Federal Income Tax

Introduction

The federal income tax is the primary source of revenue for the United States government. The modern income tax was established by the Sixteenth Amendment (1913) and the Internal Revenue Code (IRC), codified at 26 USC §§ 1-9834. The income tax is a progressive tax imposed on individuals, corporations, estates, and trusts, based on taxable income —gross income minus allowable deductions and exemptions.

Gross Income

Gross income under IRC § 61 includes “all income from whatever source derived.” The definition is broad, encompassing compensation for services, business income, gains from property, interest, dividends, rents, royalties, alimony, annuities, and pensions. The Supreme Court in Commissioner v. Glenshaw Glass Co. (1955) held that gross income includes any accession to wealth, clearly realized, over which the taxpayer has complete dominion.

The IRC provides specific exclusions from gross income, including gifts and inheritances (§ 102), life insurance proceeds (§ 101), interest on state and municipal bonds (§ 103), certain fringe benefits (§§ 132, 119), and qualified scholarship amounts (§ 117). The exclusion for municipal bond interest is a significant tax expenditure that subsidizes state and local government borrowing.

Deductions

Taxpayers may reduce gross income by deductions to arrive at taxable income. Above-the-line deductions are subtracted from gross income to arrive at adjusted gross income (AGI) and are available to all taxpayers regardless of whether they itemize. These include contributions to traditional IRAs, student loan interest, and health savings account contributions.

Itemized deductions are subtracted from AGI and include state and local taxes (subject to the $10,000 SALT cap), mortgage interest, charitable contributions, and medical expenses exceeding 7.5% of AGI. The standard deduction provides a fixed reduction in taxable income for taxpayers who do not itemize. The Tax Cuts and Jobs Act of 2017 significantly increased the standard deduction, reducing the number of taxpayers who itemize.

Tax Credits

Tax credits reduce tax liability dollar-for-dollar and are more valuable than deductions of the same amount. Nonrefundable credits may reduce tax liability to zero but cannot generate a refund. Refundable credits may generate a refund even when the credit exceeds the taxpayer’s liability.

Major tax credits include the Child Tax Credit (§ 24), the Earned Income Tax Credit (EITC) (§ 32) —a refundable credit for low- and moderate-income workers —the American Opportunity Tax Credit (§ 25A) for education expenses, and the Premium Tax Credit (§ 36B) for health insurance purchased through the marketplace.

Tax Rates and the AMT

The federal income tax uses progressive marginal tax rates. For 2026, the rates for individuals are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The rates apply to taxable income brackets that are indexed for inflation. Long-term capital gains and qualified dividends are taxed at preferential rates of 0%, 15%, or 20%.

The Alternative Minimum Tax (AMT) is a parallel tax system that ensures that taxpayers with high income pay a minimum amount of tax. The AMT adds back certain tax preference items to regular taxable income and applies a flat rate (26% or 28%) to the resulting alternative minimum taxable income. The Tax Cuts and Jobs Act increased the AMT exemption amount, reducing the number of taxpayers subject to the AMT.

Conclusion

The federal income tax is a progressive tax on realized income, with deductions, credits, and preferential rates for capital gains. The broad definition of gross income, the system of deductions and credits, and the progressive rate structure define the basic framework. The AMT serves as a backstop to ensure minimum tax liability for high-income taxpayers.