Tax definition: Federal income taxes and why we pay them

This article was fact-checked by our editors and Jennifer Samuel, senior product specialist for Credit Karma. It has been updated for the 2020 tax year.

Can you imagine a country without Medicare, Social Security, a military or law enforcement?

It’d be chaos, right? That’s why we have taxes — to help pay for societal benefits. About half of the federal government’s money comes from individual income taxes like the kind you pay.

You might have opinions about how the federal government spends all the tax the IRS collects every year. And while you know you have to pay your taxes, you may still wonder if you’re getting a good bang for your buck.

Let’s look at tax definitions, how federal income taxes work, how they get collected and how the federal government spends them.

• What is the federal income tax?
• How does my income tax get paid?
• Why do I need to file a tax return if I’ve already paid my taxes?
• How do tax deductions and credits work?
• How does the government spend its tax revenue?

What is the federal income tax?

There are lots of types of taxes. You might pay sales tax or property tax to state and local governments. And if you buy assets like stocks or real estate and then later sell for a higher price, you may owe capital gains taxes.

The taxes that most people worry about, though, are federal income taxes. Here’s how the IRS defines income tax: “Taxes 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).”

Even the IRS admits that the biggest problem with taxes is that they’re so complex.

The United States uses a progressive tax system. That means the higher your income, the bigger the share of it you’ll pay in taxes. The rationale behind this is that the more money you have, the greater your ability to pay taxes compared with a less-well-off person.

To see how this works, let’s look at the 2020 tax brackets. Notice that the more money you earn, the higher the percentage you’ll pay in taxes.

How does my income tax get paid?

Paying taxes can be a hassle, but if you work for an employer most of the task is already taken care of for you thanks to the W-4 you filled out when you onboarded for your current job.

Your W-4 tells your employer how much federal and state income tax to withhold from your paycheck, based on factors like how many dependents you have and whether you’re married or not. If you’re self-employed, it’s a bit more complicated, because you may need to make quarterly tax payments on your own based on your estimated income.

Either way, you pay the IRS throughout the year through your employer or on your own if you’re self-employed.

How do marginal taxes work?

You only owe a given percentage of your income on the amount within each tax bracket. If you earn $25,000 as a single person in the 2020 tax year, for example, you wouldn’t owe 12% of all your income. You’d only owe 10% on your income up to $9,875, and 12% on your income between $9,876 and $25,000. Learn more about how marginal tax rates work.

Why do I need to file a tax return if I’ve already paid my taxes?

Every year, the IRS sets a deadline for when you must pay all your federal income tax and file your tax return. Typically, it’s April 15, but that day can vary slightly if the 15th falls on a weekend or holiday.

Why the deadline and the need for a return? The taxes you pay throughout the year are really just an estimate of what you may owe. Many factors, such as tax deductions and credits or variations in your taxable income, can cause the actual amount you owe to be more or less than what you’ve paid (we’ll talk about that shortly ). In fact, the U.S. tax code contains millions of words detailing these alterations.

When you file your taxes, you’re actually taking into account all of these alterations along with what you’ve already paid to come up with one magical number: your final tax bill for the year. If you’ve paid more than that amount throughout the year, you get a tax refund. If you’ve paid less than that final number, you’ll owe money to the IRS.

How do tax deductions and credits work?

Did you know that you might not owe income tax on all the money you earn? You can lower your tax bill with tax deductions and credits. First, let’s look at tax deductions.

Tax definition: Deductions

If you’re eligible for certain tax deductions, you can subtract the deduction amount from your taxable income. The new number is called your adjusted gross income and is the starting point for calculating the amount of tax you’ll owe. Additional adjustments, like credits, could further reduce the amount of tax you pay.

In general, you can choose to take a standard deduction or itemize your deductions by tallying up all of the individual deductions you qualify for, but not both.

For 2020, the standard deduction amounts are …

• Single and married filing separately: $12,400
• Married filing jointly: $24,800
• Heads of household: $18,650

So if you file as single and choose to take the standard deduction on your $30,000 of income in 2020, your adjusted gross income will be $17,600, not the full $30,000.

Tax definition: Credits

Tax credits, on the other hand, work a bit differently. Instead of subtracting a tax credit from your taxable income, you subtract it directly from your tax liability. Tax credits are either refundable (you may get a refund from the credit) or nonrefundable (you can use the credit to reduce your tax bill to zero but may not get refunded any extra credit money past that).

Generally, you’ll owe less tax for every deduction and credit you qualify for. And if your annual income is low enough, you might not have to pay federal income tax at all. That was the case for 44% of Americans in 2018, according to the Tax Policy Center. The percentage is expected to increase to nearly 46% under the Tax Cuts and Jobs Act.

But keep in mind that even if you don’t pay much in federal income tax, that hardly means you pay no tax at all. Depending on where you live and how much you earn, you may pay state income tax, sales tax and state (as well as federal) gas taxes. And if you own your home, you’ll likely pay property taxes.

How does the government spend its tax revenue?

The federal income taxes paid by average folks like you and your friends are Uncle Sam’s main source of funding. Individual income taxes accounted for $1.7 trillion of the total $3.3 trillion the federal government collected in revenue during 2018, according to the Congressional Budget Office.

So where is all that money going?

Of spending in 2018, the lion’s share ($2.5 trillion) helped pay for mandatory spending — mostly benefit programs such as Social Security, Medicare and Medicaid; the earned income tax credit; unemployment compensation; veterans benefits and other programs. Many of these public-service programs, which have eligibility rules and benefit formulas established by law, are designed to help Americans who most need financial assistance, like senior citizens, disabled people, low-income families and veterans.

Lawmakers got to decide how to spend another $1.3 trillion in 2018. They put $623 billion toward defense and $639 billion toward other objectives like transportation, education, training, employment and social services, veterans benefits and services, income security, health, justice and international affairs, according to the CBO.

The process of deciding how to spend the government’s revenue starts when the president submits a budget request for the next fiscal year (Oct. 1 to Sept. 30 for the federal government). But determining where your tax dollars go can be a lengthy process that usually involves congressional committees, hearings, a revised version of the budget put forth by Congress, resolutions and amendments, and — finally — votes in both the House and Senate.

Things don’t always go smoothly, though. For example, Congress approved the 2018 budget in March 2018, about half a year after the 2018 fiscal year had started.

Bottom line

If you question why you have to pay federal taxes and how the government spends your money, you’re carrying on an American tradition. In fact, this country was founded by people who so hated having to pay taxes with no say in how their tax money was spent that they rebelled against the British government — and ultimately founded the United States of America.

It took American lawmakers about 137 years to decide that the country needed federal income taxes to stay solvent. The 16th Amendment, ratified in February 1913, gave Congress the power to levy and collect a federal income tax. Before the federal income tax, the U.S. government primarily got its revenue from consumption taxes (similar to our modern sales and excise taxes).

The National Constitution Center has this to say about the impact of creating a federal income tax: “[The] 16th Amendment matters most because it has forever changed the character of the United States government, from a modest central government dependent on consumption taxes and tariffs on imports, to the much more powerful, modern government that fought two world wars and the Cold War with the vast revenue that came from the federal income tax.”

Jennifer Samuel, senior tax product specialist for Credit Karma, has more than a decade of experience in the tax preparation industry, including work as a tax analyst and tax preparation professional. She holds a bachelor’s degree in accounting from Saint Leo University. You can find her on LinkedIn.