INCOME TAX PLANNING

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What Is Income Tax?

The term income tax refers to a type of tax that governments impose on income generated by businesses and individuals within their jurisdiction. By law, taxpayers must file an income tax return annually to determine their tax obligations.

Income taxes are a source of revenue for governments. They are used to fund public services, pay government obligations, and provide goods for citizens.

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How Income Tax Works

Most countries employ a progressive income tax system in which higher-income earners pay a higher tax rate compared to their lower-income counterparts. The U.S. imposed the nation's first income tax in 1862 to help finance the Civil War. After the war, the tax was repealed; it was reinstated during the early 20th century.

The Internal Revenue Service (IRS) collects taxes and enforces tax laws in the United States. The IRS employs a complex set of rules and regulations regarding reportable and taxable income, deductions, credits, et al. The agency collects taxes on all forms of income, such as wages, salaries, commissions, investments, and business earnings.

The personal income tax the government collects can help fund government programs and services, such as Social Security, national security, schools, and roads.

Types of Income Tax

Individual Income Tax: Individual income tax is also referred to as personal income tax. This type of income tax is levied on an individual's wages, salaries, and other types of income. This tax is usually a tax the state imposes. Because of exemptions, deductions, and credits, most individuals do not pay taxes on all of their income.

Business Income Taxes: Businesses also pay income taxes on their earnings; the IRS taxes income from corporations, partnerships, self-employed contractors, and small businesses.9 Depending on the business structure, either the corporation, its owners, or shareholders report their business income and then deduct their operating and capital expenses. Generally, the difference between their business income and their operating and capital expenses is considered their taxable business income.

State and Local Income Tax: New Hampshire also has no state tax on income. But residents must pay a 5% tax on any dividends and interest they earn.13 The state passed a bill in 2018 which would phase out the state 5% tax on interest and dividends on Jan. 1, 2024.14 This will bring the number of states with no income tax to nine by 2024.