Introduction to the United States Tax System

A laymen’s guide to our country’s income tax system. – by James R. Leichter

This article is meant to introduce businesspeople to our income tax system. A basic understanding of how our tax system works is a good idea for business owners and managers.

The United States tax system, a cornerstone of the country’s economic framework, has evolved significantly since its inception, reflecting the changing needs and complexities of the nation. This introduction provides a brief historical overview and insight into the key aspects of the system, laying the groundwork for understanding individual and S Corporation tax returns.

Taxation: An Historical Overview

Early Beginnings (Pre-16th Amendment)

Prior to the establishment of a formal tax system, the U.S. government primarily relied on tariffs and excise taxes.

The Revenue Act of 1861 introduced the first federal income tax to fund the Civil War, but it was short-lived.

16th Amendment (1913)

A pivotal moment in U.S. tax history, the 16th Amendment was ratified, granting Congress the authority to impose a federal income tax.

This amendment laid the foundation for the modern tax system.

Post-16th Amendment Developments

Over the years, the tax code has expanded and undergone numerous revisions to address the evolving economic and social landscape.

Key changes include the introduction of payroll withholding and quarterly tax payments during World War II.

The Current Tax System

Administering Body

The Internal Revenue Service (IRS), a bureau of the Department of the Treasury, is the federal agency responsible for tax collection and tax law enforcement.

Types of Taxes

The U.S. tax system encompasses various types of taxes, including income taxes, payroll taxes, corporate taxes, and excise taxes.

Individual and S Corporation Taxes:

Individual income taxes form a significant portion of the federal government’s revenue.

S Corporations, a special type of corporation, pass their income, losses, deductions, and credits through to their shareholders for federal tax purposes.

Interesting Historical Facts

First Income Tax Bracket: In 1913, the top income tax rate was only 7% on incomes over $500,000 (equivalent to over $13 million today).

World War II Impact: The need to finance World War II dramatically transformed the tax system, increasing the number of taxpayers from 7 million in 1940 to 42 million by 1945.

Technological Advances: The introduction of computer technology in the 1950s and electronic filing in the 1980s revolutionized tax processing and compliance.

Highest Tax Bracket Ever

The highest income tax bracket ever in the United States was 94%, which was in effect during and immediately after World War II. This top rate applied to individuals:

Year and Rate: The 94% top tax rate was established in 1944 and remained through 1945.

Income Threshold: In 1944-1945, this rate applied to income over $200,000, which would be equivalent to millions in today’s dollars when adjusted for inflation.

Target Group: This rate primarily affected the highest-income individuals in the country, which included top business executives, celebrities, and other extremely wealthy individuals.

This rate was part of the government’s effort to finance military operations during the war and manage economic conditions, including inflationary pressures. After the war, the top tax rates remained high by modern standards but were reduced from the peak of 94%.

It’s important to note that the effective tax rate (the rate actually paid after deductions and credits) was often lower than the nominal top rate. Additionally, the tax code at the time included many more deductions and exemptions than the current tax code, which allowed for significant reductions in taxable income.

Recapping the US Federal Tax System

Understanding the historical context and structure of the United States tax system is crucial for professionals entering the field of tax preparation. As you progress through this manual, you will gain the knowledge and skills necessary to navigate the complexities of individual and S Corporation tax returns, informed by a comprehensive background of the system you are working within.

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The Most Important Tax Law Changes

Your Comments and Suggestions are Welcome

I hope this helps you better understand the origin and meaning of our federal income tax system. If you have any questions about bookkeeping, accounting, income tax planning, state & federal tax form preparation, please contact us.

Thank You!

James R. Leichter (about me)
Majority Shareholder
RA Tax and Accounting, Inc.
Phone: (913) 894-8877