When the United States was born, there were not that many taxes for its citizens of a newly formed nation. The government’s major source of revenue came from the sales taxes imposed on trading tobacco, sugar, slaves and property sold at auctions; however it did not have income taxes like we experience now. It is hard to believe but back then things were a lot simpler than now and even the US government did not need a lot of money to operate as a functioning government. In fact, even the sales tax was removed in 1817 because the US government could function as a government from just tariffs collected from imported goods. The first income tax law was introduced during the American Civil War in 1861 to support the war effort. Under this new income tax law, 3% of all income over $800 was collected. Compared to our highest tax bracket today, which is 35%, it is incredibly low despite the fact that it was during the darkest and bloodiest moment is US history. The federal income tax became a permanent part of our lives in 1913 when the 16th amendment to the constitution was made which gave Congress real power and authority of collecting income taxes from its citizens. The 16th amendment states “Congress shall have power to lay and collect taxes on incomes, from whatever source derived”. The important key words are “whatever source”. This means that from this point on the US government is your business partner for whatever you do and therefore whatever you earn from your work or business, you now have to legally share it with the US government.

The current federal income tax is just a part of many taxes that we are paying every day. On top of federal income taxes, there are payroll taxes, excise taxes, sales taxes, tariffs, gift taxes, unemployment taxes, state income taxes, property taxes, estate taxes, and self-employment taxes. The federal income tax is a progressive tax meaning that as you make more, you will be taxed more. For 2011, the income tax bracket consists of 10%, 15%, 25%, 28%, 33%, and 35% for individuals and C corporations could be taxed up to 39% of its income. The today’s top tax rate of 35% for an individual and 39% for a business seems a lot, but during War World 2, the top tax bracket for an individual was an incredible 94% to pay for the war effort. The US income tax is unique in that no matter where you live, Korea, India, or Germany, as long as you are a US citizen or legal resident of the US, you will be subjected to US income taxes. In other words, even if you are living alone in the North Pole and earn money by fishing or living in a remote desert of Africa and make money by hunting and never lived in the US, as long as you are a US citizen, you are subject to the US tax law. Most of the other major countries do not apply income tax or estate tax law to expatriated citizens. Looking only from the outside, the current tax law looks extremely complex, more advanced, strict, and rigid than the foreign tax law, but if you look from the inside, there are many loop holes that legally allow the tax payers to pay less tax or pay no tax at all. In 2006, out of 134,372,678 individuals who filed a federal income tax return, about 32.58% didn’t pay any federal income taxes and according to CNN Money that percentage grew to 47% by 2009. Of course with our current bad economy, the government policy to give away tax credits and deductions contributed to this growth of non-income tax payers thus, it is wise to go over the tax credits and deductions carefully to make sure that you did not miss out any new tax credits and deductions.

So what is the future for income taxes? There are some very radical tax reform ideas among a very small group of politicians in Washington such as Rep. John Linder who sponsored the Fair Tax Act of 2003 which now is supported by the House Majority Leader Tom DeLay (Rep. Texas). The idea is to replace the overly complex tax laws, loop holes, and unfair current federal income tax with a flat 23% sales tax on final sales of goods and services. The suggested tax reform will never be passed and, in fact, no country in the world is planning to abandon the income tax or is even considering a personal expenditure tax to replace the income tax, but we can understand where this radical idea came from. The federal income tax is not just complex for tax payers, but also for tax collectors and law makers. For the past almost 100 years, congress has been fixing the loop holes and improving the tax law by making the tax law even more complicated. Every year more and more updates and modifications are added to the current tax laws, but rarely taken out. We can positively assume that it will get even more complicated in the future.

If you have questions, need additional information or would like to discuss more on the above topic, please feel free to call us at (951) 781-2910 and/or visit our office.

Grant Yi is an accountant in Riverside, CA at Trimble & Company. The company provides comprehensive small business accounting services throughout Southern California.