User:Fyre4ce/Income tax

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Flag of the United States.svg.png This page contains details specific to United States (US) investors. It may not apply to non-US investors.

Income tax in the United States is a complex and often-misunderstood topic. IRS Publication 17 provides much basic information about US income taxes, including who needs to file a return, when and how to file, filing statuses and dependents, tax withholding and estimated tax, common types of income and their tax implications, retirement accounts, deductions and credits, etc. Much of this information is redundant with other IRS Publications, but it may be useful to have it all in one place.

The entire US tax code is far too complex to be described in a single wiki article. This page walks readers through the major parts of income tax calculations, and lists the most common types of income, deductions, and credits that will apply to the majority of readers. IRS Form 1040 forms the main structure by which income taxes are calculated, although taxpayers age 65 and older may use Form 1040-SR. Where appropriate, this article will list the lines on Form 1040 related to each section, along with other relevant IRS forms and publications. Form 1040 Instructions may provide useful information when filling out Form 1040 as well.

This page applies to US residents who earn income domestically. See also: Taxation as a US person living abroad and IRS Publication 54.

Taxable Income

Generally, the IRS taxes all forms of income unless specifically excluded by law, although numerous forms of tax-free income exist. IRS Publication 525 describes the tax treatment of various kinds of incomes. The most common forms are described here.

Fully taxed income

The following types of income are generally fully taxed, and are reported on Form 1040 lines 1-7:

Taxed at special rates

The following types of income are are reported on Form 1040 lines 1-7 and fully contribute to Adjusted Gross Income, but are taxed at special rates. The tax rate calculation that applies these special rates occurs further down on the return, see Tax calculation.

Partially taxed income

The following forms of income require a calculation to determine the portion of the income that is taxable:

Tax-free income

The following forms of income are generally tax-free to the taxpayer who receives them:

Above-the-line deductions

So-called "above-the-line deductions" are deductions to the taxpayer's taxable income that are subtracted before Adjusted Gross income is calculated on Form 1040 line 8b. Most above-the-line deductions fall into three categories:

Common above-the-line deductions are listed here:

Adjusted Gross Income (AGI)

A taxpayer's Adjusted Gross Income (AGI) equals their taxable income minus any above-the-line deductions, and appears on Form 1040 line 8b. A taxpayer's AGI can have far-reaching consequences, including:

  • Eligibility for tax credits like as the Saver's Credit, Child Tax Credit, and Earned Income Tax Credit
  • Many below-the-line deductions are limited with a floor that's a percentage of AGI, so AGI effectively limits these deductions
  • Many states calculate income tax based on federal AGI

In addition, many other tax calculations use a Modified Adjusted Gross Income (MAGI) that is based on AGI with certain additions and subtractions. There are many different MAGI's for different purposes (see MAGI for details), but they are all tightly correlated with AGI. Examples of tax consequences of different MAGIs include:

Below-the-line deductions

Taxpayers have a choice to take either the appropriate Standard Deduction, or to "itemize" below-the-line deductions on Form 1040 Schedule A, and are allowed to choose the option most financially beneficial. Total below-the-line deductions appear on Form 1040 line 9. Below-the-line deductions are generally much less valuable to the taxpayer than above-the-line deductions, for three reasons:

  • They do not lower AGI and the various related forms of MAGI
  • Many have severe limits in the amounts that are deductible, such as State and Local Tax deduction limited to $10,000, and medical expenses only deductible above a 7.5% AGI floor
  • They compete with the Standard Deduction (made larger by the Tax Cuts and Jobs Act); only itemized deductions in excess of the Standard Deduction, if anything, are effectively deductible

Itemized deductions

As of 2020, the most common below-the-line deductions available on Schedule A are:

The Tax Cuts and Jobs Act eliminated other itemized deductions that were previously available, including unreimbursed work expenses for employees, imposed the $10,000 SALT limit, lowered the deductible mortgage interest limit to $750,000 balance, raised the charitable gift limit to 60% AGI, and lowered the medical expense deduction floor form 10% to 7.5%.

Standard Deduction

Taxpayers have the choice to deduct either itemized deductions on Schedule A, or the appropriate Standard Deduction. For 2020, the available Standard Deductions are listed below:

Filing Status No Taxpayer Age 65+ One Taxpayer Age 65+ Both Taxpayers Age 65+
Single $12,400 $14,050 N/A
Married Filing Jointly $24,800 $26,100 $27,400
Married Filing Separately $12,400 $13,700 $15,000
Head of Household $18,650 $20,300 N/A

The Standard Deductions are slightly higher if one or both taxpayers are blind. See Form 1040 Instructions for more details.

Section 199A deduction

The Tax Cuts and Jobs Act of 2017 added to the tax code the Section 199A deduction for certain types of business-related income, starting in tax year 2018. Section 199A deductions are taken below-the-line, but are in addition to and do not compete with, the Standard Deduction or Schedule A itemized deductions, and appear on Form 1040 line 10. Section 199A is extremely complex; see the main article for details.

Tax calculation

Income tax due is calculated based on taxable income (Adjusted Gross Income minus below-the-line deductions and any Section 199A deductions), listed on Form 1040 line 11b. Income tax due is entered on line 12a, along with certain other taxes and penalties discussed below. Depending on the types and amount of income, Form 1040 Instructions require tax due to be calculated one of several ways. The most common methods are listed in the table below:

Tax rates

The following tax rates apply to various types and amounts of income:

Filing status and annual taxable income - 2021 Ordinary income tax rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates
$0-$9,950 $0-$19,900 $0-$9,950 $0-$14,200 $0-$2,650 10%
$9,951-$40,525 $19,901-$81,050 $9,951-$40,525 $14,201-$54,200 n/a 12%
$40,526-$86,375 $81,051-$172,750 $40,526-$86,375 $54,201-$86,350 n/a 22%
$86,376-$164,925 $172,751-$329,850 $86,376-$164,925 $86,351-$164,900 $2,651-$9,550 24%
$164,926-$209,425 $329,851-$418,850 $164,926-$209,425 $164,901-$209,400 n/a 32%
$209,426-$523,600 $418,851-$628,300 $209,426-$314,150 $209,401-$523,600 $9,551-$13,050 35%
$523,601+ $622,051+ $314,1511+ $523,601+ $13,051+ 37%
  • Capital gains on collectibles and small business stock are taxed at the normal tax rate but a maximum of 28%. Collectibles are defined in 26 USC 408(m). Small business stocks are per Section 1202. Reference: Alistair M. Nevius (May 1, 2013). "Qualified small business stock". Journal of Accountancy. https://www.journalofaccountancy.com/issues/2013/may/20137453.html.
  • Unrecaptured Section 1250 gain (from depreciation taken on real property) is taxed at the normal tax rate but a maximum of 25%.
  • In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level. See: ACA net investment income tax
Filing status and annual taxable income - 2020 Long-term capital gain rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates Qualified dividends and other investments
$0-$40,400 $0-$80,800 $0-$40,400 $0-$54,100 $0-$2,700 0%
$40,401-$445,850 $80,801-$501,600 $40,401-$250,800 $54,101-$473,750 $2,701-$13,250 15%
$445,851+ $501,601+ $250,801+ $473,751+ $13,251+ 20%
Filing status and annual taxable income - 2020 Ordinary income tax rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates
$0-$9,875 $0-$19,750 $0-$9,875 $0-$14,100 $0-$2,600 10%
$9,876-$40,125 $19,751-$80,250 $9,876-$40,125 $14,101-$53,700 n/a 12%
$40,126-$85,525 $80,251-$171,050 $40,126-$85,525 $53,701-$85,500 n/a 22%
$85,526-$163,300 $171,051-$326,600 $85,526-$163,300 $85,501-$163,300 $2,601-$9,450 24%
$163,301-$207,350 $326,601-$414,700 $163,301-$207,350 $163,301-$207,350 n/a 32%
$207,350-$518,400 $414,701-$622,050 $207,351-$311,025 $207,351-$518,400 $9,451-$12,950 35%
$518,401+ $622,051+ $311,026+ $518,401+ $12,951+ 37%
  • Capital gains on collectibles and small business stock are taxed at the normal tax rate but a maximum of 28%. Collectibles are defined in 26 USC 408(m). Small business stocks are per Section 1202. Reference: Alistair M. Nevius (May 1, 2013). "Qualified small business stock". Journal of Accountancy. https://www.journalofaccountancy.com/issues/2013/may/20137453.html.
  • Unrecaptured Section 1250 gain (from depreciation taken on real property) is taxed at the normal tax rate but a maximum of 25%.
  • In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level. See: ACA net investment income tax
Filing status and annual taxable income - 2020 Long-term capital gain rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates Qualified dividends and other investments
$0-$40,000 $0-$80,000 $0-$40,000 $0-$53,600 $0-$2,650 0%
$40,001-$441,450 $80,001-$496,600 $40,001-$248,300 $53,651-$469,050 $2,651-$13,150 15%
$431,451+ $496,601+ $248,301+ $469,051+ $13,151+ 20%


Penalties and other taxes

Numerous possible penalties and additional taxes exist, and are either added into the tax due on Form 1040 line 12a, or appear on Form 1040 Schedule 2 and are included in Form 1040 line 12b. A lengthy list is available in Form 1040 Instructions. Common examples of additional taxes and penalties are listed in the table below:

Tax credits

The federal government offers tax credits to taxpayers as incentives for certain behaviors or to offset certain expenses. Tax credits can be categorized as refundable, meaning that they can reduce a taxpayer's total tax liability below $0 (resulting in an overall tax refund for the year), or non-refundable, meaning they can only be applied against other tax owed but cannot reduce the total tax liability below $0. For a given amount, tax credits provide a greater benefit to the taxpayer than a tax deduction. Taxpayers receive the full value of a tax credit (except if limited by income, or a non-refundable credit limited by $0 tax liability), whereas a tax deduction only reduces taxable income and has a value equal to the amount multiplied by the taxpayer's marginal tax rate. Many tax credits are phased out by level of income. Common tax credits are listed in the following table, roughly ordered by lowest to highest income limits:

Total prior payments

The US tax code is a "pay-as-you-go" system, meaning that taxpayers are required to pay throughout the year, as money is earned. Employees are required to withhold income tax from their paychecks per Form W-4 (updated for 2020), and the self-employed are required to make estimated tax payments four times per year. Credits for prior tax payments appear in several places:

Refund or tax due

The net tax due or refund is calculated by comparing total tax due (Form 1040 line 16) with total payments (Form 1040 line 19). If total payments exceed total tax due, then the refund is calculated on Form 1040 line 20. If total tax due exceeds total payments, then tax due at filing is calculated on Form 1040 line 23.

Underpayment penalties and Safe Harbor

If a taxpayer owes too much upon filing of their tax return they could be required to pay an underpayment penalty. Underpayment penalties are calculated on Form 2210 and appear on Form 1040 line 24. The IRS grants "Safe Harbor" from underpayment penalties if any of the following conditions apply:

  • The amount you owe at filing is less than $1,000
  • You have paid at least 90% of the tax owed for the current year
  • You have paid at least 100% of the tax you owed for the previous year (this amount is increased to 110% if the previous year's Adjusted Gross Income is greater than $150,000)
  • You had no tax liability the previous year

Furthermore, the IRS may otherwise waive underpayment penalties if certain conditions apply (eg. disaster or disability); see Form 2210 Instructions.