income tax

noun
Updated on: 26 Jul 2017

Definition of income tax

:a tax on the net income of an individual or a business

Examples of income tax in a Sentence

  1. Federal income tax will be deducted from your pay.

  2. The new law will lower income taxes for most taxpayers.

First Known Use of income tax

1799


Financial Definition of INCOME TAX

income tax

What It Is

Income tax refers to annual taxes levied by the federal government and most state governments on individual and business income.  By law, businesses and individuals must file federal and state income tax returns every year to determine whether they owe taxes. Governments use the taxes they collect to fund their activities.

How It Works

Income tax is applied to both earned income (wages, salaries and commission) and unearned income (dividends, interest and rents).

The U.S. and many other countries employ a progressive income tax system in which higher income earners pay a higher tax rate compared to their lower earning counterparts. The intent of progressive systems is to distribute wealth more evenly across a population.

Here's an example of how a progressive tax is structured: Assume you are single and report $80,000 in taxable income for the 2010 tax year (filing in 2011). In accordance with the federal tax rates defined for single filers in 2010, the first $8,350 of your income is taxed at 10%; the next $8,351 through $33,950 of earnings are taxed at 15%; and the remaining $33,951 through $80,000 of your earnings are taxed at 25%.

[Click here to see our Progressive Tax Definition and Example.]

Why It Matters

Income taxes reduce the amount of earnings that individuals and businesses are allowed to keep. There are a couple of strategies investors can use to retain more of their income. The first is investing in tax-advantaged assets like U.S. government bonds and municipal bonds.

The second is to open a retirement account that is tax-advantaged. An IRA, 401(k), SEP IRA and Roth IRA are all examples of tax-advantaged accounts. Investors can hold any asset they like within these accounts. The tax benefits of a retirement account don’t depend on the investments you hold in the account.

[InvestingAnswers Feature: How to Avoid an IRS Audit]


INCOME TAX Defined for English Language Learners

income tax

noun

Definition of income tax for English Language Learners

  • : a tax paid on the money that a person or business receives as income


INCOME TAX Defined for Kids

income tax

noun

Definition of income tax for Students

:a tax on the income of a person or business

Law Dictionary

income tax

noun

legal Definition of income tax

:a tax on the net income of an individual or a business — compare excise, property tax


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