What Does Income Tax Pay For [All You Need to Know in 2021]

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Do you feel intimidated when it comes to paying taxes? Do you wonder what does income tax pay for, or what various types of income taxes represent? 

In this article, we’ll talk in detail about income taxes, their use, and types like progressive income tax and personal income tax. We’ll help you resolve any doubts and ambiguities related to income taxes, and hopefully, after reading, you’ll feel more confident about taxes. 

What Is Income Tax? 

Taxes are imposed on individuals and businesses by the government to pay for public facilities. It serves as a source of income for the government. There are many types of taxes and income tax is just one of them.

Income tax is generated by the work of a person or company. The first income tax was established in 1862 to help the United States pay for the Civil War, and is still running strong after being reintroduced in the 20th century. Income tax makes up most of the government’s tax revenue.

To get a deeper understanding of income tax meaning, it is also important to understand who collects it. The IRS or Internal Revenue Service collects taxes in the U.S.A. The agency has a defined set of rules for different taxpayers and taxable income. 

Types of Income Tax 

There are mainly two types of income tax which we have discussed below. 

Personal Income Tax

This type of tax is levied on income from work including wages, salaries, bonuses, and tips. It is also imposed on investments, capital gains like a lottery, returned debts, alimony, etc. People can make use of certain tax credits to reduce their taxable income in individual taxation.

Business Income Tax

This tax is levied upon businesses. It includes paying tax on income from corporations, partnerships, self-employed, contractors, and small businesses. The tax is levied upon the income left after subtracting operating and capital expenses from the total revenue generated.

Non Taxable Income

Not every income requires you to pay tax, there are certain exemptions. Non-taxable income refers to the income which is not taxed. Here are a few things included in it.

Life Insurance Payment

The IRS does not charge tax on life insurance payments. It is an income from a policy, which does not require you to pay tax.

Vow of Poverty of a Member of a Religious Organization

Certain members of a religious organization take a vow of poverty that requires them to give up their luxury lifestyle. They only focus on the basic necessities of life. Their income is not included in the taxpayer money.

Employee Achievement Award

These are given to selected employees by their employers apart from the basic salary. It is usually based on an employee’s performance and acts as a bonus income. This is not taxable as it comes under ‘tangible personal property.

Inheritance

Inheritance received by an individual is also not taxable by law. It includes both non-movable assets like properties or moveable assets like shares. Tax is only levied if the person sells the property or uses it to generate income.

DID YOU KNOW? Many people assume that profits from trading in cryptocurrencies are non-taxable. This is not true and you have to include gains from crypto while you calculate your tax. There are crypto tax software that can help ease the process.

What Does Income Tax Pay For?

Income tax pays for many things. Most of the tax revenue of the government is collected through income tax. It is used for many things and services. These are mainly divided into three categories.

Major Health Programs

Income tax revenue is used to provide medical facilities to people. Major health programs like Medicare and Medicaid are funded through the income tax collected by the government.

Social Security

Social security is a type of insurance plan. It provides monthly payments to retired people, people who cannot work due to disability, and also provides survivor benefits.

Defense and Security

Income taxes are also used to pay for the defense and security of the country. It requires paying the army personnel, machinery, etc. 

Still not clear about where do taxpayers’ dollars go? Below we’ve listed a few more services that are funded by income tax. 

Safety Net Programs

These programs are focused on the needs of the vulnerable population of the country. They include unemployment insurance, providing food stamps, providing low-income housing assistance, and programs for abused and neglected children.

Interest on National Debt

Just like we pay interest on our debts, the government also pays interest on international debts. The only difference is that the government’s income is derived from taxes.

These are the main categories where taxes go. However, 19% of the remaining income tax goes to the categories below. 

Benefits for Federal Retirees and Veterans

 7% of the income tax is spent to provide benefits for federal retirees and veterans. The benefits include job training, low-cost medical care, disability compensation, etc.

Transportation Infrastructure

It includes building and maintaining transport infrastructures like roads, buses, and other public transportation services.

Education

The government also uses income tax to provide educational facilities to people. This includes scholarships, funding colleges, etc.

Science and Medical Research

A small percentage of income tax is also spent on science and medical research.

Now that you have a clear understanding of what is income tax and how it is used, you will be able to determine if the taxes are being used for the right purposes or not. As per a 2009 survey, most Americans were unhappy about the way their taxes were being used.

However, another survey pointed out that the main reason for their dissatisfaction was the lack of information. Once you know where your money is going and who is it helping, filing the tax return will not seem so dreadful!

DID YOU KNOW? The government keeps on changing the amount of income tax to be used for different services. That’s why it is important for us to be aware of the new policies.

Key Takeaways

There are mainly two types of income tax: individual income tax and business income tax
Certain incomes are exempted from paying taxes like inheritance, life insurance, and applicable awards.
Income tax is used for a variety of things by the government, as it constitutes a major source of revenue for the federal government
Some services that are funded include education, medical care, transportation, defense, and safety net programs. 

What Is Progressive Income Tax?

Taxes in the US are collected through a progressive system, meaning that people who earn more pay more tax than those who earn less. A higher tax rate is charged to those with a higher income, and someone with a lower income pays less

Incomes are divided into seven income slabs that determine tax rates.

This system is generally praised, as it helps people with lower incomes. Moreover, it allows people to enjoy services like medical care, transportation, and education at a reduced cost

However, everything has pros and cons. This system is mainly opposed by people with higher income as they’re forced to pay more money. It can also discourage people from becoming more successful.

DID YOU KNOW? There are more than seven types of taxes that Americans pay during their lifetime, which can make taxes very complicated for both taxpayers and the government collecting them.

What Percentage of Americans Pay Income Tax?

Not all 50 states impose income tax. Currently, there are eight states that do not impose income tax: Alaska, Florida, Nevada, South Dakota, Texas, Tennessee, Washington, and Wyoming.

Before you pack your bags and get ready to move there, though, let us remind you that the states compensate for this with other types of taxes. For example, residents of Florida are charged a sales tax of 6%. States also compensate by not providing facilities like affordable healthcare or maintained transportation.

Income tax is usually paid once a year every April, but it can also be paid quarterly. Many companies automatically deduct the tax amount from your salary. If you do not work for a company, you need to calculate your tax amount and file a return to the federal government. This can also be done either yearly or quarterly. 

You can file taxes manually yourself, or hire the help of a professional or tax software. Even if you do use assistance, you should have all your documents like W-2 and 1099 forms at hand.

As already mentioned, income tax forms the highest portion of federal tax revenue. The government takes strict actions against those who do not file taxes. Initially, you will be charged a small penalty which can continue to grow over time. If you still do not pay your taxes, you will be listed under tax evaders and the IRS can seize your properties and assets

Our word of advice: pay your taxes on time!

DID YOU KNOW? Nearly 50% of Americans are exempt from paying taxes! This is because either their income is too low or they have retired and rely on social security.

Conclusion 

Income tax is a major source of revenue for the government, and it is required of both individuals as businesses. The rate of tax depends upon the income. For businesses, income is calculated by considering capital and operating expenses and subtracting it from revenue. Income tax is used for providing services like affordable healthcare, security, education, and maintaining the infrastructure of the state.

FAQ

Do we have to pay income tax on lottery winnings? 

Yes, you have to pay income tax on lottery winnings; it’s considered capital gain, which is taxable. Taxes are levied on every type of lottery winning, whether it’s cash or a prize.

What is an example of income tax? 

A usual example of income tax are deductions that appear on your paychecks. Income taxes are not voluntary and have to be paid by every earning person yearly or quarterly.

Why does the government need to collect taxes? 

The government collects taxes, especially income tax, to pay for many essential services. So what does income tax pay for? It pays for affordable healthcare, education, security, affordable housing, and building and maintaining infrastructure.

ABOUT AUTHOR

I learned a lot about finance after working for a digital marketing company specializing in investing and trading stocks, forex, etc. After that, I got exposed to other verticals such as wealth management and personal finance, which further improved my understanding of the financial world.

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