25 percent to 63 percent on top earners in 1932.
- World War II: The top tax rate was 94 percent for taxable USA income above $200,000 in 1944 ($2.5 million today). This is a high tax rate.
- In the 50s and 70s: The federal USA income tax rate was high for the next 30 years, and never fell below 70 percent.
- In the 80s: 1981 Economic Recovery Tax Act slashed the highest tax rate from 70 percent to 50 percent, and index the brackets for inflation.
- In the 90s: The top rate was 39.5 percent in the 1990s. The highest income tax rate was reduced to 35 percent by the Economic Growth and Tax Relief and Reconciliation Act of2001. This change took effect from 2003 to 2010. Through 2012, the tax rate of 35 percent was maintained by the Tax Relief, Unemployment Insurability Reauthorization, and Job Creation Act of 2010.
- From 2013 to 2017: The highest income tax rate was raised to 39.6 percent by the American Taxpayer Relief Act of 2012. Patient Protection and Affordable Health Act was added 3.8 percent to make the federal maximum income tax rate 43.4 %.
- From 2018 to 2021: For tax years starting in 2018, the highest U Sincome tax rate was reduced to 37 percent. An additional 3.8 percent applies, which makes the maximum federal income tax rate 40.8 percent.
This brief history of taxation is important because it shows how tax law changes constantly and can have a significant impact on your budget.
How do the individual income tax rates vary across states?
The top individual state income tax rates for 2021 range from 2.9 percent to 13.3 percent in North Dakota and California, including the 1 percent surcharge on taxable income above $1 million. Hawaii (11%) and New Jersey (10.75%) are the next highest individual income tax rates. Nineteen states and the District of Columbia all have income tax rates above 8 percent.
The top individual income tax rate in 13 states that have a broad-based income tax is 5% or lower. The top tax rate is below 4 percent in Indiana, North Dakota, and Pennsylvania.
Nine states that have a broad-based tax system use one flat USA income tax rate for all income.
Additionally, states that have multiple brackets, and unlike the federal individual income taxes, have top tax rates that start at very low levels of taxable income. There are different brackets in some states, with higher totals for married couples and others that have more progressive rates.
How is income taxed in the United States of America?
The federal definition of taxable income is generally followed by states. The federal adjusted gross income (AGI), is used by 32 states and the District of Columbia as the starting point to calculate their state income taxes.
Federal AGI refers to a taxpayer’s gross earnings after any “above the line” adjustments such as deducting individual retirement account contributions or student loan interest.
However, these state definitions are heavily influenced by federal tax rules and generally mirror federal AGI. Colorado, Idaho, and North Dakota use the federal taxable income as their starting point. Federal taxable income includes AGI and federal calculations for standard or itemized deductions, as well as any personal exemptions.
The USA income tax rules differ from federal laws in some ways. States often tax municipal bond interest in securities that are not issued within their state, which is a departure from the federal government.
Several states allow for a partial or full exemption from income from pensions that would otherwise be taxable on federal returns.
Filers who itemize federal tax deductions and claim deductions from state and local taxes in most states have a broad-based income tax. They cannot deduct USA income taxes from their state income tax itemized deductions.
Many states use federal rules to modify the taxation systems.
The Tax Cuts and Job Acts forced many states to make changes to their systems. This was particularly true for states that had used the federal standard deduction or personal exemption in their state income tax calculations (before the TCJA, the former nearly doubled and eliminated the latter).
The TCJA created a federal deduction for income earned through pass-through businesses (income earned by sole proprietors or partnerships and certain corporations). This deduction was only applicable to states that use federal USA income tax as their starting point for tax calculation, however.
Similar dynamics, but with less fiscal ramifications, occurred when Congress increased the federal earned USA income tax credit (and the child tax credit) in response to the COVID-19 pandemic. States that comply with these policies will see an increase in their state-level EITC due to the connections between state and federal tax codes.
What taxes does a state levy on capital gains and losses?
Capital gains and losses are treated the same way in five states and the District of Columbia: They tax all realized capital gain, allow a deduction of $3,000 for net capital loss, and allow taxpayers to carry forward unused capital losses to future years.
New Hampshire exempts all capital gains. Arkansas does not. Arkansas, however, excludes at most 50 percent of income from capital gains and up to 100 percent of capital gains above $10 million. Arizona exempts 25% of long-term capital gain income, while New Mexico exempts 50% or up to $1,000 in federal taxable gains. Alabama and Pennsylvania allow losses to only be deducted in their year of occurrence, while New Jersey prohibits losses from being deducted from ordinary income. (See our table on state capital gains treatment for more details).
However, unlike the federal government, which offers a preferential rate on capital gains, most state tax capital gains at the exact same rate as regular income. Capital gains income is subject to special tax rates in Connecticut, Hawaii, and Massachusetts.
What is the tax treatment of income earned in another jurisdiction?
Many states allow taxpayers to deduct USA income taxes from their home state that they have paid to other states.
The state where the income is earned imposes THE USA income taxes. However, some states have made reciprocity agreements that allow income earned outside of the state to be subject to tax in their home states.
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