• Cost of goods sold, including costs required to be capitalized under tax rules that differ from financial accounting rules,

• Personal, living, and family expenses,

• Items producing future benefits,

• Political contributions,

• Expenses not properly documented under tax rules, and

• Other items.

Business losses may reduce nonbusiness income for individuals and corporations. However, losses from passive activities may reduce only income from other passive activities. Passive activities include most rental activities (except for real estate professionals) and business activities in which the taxpayer does not materially participate. In addition, losses may not, in most cases, be deducted in excess of the taxpayer's amount at risk (generally tax basis in the entity plus share of debt).

Overall net operating losses (business deductions in excess of gross income) may be deducted in other years by carryover or carryback of the loss.

[edit]Personal deductions

Individuals are allowed a special deduction called a personal exemption for dependents. This is a fixed amount allowed each taxpayer, plus an additional fixed amount for each child or other dependents the taxpayer supports. The amount of this deduction for 2009 and 2010 is $3,650. The amount is indexed annually for inflation. The amount of exemption is phased out at higher incomes through 2009; the phase out expired for 2010.^[15]

Citizens and individuals who have U.S. tax residence may deduct a flat amount as a standard deduction. Alternatively, they may claim an itemized deduction for actual amounts incurred for specific categories of nonbusiness expenses. Home owners may deduct the amount of interest andproperty taxes paid on their principal and second homes. Local and state income taxes are deductible, or the individual may elect to deduct state and local sales tax. Contributions to charitable organizations are deductible by individuals and corporations, but the deduction is limited to 50% and 10% of gross income respectively. Medical expenses in excess of 7.5% of adjusted gross income are deductible, as are uninsured casualty losses. Other income producing expenses in excess of 2% of adjusted gross income are also deductible. For years before 2010, the allowance of itemized deductions was phased out at higher incomes. The phase out expired for 2010.^[16]

[edit]Capital gains

Main article: Capital gains tax in the United States

Taxable income includes capital gains. A capital gain is the excess of the sales price over the tax basis (usually, the cost) of capital assets, such as corporate stock, land, buildings, etc. Capital losses (where basis is more than sales price) are deductible, but deduction for long term capital losses is limited to the total capital gains for the year, plus up to $3,000 of ordinary income ($1,500 if married filing separately). An individual may exclude $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of the individual's primary residence, subject to certain conditions and limitations.

In determining gain, it is necessary to determine which property is sold and the amount of basis of that property. This may require identification conventions, such as first-in-first-out, for identical properties like shares of stock. Further, tax basis must be allocated among properties purchased together unless they are sold together. Original basis, usually cost paid for the asset, is reduced by deductions for depreciation or loss.

Certain capital gains are deferred; that is, they taxed at a time later than the year of disposition. Gains on property sold for installment payments may be recognized as those payments are received. Gains on property exchanged for like kind property are not recognized, and the tax basis of the new property is based on the tax basis of the old property.

Before 1986 and from 2004 onward, individuals have been subject to a reduced rate of federal tax on long term capital gains. This reduced rate (limited to 15%) applies for regular tax and the Alternative Minimum Tax.

Ordinary Income Rate	Long-term Capital Gain Rate*	Short-term Capital Gain Rate	Recapture of Depreciation on Long-term Gain of Real Estate	Long-term Gain on Collectibles	Long-term Gain on Certain Small Business Stock
10%	0%	10%	10%	10%	10%
15%	0%	15%	15%	15%	15%
25%	15%	25%	25%	25%	25%
28%	15%	28%	25%	28%	28%
33%	15%	33%	25%	28%	28%
35%	15%	35%	25%	28%	28%

* Capital gains up to $250,000 ($500,000 if filed jointly) on real estate used as primary residence are exempt.

[edit]Partnerships and LLCs

Business entities treated as partnerships are not subject to income tax at the entity level. Instead, their members include their shares of income, deductions, and credits in computing their own tax. The character of the partner's share of income (such as capital gains) is determined at the partnership level. Many types of business entities, including limited liability companies (LLCs), may elect to be treated as a corporation or as a partnership. Distributions from partnerships are not taxed as dividends.

[edit]Corporate tax

Main article: Corporate tax in the United States

The U.S. federal effective corporate tax rate has become much lower than the nominal rate because of tax shelters such as tax havens.

Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Shareholders of a corporation wholly owned by U.S. citizens and resident individuals may elect for the corporation to be taxed similarly to partnerships (see S Corporation). Corporate income tax is based on taxable income, which is defined similarly to individual taxable income.

Shareholders (including other corporations) of corporations (other than S Corporations) are taxed on dividend distributions from the corporation. They are also subject to tax on capital gains upon sale or exchange of their shares for money or property. However, certain exchanges, such as in reorganizations, are not taxable.

Multiple corporations may file a consolidated return at the federal and some state levels with their common parent.

[edit]Corporate tax rates

Federal corporate income tax is imposed at graduated rates from 15% to 35%. The lower rate brackets are phased out at higher rates of income, with all income subject to tax at 34% to 35% where taxable income exceeds $335,000. All income is taxed at the same rate. Additional tax rates imposed below the federal level vary widely by jurisdiction, from under 1% to over 16%. State and local income taxes are allowed as tax deductions in computing federal taxable income.

[edit]Deductions for corporations

Corporations are not allowed the personal deductions allowed to individuals, such as deductions for exemptions and the standard deduction. However, most other deductions are allowed. In addition, corporations are allowed certain deductions unique to corporate status. These include a partial deduction for dividends received from other corporations, deductions related to organization costs, and certain other items.

Some deductions of corporations are limited at federal or state levels. Limitations apply to items due to related parties, including interest and royalty expenses.

[edit]Estates and trusts

Estates and trusts may be subject to income tax at the estate or trust level, or the beneficiaries may be subject to income tax on their share of income. Where the all income must be distributed, the beneficiaries are taxed similarly to partners in a partnership. Where income may be retained, the estate or trust is taxed. It may get a deduction for later distributions of income. Estates and trusts are allowed only those deductions related to producing income, plus $1,000. They are taxed at graduated rates that increase rapidly to the maximum rate for individuals. The tax rate for trust and estate income in excess of $11,500 was 35% for 2009. Estates and trusts are eligible for the reduced rate of tax on dividends and capital gains through 2011.

[edit]Retirement savings and fringe benefit plans

Employers get a deduction for amounts contributed to a qualified employee retirement plan or benefit plan. The employee does not recognize income with respect to the plan until he or she receives a distribution from the plan. The plan itself is organized as a trust and is considered a separate entity. For the plan to qualify for tax exemption, and for the employer to get a deduction, the plan must meet minimum participation, vesting, funding, and operational standards.

Examples of qualified plans include:

• pension plans (Defined benefit pension plan),

• profit sharing plans (defined contribution plan),

• Employee Stock Ownership Plan (ESOPs),

• stock purchase plans,

• health insurance plans,

• employee benefit plans,

• Cafeteria plans.

Employees or former employees are generally taxed on distributions from retirement or stock plans. Employees are not taxed on distributions from health insurance plans to pay for medical expenses. Cafeteria plans allow employees to choose among benefits (like choosing food in a cafeteria), and distributions to pay those expenses are not taxable.

In addition, individuals may make contributions to Individual Retirement Accounts (IRAs). Those not currently covered by other retirement plans may claim a deduction for contributions to certain types of IRAs. Income earned within an IRA is not taxed until the individual withdraws it.

[edit]Credits

Main article: Tax credits

The federal and state systems offer numerous tax credits for individuals and businesses. Among the key federal credits for individuals are:

• Child credit: a credit up to $1,000 per qualifying child.

• Child and dependent care credit: a credit up to $6,000, phased out at incomes above $15,000.

• Earned Income Tax Credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount. For 2009, the maximum credit was $5,657.

• Credit for the elderly and disabled: A nonrefundable credit up to $1,125

• Two mutually exclusive credits for college expenses.

Businesses are also eligible for several credits. These credits are available to individuals and corporations, and can be taken by partners in business partnerships. Among the federal credits included in a "general business credit" are:

• Credit for increasing research expenses.

• Work Incentive Credit or credit for hiring people in certain enterprise zones or on welfare.

• A variety of industry specific credits.

In addition, a federal foreign tax credit is allowed for foreign income taxes paid. This credit is limited to the portion of federal income tax arising due to foreign source income. The credit is available to all taxpayers.

Business credits and the foreign tax credit may be offset taxes in other years.

States and some localities offer a variety of credits that vary by jurisdiction. States typically grant a credit to resident individuals for income taxes paid to other states, generally limited in proportion to income taxed in the other state(s).

[edit]Alternative Minimum Tax

Main article: Alternative Minimum Tax

Taxpayers must pay the higher of the regular income tax or the Alternative Minimum Tax (AMT). Taxpayers who have paid AMT in prior years may claim a credit against regular tax for the prior AMT. The credit is limited so that regular tax is not reduced below current year AMT.

AMT is imposed at a nearly flat rate (20% for corporations, 26% or 28% for individuals, estates, and trusts) on taxable income as modified for AMT. Key differences between regular taxable income and AMT taxable income include:

• The standard deduction and personal exemptions are replaced by a single deduction, which is phased out at higher income levels,

• No deduction is allowed individuals for state taxes,

• Most miscellaneous itemized deductions are not allowed for individuals,

• Depreciation deductions are computed differently, and

• Corporations must make a complex adjustment to more closely reflect economic income.

[edit]Accounting periods and methods

The United States tax system allows individuals and entities to choose their tax year. Most individuals choose the calendar year. There are restrictions on choice of tax year for some closely held entities. Taxpayers may change their tax year in certain circumstances, and such change may require IRS approval.

Taxpayers must determine their taxable income based on their method of accounting for the particular activity. Most individuals use the cash method for all activities. Under this method, income is recognized when received and deductions taken when paid. Taxpayers may choose or be required to use the accrual method for some activities. Under this method, income is recognized when the right to receive it arises, and deductions are taken when the liability to pay arises and the amount can be reasonably determined. Taxpayers recognizing cost of goods sold on inventory must use the accrual method with respect to sales and costs of the inventory.

Methods of accounting may differ for financial reporting and tax purposes. Specific methods are specified for certain types of income or expenses. Gain on sale of property other than inventory may be recognized at the time of sale or over the period in which installment sale payments are received. Income from long term contracts must be recognized ratably over the term of the contract, not just at completion. Other special rules also apply.

[edit]Tax exempt entities

Main article: Tax exemption

U.S. tax law exempts certain types of entities from income and some other taxes. These provisions arose during the late 19th century. Charitable organizations and cooperatives may apply to the IRS for tax exemption. Exempt organizations are still taxed on any business income. An organization which participates in lobbying, political campaigning, or certain other activities may lose its exempt status. Special taxes apply to prohibited transactions and activities of tax exempt entities.

[edit]Special taxes

There are many federal tax rules designed to prevent people from abusing the tax system. Provisions related to these taxes are often complex. Such rules include:

• Accumulated earnings tax on corporation accumulations in excess of business needs,

• Personal holding company taxes,

• Passive foreign investment company rules, and

• Controlled Foreign Corporation provisions.

[edit]Special industries

Tax rules recognize that some types of businesses do not earn income in the traditional manner and thus require special provisions. For example, Insurance companies must ultimately pay claims to some policy holders from the amounts received as premiums. These claims may happen years after the premium payment. Computing the future amount of claims requires actuarial estimates until claims are actually paid. Thus, recognizing premium income as received and claims expenses as paid would seriously distort an insurance company's income.

Special rules apply to some or all items in the following industries:

• Insurance companies (rules related to recognition of income and expense; different rules apply to life insurance and to property and casualty insurance)

• Shipping (rules related to the revenue recognition cycle)

• Extractive industries (rules related to expenses for exploration and development and for recovery of capitalized costs)

In addition, mutual funds (regulated investment companies) are subject to special rules allowing them to be taxed only at the owner level. The company must report to each owner his/her share of ordinary income, capital gains, and creditable foreign taxes. The owners then include these items in their own tax calculation. The fund itself is not taxed, and distributions are treated as a return of capital to the owners. Similar rules apply to real estate investment trusts and real estate mortgage investment conduits.

[edit]International aspects

Total tax revenue as share of GDP for OECD countries in 2009. The tax burden in the US (black) is relatively small in comparison to other industrialised countries.^[17]

Federal income tax is imposed on citizens, residents, and U.S. corporations based on their worldwide income. To mitigate double taxation, a credit is allowed for foreign income taxes. This foreign tax credit is limited to that part of current year tax caused by foreign source income. Determining such part involves determining the source of income and allocating and apportioning deductions to that income. States tax resident individuals and corporations on their worldwide income, but few allow a credit for foreign taxes.

Federal and state income taxes are imposed on foreign persons on their income within the jurisdiction. Federal rules tax interest, dividends, royalties, and certain other income of foreign persons at a flat rate of 30%. This rate is often reduced under tax treaties. Foreign persons are taxed on income from a U.S. business similarly to U.S. persons. Foreign persons are not subject to U.S. tax on capital gains and certain other income. The states tax non-resident individuals only on income earned within the state (wages, etc.) and tax individuals and corporations on business income apportioned to the state. Most of the states otherwise do not impose income tax on persons not resident in the state.

The United States has income tax treaties with over 65 countries. These treaties reduce the chance of double taxation by allowing each country to fully tax its citizens and residents and reducing the amount the other country can tax them. Generally the treaties provide for reduced rates of tax on investment income and limits as to which business income can be taxed. The treaties each define which taxpayers can benefit from the treaty.

[edit]Social Security tax

Main article: Federal Insurance Contributions Act tax

The United States social insurance system is funded by a tax similar to an income tax. Social Security tax of 6.2% is imposed on wages paid to employees. The tax is imposed on both the employer and the employee. For 2011 and 2012, the employee tax has been reduced by 2% to 4.2%. The maximum amount of wages subject to the tax for 2009, 2010, and 2011 was/is $106,800. This amount is indexed for inflation. A companion Medicare Tax of 1.45% of wages is imposed on employers and employees, with no limitation. A self-employment tax in like amounts (totaling 15.3%, 13.3% for 2011 and 2012) is imposed on self-employed persons.

[edit]Withholding of tax

Main article: Tax withholding in the United States

Persons paying wages or making certain payments to foreign persons are required to withhold income tax from such payments. The Social Security tax is one type of withholding tax. Withholding of income tax is also required. Income tax withholding on wages is based on declarations by employees and tables provided by the IRS. Persons paying interest, dividends, royalties, and certain other amounts to foreign persons must also withhold income tax at a flat rate of 30%. This rate may be reduced by a tax treaty. Additional backup withholding provisions apply to some payments of interest or dividends to U.S. persons. The amount of income tax withheld is treated as a payment of tax by the person receiving the payment on which tax was withheld.

[edit]Tax returns

Individuals (with income above a minimum level), corporations, partnerships, estates, and trusts must file annual reports, called tax returns, with federal and appropriate state tax authorities. These returns vary greatly in complexity level depending on the type of filer and complexity of their affairs. On the return, the taxpayer reports income and deductions, calculates the amount of tax owed, reports payments and credits, and calculates the balance due.

Federal individual, estate, and trust income tax returns are due by April 15 for most taxpayers. Corporate returns are due two and one half months following the corporation's year end. Partnership returns are due three and one half months following the partnership's year end. Tax exempt entity returns are due four and one half months following the entity's year end. All federal returns may be extended, with most extensions available upon merely filing a single page form. Due dates and extension provisions for state and local income tax returns vary.

Income tax returns generally consist of the basic form with attached forms and schedules. Several forms are available for individuals and corporations, depending on complexity and nature of the taxpayer's affairs. Many individuals are able to use the one page Form 1040-EZ, which requires no attachments except wage statements from employers (Forms W-2). Individuals claiming itemized deductions must complete Schedule A. Similar schedules apply for interest (B), dividends (B), business income (C), capital gains (D), farm income (F), and self-employment tax (SE). All taxpayers must file those forms for credits, depreciation, AMT, and other items that apply to them.

Electronic filing of tax returns may be done for taxpayers by registered tax preparers.

If a taxpayer discovers an error on a return, or determines that tax for a year should be different, the taxpayer should file an amended return. These returns constitute claims for refund if taxes are determined to have been overpaid.

[edit]Tax examinations

People filing tax forms in 1920.

The IRS and state, and local tax authorities may examine a tax return and propose changes. Changes to tax returns may be made with minimal advance involvement by taxpayers, such as changes to wage or dividend income to correct errors. Other examination of returns may require extensive taxpayer involvement, such as an audit by the IRS. These audits often require that taxpayers provide the IRS or other tax authority access to records of income and deductions. Audits of businesses are usually conducted by IRS personnel at the business location.

Changes to returns are subject to appeal by the taxpayer, including going to court. IRS changes are often first issued as proposed adjustments. The taxpayer may agree to the proposal, or may advise the IRS why it disagrees. Proposed adjustments are often resolved by the IRS and taxpayer agreeing to what the adjustment should be. For those adjustments to which agreement is not reached, the IRS issues a 30-day letter advising of the adjustment. The taxpayer mayappeal this preliminary assessment within 30 days within the IRS.

The Appeals Division reviews the IRS field team determination and taxpayer arguments, and often proposes a solution that the IRS team and the taxpayer find acceptable. Where agreement is still not reached, the IRS issues an assessment as a notice of deficiency or 90-day letter. The taxpayer then has three choices: file suit in United States Tax Court without paying the tax, pay the tax and sue for refund in regular court, or pay the tax and be done. Recourse to court can be costly and time consuming, but is often successful.

IRS computers routinely make adjustments to correct mechanical errors in returns. In addition, the IRS conducts an extensive document matching computer program that compares taxpayer amounts of wages, interest, dividends, and other items to amounts reported by taxpayers. These programs automatically issue 30-day letters advising of proposed changes. Only a very small percentage of tax returns are actually examined. These are selected by a combination of computer analysis of return information and random sampling. The IRS has long maintained a program to identify patterns on returns most likely to require adjustment.

Procedures for examination by state and local authorities vary by jurisdiction.

[edit]Tax collection

Taxpayers are required to voluntarily pay all taxes owed based on the self-assessed tax returns, as adjusted. The IRS allows taxpayers to extent payment in certain circumstances, and provides time payment plans that include interest and a "penalty" that is merely added interest. Where taxpayers do not pay tax owed, the IRS has strong means to enforce collection. These include the ability to levy bank accounts and seize property. Generally, significant advance notice is given before levy or seizure. However, in certain rarely used jeopardy assessments the IRS may immediately seize money and property. The IRS Collection Divisions are responsible for most collection activities.

[edit]Statute of limitations

Taxpayers and the IRS are both precluded from changing tax after a certain period of time. Generally, this period is three years from the later of the due date of the original tax return or the date the original return was filed. The IRS has an additional three more years to make changes if the taxpayer has substantially understated gross income. The period under which the IRS may make changes is unlimited in the case of fraud by the taxpayer.

[edit]Penalties

Main article: IRS penalties

Taxpayers who fail to file returns, file late, or file returns that are wrong, may be subject to penalties. These penalties vary based on the type of failure. Some penalties are computed like interest, some are fixed amounts, and some are based on other measures. Penalties for filing or paying late are generally based on the amount of tax that should have been paid and the degree of lateness. Penalties for failures related to certain forms are fixed amounts, and vary by form from very small to huge.

Intentional failures, including tax fraud, may result in criminal penalties. These penalties may include jail time or forfeiture of property. Criminal penalties are assessed in coordination with the United States Department of Justice.

[edit]History

[edit]Constitutional

Main article: United States income tax (legal history)

See also: Taxation history of the United States

President Abraham Lincoln and the United States Congressintroduced in 1861 the first personal income tax in the United States.

Article I, Section 8, Clause 1 of the United States Constitution (the "Taxing and Spending Clause"), specifies Congress's power to impose "Taxes, Duties, Imposts and Excises," but Article I, Section 8 requires that, "Duties, Imposts and Excises shall be uniform throughout the United States."^[18]

The Constitution specifically limited Congress' ability to impose direct taxes, by requiring Congress to distribute direct taxes in proportion to each state's census population. It was thought that head taxes and property taxes (slaves could be taxed as either or both) were likely to be abused, and that they bore no relation to the activities in which the federal government had a legitimate interest. The fourth clause of section 9 therefore specifies that, "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken."

Taxation was also the subject of Federalist No. 33 penned secretly by the Federalist Alexander Hamilton under the pseudonym Publius. In it, he asserts that the wording of the "Necessary and Proper" clause should serve as guidelines for the legislation of laws regarding taxation. The legislative branch is to be the judge, but any abuse of those powers of judging can be overturned by the people, whether as states or as a larger group.

The courts have generally held that direct taxes are limited to taxes on people (variously called "capitation", "poll tax" or "head tax") and property.^[19] All other taxes are commonly referred to as "indirect taxes," because they tax an event, rather than a person or property per se.^[20] What seemed to be a straightforward limitation on the power of the legislature based on the subject of the tax proved inexact and unclear when applied to an income tax, which can be arguably viewed either as a direct or an indirect tax.

[edit]Early federal income taxes

The first income tax suggested in the United States was during the War of 1812. The idea for the tax was based on the British Tax Act of 1798. The British tax law applied progressive rates to income. The British tax rates were 0.08% on income above £60 and 10% on income above £200. The tax proposal was developed in 1814. Because the treaty of Ghent was signed in 1815, ending hostilities and the need for additional revenue, the tax was never imposed in the United States.

In order to help pay for its war effort in the American Civil War, Congress imposed its first personal income tax in 1861.^[21] It was part of the Revenue Act of 1861 (3% of all incomes over US $800).^[22] This tax was repealed and replaced by another income tax in 1862.^[23]

In 1894, Democrats in Congress passed the Wilson-Gorman tariff, which imposed the first peacetime income tax. The rate was 2% on income over $4000, which meant fewer than 10% of households would pay any. The purpose of the income tax was to make up for revenue that would be lost by tariff reductions.^[24]

In 1895 the United States Supreme Court, in its ruling in Pollock v. Farmers' Loan & Trust Co., held a tax based on receipts from the use of property to be unconstitutional. The Court held that taxes on rents from real estate, on interest income from personal property and other income from personal property (which includes dividend income) were treated as direct taxes on property, and therefore had to be apportioned (divided among the states based on their populations). Since apportionment of income taxes is impractical, this had the effect of prohibiting a federal tax on income from property. However, the Court affirmed that the Constitution did not deny Congress the power to impose a tax on real and personal property, and it affirmed that such would be a direct tax.^[25] Due to the political difficulties of taxing individual wages without taxing income from property, a federal income tax was impractical from the time of the Pollock decision until the time of ratification of the Sixteenth Amendment (below).

[edit]Ratification of the Sixteenth Amendment

Main article: Sixteenth Amendment to the United States Constitution

Amendment XVI in the National Archives

In response, Congress proposed the Sixteenth Amendment (ratified by the requisite number of states in 1913),^[26] which states:

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.

The Supreme Court in Brushaber v. Union Pacific Railroad, 240 U.S. 1 (1916), indicated that the amendment did not expand the federal government's existing power to tax income (meaning profit or gain from any source) but rather removed the possibility of classifying an income tax as a direct tax on the basis of the source of the income. The Amendment removed the need for the income tax to be apportioned among the states on the basis of population. Income taxes are required, however, to abide by the law of geographical uniformity.

Some tax protesters and others opposed to income taxes cite what they contend is evidence that the Sixteenth Amendment was never properly ratified, based in large part on materials sold by William J. Benson. In December 2007, Benson's "Defense Reliance Package" containing his non-ratification argument which he offered for sale on the Internet, was ruled by a federal court to be a "fraud perpetrated by Benson" that had "caused needless confusion and a waste of the customers' and the IRS' time and resources."^[27] The court stated: "Benson has failed to point to evidence that would create a genuinely disputed fact regarding whether the Sixteenth Amendment was properly ratified or whether United States Citizens are legally obligated to pay federal taxes."^[28] See also Tax protester Sixteenth Amendment arguments.

[edit]Modern interpretation of the power to tax incomes

The modern interpretation of the Sixteenth Amendment taxation power can be found in Commissioner v. Glenshaw Glass Co. 348 U.S. 426 (1955). In that case, a taxpayer had received an award of punitive damages from a competitor for antitrust violations and sought to avoid paying taxes on that award. The Court observed that Congress, in imposing the income tax, had defined gross income, under the Internal Revenue Code of 1939, to include:

gains, profits, and income derived from salaries, wages or compensation for personal service . . . of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.^[29]

(Note: The Glenshaw Glass case was an interpretation of the definition of "gross income" in section 22 of the Internal Revenue Code of 1939. The successor to section 22 of the 1939 Code is section 61 of the current Internal Revenue Code of 1986, as amended.)

The Court held that "this language was used by Congress to exert in this field the full measure of its taxing power", id., and that "the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted."^[30]

The Court then enunciated what is now understood by Congress and the Courts to be the definition of taxable income, "instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." Id. at 431. The defendant in that case suggested that a 1954 rewording of the tax code had limited the income that could be taxed, a position which the Court rejected, stating:

The definition of gross income has been simplified, but no effect upon its present broad scope was intended. Certainly punitive damages cannot reasonably be classified as gifts, nor do they come under any other exemption provision in the Code. We would do violence to the plain meaning of the statute and restrict a clear legislative attempt to bring the taxing power to bear upon all receipts constitutionally taxable were we to say that the payments in question here are not gross income.^[31]

Tax statutes passed after the ratification of the Sixteenth Amendment in 1913 are sometimes referred to as the "modern" tax statutes. Hundreds of Congressional acts have been passed since 1913, as well as several codifications (i.e., topical reorganizations) of the statutes (seeCodification).

In Central Illinois Public Service Co. v. United States, 435 U.S. 21 (1978), the U.S. Supreme Court confirmed that wages and income are not identical as far as taxes on income are concerned, because income not only includes wages, but any other gains as well. The Court in that case noted that in enacting taxation legislation, Congress "chose not to return to the inclusive language of the Tariff Act of 1913, but, specifically, 'in the interest of simplicity and ease of administration,' confined the obligation to withhold [income taxes] to 'salaries, wages, and other forms of compensation for personal services'" and that "committee reports ... stated consistently that 'wages' meant remuneration 'if paid for services performed by an employee for his employer'".^[32]

Other courts have noted this distinction in upholding the taxation not only of wages, but also of personal gain derived from other sources, recognizing some limitation to the reach of income taxation. For example, in Conner v. United States, 303 F. Supp. 1187 (S.D. Tex. 1969), aff’d in part and rev’d in part, 439 F.2d 974 (5th Cir. 1971), a couple had lost their home to a fire, and had received compensation for their loss from the insurance company, partly in the form of hotel costs reimbursed. The court acknowledged the authority of the IRS to assess taxes on all forms of payment, but did not permit taxation on the compensation provided by the insurance company, because unlike a wage or a sale of goods at a profit, this was not a gain. As the Court noted, "Congress has taxed income, not compensation".

By contrast, other courts have interpreted the Constitution as providing even broader taxation powers for Congress. In Murphy v. IRS, the United States Court of Appeals for the District of Columbia Circuit upheld the federal income tax imposed on a monetary settlement recovery that the same court had previously indicated was not income, stating: "[a]lthough the 'Congress cannot make a thing income which is not so in fact,' [ . . . ] it can label a thing income and tax it, so long as it acts within its constitutional authority, which includes not only the Sixteenth Amendment but also Article I, Sections 8 and 9."^[33]

Similarly, in Penn Mutual Indemnity Co. v. Commissioner, the United States Court of Appeals for the Third Circuit indicated that Congress could properly impose the federal income tax on a receipt of money, regardless of what that receipt of money is called:

It could well be argued that the tax involved here [an income tax] is an "excise tax" based upon the receipt of money by the taxpayer. It certainly is not a tax on property and it certainly is not a capitation tax; therefore, it need not be apportioned. [ . . . ] Congress has the power to impose taxes generally, and if the particular imposition does not run afoul of any constitutional restrictions then the tax is lawful, call it what you will.^[34]

[edit]Income tax rates in history

[edit]History of top rates

Historical federal marginal tax rates for income for the lowest and highest income earners in the US.^[35]

• In 1913, the top tax rate was 7% on incomes above $500,000 ($10 million 2007 dollars) and a total of $28.3 million was collected.^[36]

• During World War I, the top rate rose to 77% and the income threshold to be in this top bracket increased to $1,000,000 ($16 million 2007 dollars).

• Under Treasury Secretary Andrew Mellon, top tax rates were reduced in 1921, 1924, 1926, and 1928. Mellon argued that lower rates would spur economic growth.^[37] By 1928, the top rate was scaled down to 24% and the income threshold for paying this rate fell to $100,000 ($1 million 2007 dollars).

• During the Great Depression and World War II, the top income tax rate rose from pre-war levels. In 1939, the top rate was 75% applied to incomes above $5,000,000 ($75 million 2007 dollars). During 1944 and 1945, the top rate was its all-time high at 94% applied to income above $200,000.

• Since 1964, the threshold for paying top income tax rate has generally been between $200,000 and $400,000. The one exception is the period from 1982–1992 when the top income tax brackets were removed and incomes above around $100,000 (varies by year) paid the top rate. From 1981 until 1986 the top marginal rate was lowered to 50%. From 1988–1990, the threshold for paying the top rate was even lower, with incomes above $29,750 to $32,450 ($51,000 in 2007 dollars) paying the top rate of 28% in those years.^[38]

• Top tax rates were increased in 1992 and 1994, culminating in a 39.6% top individual rate applicable to all classes of income.

• Top individual tax rates were lowered in 2004 to 35% and tax rates on dividends and capital gains lowered to 15%, with the Bush administration claiming lower rates would spur economic growth.

[hide]History of income tax rates adjusted for inflation (1913-2010)[39]
	Number of	First Bracket	Top Bracket
Year	Brackets	Rate	Rate	Income	Adj. 2011	Comment
1913	7	1%	7%	$500,000	$11.3M	First permanent income tax
1917	21	2%	67%	$2,000,000	$35M	World War I financing
1925	23	1.5%	25%	$100,000	$1.28M	Post war reductions
1932	55	4%	63%	$1,000,000	$16.4M	Depression era
1936	31	4%	79%	$5,000,000	$80.7M
1941	32	10%	81%	$5,000,000	$76.3M	World War II
1942	24	19%	88%	$200,000	$2.75M	Revenue Act of 1942
1944	24	23%	94%	$200,000	$2.54M	Individual Income Tax Act of 1944
1946	24	20%	91%	$200,000	$2.30M
1964	26	16%	77%	$400,000	$2.85M	Tax reduction during Vietnam war
1965	25	14%	70%	$200,000	$1.42M
1981	16	14%	70%	$212,000	$532k	Reagan era tax cuts
1982	14	12%	50%	$106,000	$199k	Reagan era tax cuts
1987	5	11%	38.5%	$90,000	$178k	Reagan era tax cuts
1988	2	15%	28%	$29,750	$56k	Reagan era tax cuts
1991	3	15%	31%	$82,150	$135k
1993	5	15%	39.6%	$250,000	$388k	Omnibus Budget Reconciliation Act of 1993
2003	6	10%	35%	$311,950	$380k	Bush tax cuts
2011	6	10%	35%	$379,150	$379k

[edit]Federal income tax rates

Federal and state income tax rates have varied widely since 1913. For example, in 1954, the federal income tax was based on layers of 24 income brackets at tax rates ranging from 20% to 91% (for a chart, see Internal Revenue Code of 1954). Overall effective Federal tax rates on the top 0.01 percent of earners have declined from about 70% in 1960 to about 35% in 2005, while effective rates for the middle class have remained constant over the same period.^[40] Below is a table of historical marginal income tax rates for married filing jointly tax payers at stated income levels. Note that these income numbers are not the amounts used in the tax laws at the time.

[show]Historical income tax rates not adjusted for inflation (1913–2010)[41]

[edit]Sources of U.S. income tax laws

United States income tax law comes from a number of sources. These sources have been divided into three tiers as follows:^[42]