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PAGE ONE Economics

®

Income Tax:
Facts and Filings
Jeannette N. Bennett, Senior Economic Education Specialist

GLOSSARY
Adjusted gross income: Gross income
minus specific adjustments.
File (a tax return): To mail or electronically
transmit a taxpayer’s income and tax liability information in a specified format.
Gross income: The total amount earned
before any adjustments are subtracted.
Income: The payment people receive for
providing resources in the marketplace.
People also earn income in the form of
rent, profit, and interest.
Income tax: Tax on income, both earned
(salaries, wages, tips, commissions) and
unearned (interest, dividends). Income
taxes can be levied on both individuals
(personal income taxes) and businesses
(business and corporate income taxes).
Revenue: The income received by government from taxes and other nontax sources.
Tax credit: An amount directly deducted
from the total tax owed.
Tax deduction: A fixed amount or percentage permitted by taxation authorities that
a taxpayer could subtract from his or her
gross income to reduce taxable income.
Taxes: Fees charged on business and individual income, activities, property, or
products by governments. People are
required to pay taxes.
Tax exemption: Amount allowed by the IRS
that can be deducted from taxable income
to reduce the amount of income tax owed.
There are two types: personal and dependency. The personal exemption is for the
taxpayer; the dependency exemption is
based on the number of dependents the
taxpayer has. The exemption amount is a
set amount that changes from year to year.

December 2016	

“The hardest thing in the world to understand is the income tax.”
—Albert Einstein

Introduction
It’s on the calendar: the April 15th filing deadline for federal individual
income tax. Just as a new year begins, it’s tax-filing season and the frenzy
begins. Some taxpayers are excited and eagerly anticipate a tax refund.
Predictably, they are likely to file their tax returns early. Others are stressed
and fearful of how much they might owe the government. Tax preparers
are extremely busy filling out forms and filing tax returns. And on April 15th,
some post offices stay open late to accommodate filers who wait until the
last minute to make the midnight deadline. Why do tax forms cause such
frenzy?
Taxes must be paid—it’s the law. Federal individual income tax must be
paid to the U.S. government on all forms of annual earnings that make up
a taxpayer’s taxable income. Taxable income is calculated based on the
taxpayer’s adjusted gross income for the tax year minus allowable tax
exemptions, deductions, and credits. But making the calculations and
completing the forms necessary for determining taxable income can be
confusing and complex!
16th Amendment to the U.S. Constitution (1913)
The Congress shall have the 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.
SOURCE: http://www.ourdocuments.gov/doc.php?flash=true&doc=57.

History of the Federal Income Tax
Congress initiated the first U.S. federal income tax in 1862 to collect revenue for the expenses of the Civil War. The tax was eliminated in 1872. It
made a short-lived comeback in 1894 but was ruled unconstitutional the
very next year. Then, in 1913, the federal income tax resurfaced when the
16th Amendment to the Constitution gave Congress legal authority to tax
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2016 Income Tax Brackets
The seven IRS tax brackets are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The amount of income tax owed depends on taxable income and
filing status. Income falling within a particular bracket will be taxed at that tax rate. Additional income will be taxed according to the rate in
the next tax bracket.
Example: The income tax a single taxpayer with a taxable income of $10,000 must pay is 10% for the first $9,275 plus 15% for the remaining $725.
10% × $9,275 = $927.50
15% × $725 = $108.75
Total Tax = $927.50 + $108.75 = $1,036.25
Filing Status

Rate

Single

Married filing separately

Married filing jointly or
qualifying widow(er)

Head of household

10%

$0 to $9,275

$0 to $9,275

$0 to $18,550

$0 to $13,250

15%

$9,276 to $37,650

$9,276 to $37,650

$18,551 to $75,300

$13,251 to $50,400

25%

$37,651 to $91,150

$37,651 to $75,950

$75,301 to $151,900

$50,401 to $130,150

28%

$91,151 to $190,150

$75,951 to $115,725

$151,901 to $231,450

$130,151 to $210,800

33%

$190,151 to $413,350

$115,726 to $206,675

$231,451 to $413,350

$210,801 to $413,350

35%

$413,351 to $415,050

$206,676 to $233,475

$413,351 to $466,950

$413,351 to $441,000

39.6%

$415,051 or more

$233,476 or more

$466,951 or more

$441,001 or more

SOURCE: IRS; https://www.irs.com/articles/2016-federal-tax-rates-personal-exemptions-and-standard-deductions.

income. The result was a revenue law that taxed the
income of both individuals and corporations.1

Collection of the Federal Income Tax
Income tax is collected by the Internal Revenue Service
(IRS), a federal agency. The IRS was originally called the
Bureau of Internal Revenue, but the name changed in
the 1950s.2 Making the collection of the tax easier, the
Current Tax Payment Act was signed into law in 1943.
This law requires employers to withhold federal income
tax from an employee’s paycheck each pay period and
send the payment directly to the IRS on behalf of the
employee.3 In this way, income tax is collected on a “pay
as you earn” basis.

used by employees to complete individual tax returns.
Among other things, it includes the total amount of
income earned and the amount of federal income tax
withheld over the given year. Generally, if too much federal income tax has been withheld, a taxpayer will receive
a refund. If not enough has been withheld, the taxpayer
must pay the government the additional amount owed.

The Individual Income Tax Structure

The amount withheld is determined by information the
employee provides on an IRS W-4 form. This form collects information including the employee’s filing status,
whether married or single, and allowances that can be
claimed. The information is used to calculate a reasonable estimate of the amount of income tax to be withheld from each paycheck.

The federal individual income tax is a progressive tax
based on the ability-to-pay principle. A progressive tax
is a tax in which higher-income earners pay a larger
percentage of their income in tax than do lower-income
earners. The IRS categorizes taxable income into tax
brackets, and each tax bracket pays a different tax rate.
To arrive at the tax rate, the taxpayer’s filing status must
be determined as explained in Publication 501 from
the IRS. After calculating the amount of taxable income
and identifying the filing status, the tax rate can be
identified. For example, for 2016, the seven tax brackets
range from 10 to 39.6 percent. (See “2016 Income Tax
Brackets.”)

By January 31 of each year, employers must furnish
employees a W-2 Wage and Tax Statement. This form is

Without doubt, the highest income earners pay a greater
portion of total income taxes collected by the IRS. For

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High-Income Taxpayers Pay the Highest Average Tax Rates
Average Income Tax Rate, by Income Group (2013)
Percent
30

27.1

18.4

15
10.1

15
10

3.3
Bottom 50% 50% to 25% 25% to 10%

5
10% to 5%

5% to 1%

Top 1%

0

22.2

20.4

20

7.3

37.8

Share of Adjusted Gross Income
Share of Income Taxes Paid

25

13.4

10

0

Percent
40

30

20

5

Half of Taxpayers Pay 97.2 Percent of All Income Taxes
Share of Income and Share of Income Taxes Paid,
by Income Group (2013)

35

25

3

20.7

16.5
11.5

10.9

19.0

15.4
11.5 11.3

2.8
Bottom 50% 50% to 25% 25% to 10%

10% to 5%

5% to 1%

Top 1%

NOTE: Original images ©Tax Foundation.
SOURCE: IRS; http://www.irs.gov/uac/SOI-Tax-Stats-Individual-Income-Tax-Rates-and-Tax-Shares. Tax Foundation. “Summary of the Latest Federal Income Tax Data, 2015 Update.”
November 19, 2015; http://taxfoundation.org/article/summary-latest-federal-income-tax-data-2015-update.

example, the top 50 percent of income earners paid 97.2
percent of all federal income taxes in the year 2013.
(See the graphs.)

The Purpose of the Federal Income Tax
The U.S. government collects trillions of dollars in revenue
from several types of taxes and fees. (See the pie chart.)
Of all the federal taxes and fees, the individual income
tax is the largest revenue source. For example, in 2015,
it was $1.54 trillion and nearly half of all tax revenue collected.4 Congress and the president determine how this
tax revenue is spent. The revenue allows the government
to operate and provide goods and services for citizens,
such as roads, bridges, national parks, education, research,
and national defense.

Tax Refunds
A tax refund is money owed to a taxpayer when total tax
payments or credits are greater than the total tax liability.
On average, nearly four out of five U.S. tax filers get a
tax refund from the government each year.5 For the 2015
tax year, the IRS reports nearly 117 million individual
income tax refunds, which totaled over $346 billion.6

Overpayment
The majority of tax refunds are due to taxpayers having
paid the government more than they actually owed in
taxes. When a tax return is completed and an overpay-

All Other Taxes
6.2%
Excise Taxes
3.0%
Corporate
Income Taxes
10.6%

Federal Tax Revenue, 2015
$3.25 Trillion

Individual
Income Taxes
47.4%
Payroll Taxes
32.8%

SOURCE: Office of Management and Budget. Historical Tables 2.1 and 2.2.
Accessed October 26, 2016; https://www.whitehouse.gov/omb/budget/Historicals.

ment is shown, the IRS refunds the overpayment. The
government is not giving anything away—just returning
money. Actually, since the government does not pay
interest on an overpayment, the taxpayer is giving the
government an interest-free loan out of each paycheck.

Earned Income Tax Credit
A second reason for tax refunds is the earned income
tax credit (EITC). Of the nearly 117 million refunds for
individual income tax in 2015, almost 24.1 million were
based on the EITC.7
The EITC is a tax credit for low- to moderate-income
working taxpayers, particularly those with children. The

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2013 Federal Spending on the
Largest Anti-Poverty Programs

About the EITC
IRS Publication 596 is updated each year to assist taxpayers in
determining the EITC allowed. Some of the general rules for
2015 are shown below.

Rules for Qualifying for the EITC in 2015

Program

Millions of dollars*

Medicaid

$266,565

SNAP

$82,603

EITC

$55,123

•	You must have a valid Social Security number by the due date
	 of your 2015 income tax return.

•	Your filing status cannot be “married filing separately.”
•	You must be a U.S. citizen or resident alien all year.
•	You must have earned income.

4

NOTE: *Inflation adjusted.
SOURCE: Office of Management and Budget; https://www.whitehouse.gov/
sites/default/files/omb/budget/fy2014/assets/hist.pdf.

Note: Your income must be less than the maximum amount
given in the table. If you earn more, you do not qualify.

Number of
qualifying children

Adjusted gross
income for single
taxpayers

Adjusted gross
income for married
filing jointly
taxpayers

3 or more

Less than $47,747

Less than $53,267

2

Less than $44,454

Less than $49,974

1

Less than $39,131

Less than $44,651

0
(You must be
at least age 25
but under age 65.)

Less than $14,820

Less than $20,330

Estimated EITC (billions of dollars)
Year

Total EITC

Refundable

2016

$73.3

$63.7

2017

$76.0

$66.1

2018

$73.8

$63.8

2019

$75.6

$65.3

Total estimated

$298.7

$258.9

SOURCE: The Joint Committee on Taxation. “Estimates of Federal Tax
Expenditures for Fiscal Years 2015-2019.” December 7, 2015;
https://www.jct.gov/publications.html?func=startdown&id=4857.

SOURCE: IRS Publication 596.

amount of the EITC benefit depends on the recipient’s
income and number of children. (See the “About the
EITC” boxed insert.)
A tax credit directly reduces the amount of taxes owed.
The EITC is different from most tax credits because it is
a refundable tax credit. The credit can completely eliminate the income tax liability and result in a refund. For
example, if a taxpayer has a tax liability of $200 and an
EITC of $500, the taxpayer would be refunded the difference and receive a refund check in the amount of $300.

Federal Spending
The EITC began with the Tax Reduction Act of 1975,
and this anti-poverty program has expanded over the
years as determined by Congress.8 The refundable
portion of the EITC is classified as a spending program
of the government and currently is the third-largest
social welfare program in the United States. The largest
two are Medicaid, a health care program for qualifying
low-income individuals and those with disabilities, and

the Supplemental Nutrition Assistance Program (SNAP,
formerly called food stamps), which helps low-income
individuals purchase food.
The EITC is a benefit to taxpayers who receive it but
directly reduces the amount of tax revenue for the U.S.
government. In 2015, the refundable portion of the EITC
was more than $60 billion.9 Looking forward, the Joint
Com­mittee on Taxation has estimated the cost of the
EITC for each year through 2019. (See the table “Estimated
EITC.”)

Conclusion
The original income tax codes and regulations designed
in 1862 took about 400 pages to describe. In 1913, the
tax form was four pages and included one page of
instructions.10 Today, the federal tax code is almost
75,000 pages,11 and the IRS website lists over 2,000 different forms and publications.12 The increasing complexity
causes many taxpayers to rely on professional tax preparers to complete and file their tax returns. In fact, a
study of the 2011 tax year shows more than half of the

PAGE ONE Economics®
145 million individual tax returns were completed by a
paid tax preparer.13 With tax returns becoming longer
and more complex and with more forms to file, the frenzy
continues. n

Notes
1

Library of Congress. “Today in History: Tax Day.” Accessed October 17, 2016;
https://www.loc.gov/item/today-in-history/april-15#tax-day.
2

IRS. “Brief History of IRS.” Accessed October 17, 2016;
https://www.irs.gov/uac/brief-history-of-irs.
3

Tax History.com. “Historical Perspectives on the Federal Income Tax.” Accessed
October 17, 2016; http://www.taxhistory.com/1943.html.
4

Office of Management and Budget. Historical Tables 2.1 and 2.2. Accessed
October 26, 2016; https://www.whitehouse.gov/omb/budget/Historicals.
5

Sahadi, Jeanne. “Nearly 8 Out of 10 U.S. Taxpayers Get Refunds.” CNN Money,
January 14, 2015; http://money.cnn.com/2015/01/13/pf/taxes/taxpayer-refunds/.

Federal Reserve Bank of St. Louis | research.stlouisfed.org

5

8

Hungerford, Thomas L. and Thiess, Rebecca. “The Earned Income Tax Credit and
the Child Tax Credit: History, Purpose, Goals, and Effectiveness.” Economic Policy
Institute, September 25, 2013;
http://www.epi.org/publication/ib370-earned-income-tax-credit-and-the-childtax-credit-history-purpose-goals-and-effectiveness/.
9

IRS. Internal Revenue Service Data Book, 2015. Publication 55B. Washington, DC:
March 2016, p. 19; https://www.irs.gov/pub/irs-soi/15databk.pdf.
10

Chamberlain, Andrew. “America’s First Income Tax Form.” Tax Foundation,
July 7, 2005; http://taxfoundation.org/blog/americas-first-income-tax-form.
11

Russell, Jason. “Look at How Many Pages Are in the Federal Tax Code.”
Washington Examiner, April 15, 2016; http://www.washingtonexaminer.com/lookat-how-many-pages-are-in-the-federal-tax-code/article/2563032.
12

IRS. “Forms and Publications.” Accessed October 19, 2016;
https://www.irs.gov/forms-pubs.
13

McTigue, James R. Jr. “Paid Tax Return Preparers: In a Limited Study, Preparers
Made Significant Errors.” GA0-14-467T. Washington DC: April 8, 2014;
http://www.gao.gov/assets/670/662356.pdf.

6

IRS. Internal Revenue Service Data Book, 2015. Publication 55B. Washington, DC:
March 2016, pp. 17 and 19; https://www.irs.gov/pub/irs-soi/15databk.pdf.
7

IRS. Internal Revenue Service Data Book, 2015. Publication 55B. Washington, DC:
March 2016, p. 2; https://www.irs.gov/pub/irs-soi/15databk.pdf.

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Name___________________________________ Period_______
Federal Reserve Bank of St. Louis Page One Economics ®:

“Income Tax: Facts and Filings”

After reading the article, complete the following:
1.	 For each question, write the title of the section(s) of the article that addresses the question and write a
	 response. Cite information from the text that verifies your response.
Question
a. From the first income tax until today,
explain reasons why the government
needs income tax revenue. What
benefits are provided by income tax
revenue?

b. How is a refundable tax credit different
from most tax credits?

c. What gives the federal government
the authority to collect income tax?
What is the connection between the
Current Tax Payment Act and the W-4
form?

d. How do tax brackets affect the amount
of income tax revenue collected?

e. Why are tax refunds issued to taxpayers? What effect do income tax
refunds have on the amount of federal
tax revenue?

f. How does a taxpayer’s number of children affect the adjusted gross income
limits to qualify for the EITC?

Response

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2.	 It’s tax-filing season, and George has asked you to review his tax facts and estimate his tax liability for the year.
		George’s Facts
		 • Adjusted gross income: $52,500	
		 • Taxable income: $31,900 after allowable credits, deductions, and exemptions
		 • W-2: $7,875 withheld for federal income tax
		 • Filing status: Married filing jointly
		 • Children: None
	

a.	 Does George qualify for the EITC? Explain your answer.

	 b.	 Use the chart in “2016 Income Tax Brackets” to calculate the additional income tax George will owe or the 		
		 refund he will receive.

	 c.	 George expects his income and filing status to remain the same for the next tax year. Review the facts and 		
		 the results of George’s income tax liability for the year. What, if any, changes might you suggest George make 		
		 on his W-4 form? Defend your decision.

3.	 It’s tax-filing season, and Parker has asked you to help fill out his income tax forms and complete his tax return 		
	 based on these facts:
		Parker’s Facts
		 • Adjusted gross income: $12,000	
		 • Taxable income: $1,700 after allowable credits, deductions, and exemptions
		 • W-2: $500 withheld for federal income tax
		 • Filing status: Married filing jointly
		 • Children: None
	 a.	 Use the table in “2016 Income Tax Brackets” to calculate the additional income tax Parker will owe or the 		
		 refund Parker will receive.

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	 b.	 When Parker’s tax refund arrived, Parker was surprised that it was not $330 but $543! Use the chart in “About 		
		 the EITC” to explain why Parker received a larger refund than expected.

4.	 The Current Tax Payment Act requires taxpayers to pay federal income tax each time they receive a paycheck. 		
	 Explain advantages and disadvantages of this “pay as you earn” law. How is the law beneficial to the government?

5.	 You have a great job, and your taxable income puts you in the 35% income tax bracket. Explain how the
	 ability-to-pay principle affects you.

6.	 The EITC can be described as a transfer of money from those who pay taxes to those who receive the benefits. 		
	 Explain how this design affects income redistribution in the United States.

7.	 Explain the difference between a tax deduction and a tax credit.

8.	 In 1913, the income tax form was four pages and included one page of instructions.
	 Go to https://www.irs.gov/pub/irs-utl/1913.pdf to view the original form. Work with a partner to analyze the 		
	 form. Identify at least two facts from the form that you find interesting.


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