A Fundamental Guide to the Tax Code
By F. F. John
, last updated October 2, 2011
A fundamental guide to the American tax code would be incomplete without a basic history of it’s origins and the many starts and stops that came along the way. The current code evolved from a century of laws and today, is considered very confusing by many but still plays an important role in raising funds for the country’s needs. If you are interested in learning about the code, which contains the rules by which tax collection and other related-activities are regulated, the information below will provide you with much of what you need.
The first country-wide tax in the United States was introduced in 1864 by President Lincoln to raise money to fund the Civil War. At the time, those who earned between $600 and $10,000, paid a 3 percent tax, while those who earned more than $10,000 paid a 5 percent tax on their income. Less than four years later, however, changes were made to the tax system due to public criticism and by 1872, the collection of income tax was discontinued. Instead, 90 percent of government revenue was obtained from liquor, beer, wine and tobacco taxes. It was not until 1913, with the threat of World War I coming, that Article 16 of the Constitution was enacted. It gave the federal government power to once again collect taxes.
Internal Revenue Service
Once known as the Bureau of Internal Revenue, the Internal Revenue Service (IRS) regulates the collection of federal tax returns, which must be submitted by April 15th each year. It has four main sections: the Large Business and International division, the Small Business/Self-Employed division, the Wage and Investment division, and the Tax Exempt & Government Entities division. State governments are also empowered to collect taxes from resident businesses and individuals. Like the federal government, which uses tax money to fund important programs, so also do states use tax revenue to improve roads, schools and even social welfare programs.
Internal Revenue Code
At the federal level, taxes are regulated by the Internal Revenue Code (IRC). The IRC is a system of rules and forms that must be completed to pay taxes, including excise taxes, gift taxes, income taxes and estate taxes. The code is also necessary to achieve a specific tax designation such as tax-free status. For instance, forms 1023 and 1024 are required to apply for tax-exempt designation. The IRC is issued by the Treasury Department.
What Is Taxed?
The IRC specifies what income can or cannot be taxed by the federal government. Non-taxable income includes child support payments, money received from disaster relief funds, and disability payments. However, many other forms of income are taxed. These include salaries and wages, profits from stocks, bonds and dividends, and profits from residential sales.
Tax Deductions & Credits
The code allows tax payers to lower their taxable income through itemized or standard deductions. Home mortgage interest, donations to charities, certain health care costs and real estate taxes can be deducted annually. Tax credits also lower an individual’s tax burden. There are tax credits for parents with children, students paying college tuition, energy efficiency home improvements and new home buyers. There are also credits for those who contribute to their retirement funds.
An audit is triggered when a tax return, be it from a business or an individual, is inaccurate or features a discrepancy. When this is the case, the code allows the IRS to send a notice of audit letter and either requests additional information, called a paper audit, or establishes a future date for an interview, known as an in-person audit. To complete the paper audit, documents supporting the tax return must be submitted and if successful, the audit will be closed. For an in-person interview, it is best to be represented or accompanied by a lawyer or tax professional. If the IRS is not satisfied with the results of the paper or in-person audit, a fine is issued. That decision can however be appealed to the IRS and then, if necessary, to the United States Tax Court.
The Future of The Tax Code
There have been repeated calls to simplify the tax code and make it easier for individuals to understand. While there is little indication that such simplification is forthcoming, there are changes that will likely happen in the next few years. These include the introduction of a tax on the super wealthy. On September 19th, 2011, President Obama presented his vision of a tax overhaul and a main point was the creation of a millionaire’s tax to help pay down the country’s budget deficit. The plan is nicknamed the ‘Buffet Rule’ because billionaire Warren Buffet publicly supported such a tax. Another deficit reduction strategy planned by President Obama is to lower corporate taxes so that American businesses can make more profits. Time will tell which of these and other recommended plans will make it into the tax code.