Basics of Taxes

Congress, the legislative branch of the government, writes the Internal Revenue Code (IRC), also called the tax code. The tax code directs the collection of taxes, the enforcement of the tax rules, and the issuance of tax refunds, rebates, and credits. Remember, credits can be more beneficial than deductions, because with credits, you can actually get money back from the IRS. Money that you didn’t even pay into the system. So you need to keep your eyes out for these. The IRS is the government agency within the U.S. Department of Treasury charged with carrying out these functions. Since everyone must pay taxes of some sort — whether it’s sales tax on a gallon of milk or capital gains tax on a $5 million stock sale — it’s important to get a general understanding of taxation in the United States.

Tax Basics: How is the Tax Code Interpreted?

The IRS interprets tax provisions through IRS regulations, which provide guidance on the application of tax law. Because not every tax code has a regulation, the IRS also uses revenue rulings, revenue procedures, and letter rulings to offer guidance. Although the IRS can offer its own interpretation of the tax code, when a dispute arises it is the role of the federal court system — a part of the judicial branch of the government — to interpret the tax code and to decide how Congress intended its application.

Tax Basics: How Does the Government Use Taxes?

The U.S. government collects income taxes, payroll taxes, sales taxes and real estate taxes from individuals and companies. The government disburses the money, according to its budget, to the appropriate agency to use for purposes like national defense, Social Security, education, national parks, and for government services like welfare.

Tax Basics: How Does the Government Collect Income Taxes?

The government receives most of its revenue for its budget through income taxes. The collection of income taxes occurs throughout the year by withholdings from a person’s paychecks. At the end of the year, every person that earned income must file a tax return to determine whether the government collected enough taxes through withholding or whether the government owes a person a refund for paying too much tax.

Tax Basics: What is Taxable Income?

There are two types of income subject to taxation: earned income and unearned income. Earned income includes:

Salary
Wages
Tips
Commissions
Bonuses
Unemployment benefits
Sick pay
Some non-cash fringe benefits

Taxable unearned income includes:

Interest
Dividends
Profit from the sale of assets
Business and farm income
Rents
Royalties
Gambling winnings
Alimony

It is possible to reduce taxable income by contributing to a retirement account like a 401(k) or an IRA.

Tax Basics: What are Allowed Deductions?

The government allows the deduction of some types of expenses from a person’s adjusted gross income, or gross income minus adjustments. A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, state and local taxes, charitable contributions, and medical expenses.