An individual income tax, also called a personal income tax, is a tax on a person's income. Income includes wages, salaries, and other earnings from one's occupation; interest earned by savings accounts and certain types of bonds; rents (earnings from rented properties); royalties earned on sales of patented or copyrighted items, such as inventions and books; and dividends from stock. Income also includes capital gains, which are profits from the sale of stock, real estate, or other investments whose value has increased over time.
The national governments of the United States, Canada, and many other countries require citizens to file an individual income tax return each year. Each taxpayer must compute his or her tax liability-the amount of money he or she owes the government. This computation involves four major steps. (1) The taxpayer computes adjusted gross income-one's income from all taxable sources minus certain expenses incurred in earning that income. (2) The taxpayer converts adjusted gross income to taxable income-the amount of income subject to tax-by subtracting various amounts called exemptions and deductions. Some deductions exist to enhance the fairness of the tax system. For example, the U.S. government permits a deduction for extraordinarily high medical expenses. Other deductions are allowed to encourage certain kinds of behavior. For example, some governments permit deductions of charitable contributions as an incentive for individuals to give money to worthy causes. (3) The taxpayer calculates the amount of tax due by consulting a tax table, which shows the exact amount of tax due for most levels of taxable income. People with very high incomes consult a rate schedule, a list of tax rates for different ranges of taxable income, to compute the amount of tax due. (4) The taxpayer subtracts taxes paid during the year and any allowable tax credits to arrive at final tax liability.
After computing the amount of tax due, the taxpayer must send this information to the government and enclose the amount due. In 1995 the average four-person family in the United States paid about 9.2 percent of its income in income taxes. Many taxpayers, rather than owing money, receive a refund from the government after filing a tax return, typically because they had too much tax withheld from their wages and salaries during the year. Low-income workers in the United States may also receive a refund because of the earned income tax credit, a federal-government subsidy for the working poor.
Income taxation enjoys widespread support because income is considered a good indicator of an individual's ability to pay. However, income taxes are hard to administer because measuring income is often difficult. For example, some people receive part of their income "in-kind"-in the form of goods and services rather than in cash. Farmers provide field hands with food, and corporations may give employees access to company cars and free parking spaces. If governments tax cash income but not in-kind compensation, then people can avoid taxation by taking a higher proportion of their income as in-kind compensation.
The Internal Revenue Service (IRS), an agency of the Department of the Treasury, administers the federal income tax in the United States. Canada Customs and Revenue Agency, which operates under the Minister of National Revenue, administers the tax in Canada. See Income Tax.