History of the Income Tax in the United States

The nation had few taxes in its early history. From 1791 to 1802, the United States government was supported by internal taxes on distilled spirits, carriages, refined sugar, tobacco and snuff, property sold at auction, corporate bonds, and slaves. The high cost of the War of 1812 brought about the nation's first sales taxes on gold, silverware, jewelry, and watches. In 1817, however, Congress did away with all internal taxes, relying on tariffs on imported goods to provide sufficient funds for running the government.

In 1862, in order to support the Civil War effort, Congress enacted the nation's first income tax law. It was a forerunner of our modern income tax in that it was based on the principles of graduated, or progressive, taxation and of withholding income at the source. During the Civil War, a person earning from $600 to $10,000 per year paid tax at the rate of 3%. Those with incomes of more than $10,000 paid taxes at a higher rate. Additional sales and excise taxes were added, and an “inheritance” tax also made its debut. In 1866, internal revenue collections reached their highest point in the nation's 90-year history—more than $310 million, an amount not reached again until 1911.

The Act of 1862 established the office of Commissioner of Internal Revenue. The Commissioner was given the power to assess, levy, and collect taxes, and the right to enforce the tax laws through seizure of property and income and through prosecution. The powers and authority remain very much the same today.

In 1868, Congress again focused its taxation efforts on tobacco and distilled spirits and eliminated the income tax in 1872. It had a short-lived revival in 1894 and 1895. In the latter year, the U.S. Supreme Court decided that the income tax was unconstitutional because it was not apportioned among the states in conformity with the Constitution.

In 1913, the 16th Amendment to the Constitution made the income tax a permanent fixture in the U.S. tax system. The amendment gave Congress legal authority to tax income and resulted in a revenue law that taxed incomes of both individuals and corporations. In fiscal year 1918, annual internal revenue collections for the first time passed the billion-dollar mark, rising to $5.4 billion by 1920. With the advent of World War II, employment increased, as did tax collections—to $7.3 billion. The withholding tax on wages was introduced in 1943 and was instrumental in increasing the number of taxpayers to 60 million and tax collections to $43 billion by 1945.

In 1981, Congress enacted the largest tax cut in U.S. history, approximately $750 billion over six years. The tax reduction, however, was partially offset by two tax acts, in 1982 and 1984, that attempted to raise approximately $265 billion.

On Oct. 22, 1986, President Reagan signed into law the Tax Reform Act of 1986, one of the most far-reaching reforms of the United States tax system since the adoption of the income tax. The top tax rate on individual income was lowered from 50% to 28%, the lowest it had been since 1916. Tax preferences were eliminated to make up most of the revenue. In an attempt to remain revenue neutral, the act called for a $120 billion increase in business taxation and a corresponding decrease in individual taxation over a five-year period.

Following what seemed to be a yearly tradition of new tax acts that began in 1986, the Revenue Reconciliation Act of 1990 was signed into law on Nov. 5, 1990. As with the '87, '88, and '89 acts, the 1990 act, while providing a number of substantive provisions, was small in comparison with the 1986 act. The emphasis of the 1990 act was increased taxes on the wealthy.

On Aug. 10, 1993, President Clinton signed the Revenue Reconciliation Act of 1993 into law. The act's purpose was to reduce by approximately $496 billion the federal deficit that would otherwise accumulate in fiscal years 1994 through 1998. In 1997, Clinton signed another tax act. The act, which cut taxes by $152 billion, included a cut in capital-gains tax for individuals, a $500 per child tax credit, and tax incentives for education.

President George W. Bush signed a series of tax cuts into law. The largest was the Economic Growth and Tax Relief Reconciliation Act of 2001. It was estimated to save taxpayers $1.3 trillion over ten years, making it the third largest tax cut since World War II. The Bush tax cut created a new lowest rate, 10% for the first several thousand dollars earned. It also established a slow schedule of incremental tax cuts that would eventually double the child tax credit from $500 to $1,000, adjust brackets so that middle-income couples owed the same tax as comparable singles, cut the top four tax rates (28% to 25%; 31% to 28%; 36% to 33%; and 39.6% to 35%).

The Jobs and Growth Tax Relief and Reconciliation Act of 2003 accelerated the tax rate cuts that had been enacted in 2001, and temporarily reduced the tax rate on capital gains and dividends to 15%. In 2004, the U.S. was forced to eliminate a corporate tax provision that had been ruled illegal by the World Trade Organization. Along with that tax hike, Congress passed a cornucopia of tax breaks, which for individuals included an option to deduct the payment of whichever state taxes were higher, sales or income taxes.

Two tax bills signed in 2005 and 2006 extended through 2010 the favorable rates on capital gains and dividends that had been enacted in 2003, raised the exemption levels for the Alternative Minimum Tax, and enacted new tax incentives designed to persuade individuals to save more for retirement.
 

The sooner you get your money back from the IRS, the better, so start now. Get your taxes done faster and more accurately with these seven strategies from Jeff Schnepper, author of the best-selling "How to Pay Zero Taxes" and a tax expert for MSN Money.

1. Get started

The first step is the hardest. Stop thinking about it and get moving. Until you actually start your return, you'll never get to finish it.

If you don't have all your numbers, just put your name and address on the form. It will get you in the mindset to move forward. Your first step is to break the inertia.

2. Accumulate the data

By the end of January, make sure you've gotten W-2s and any statements from your brokers and banks. You'll receive 1099 Forms for any interest, dividends, and sales of stock. Your mortgage company will send you a Form 1098 for any interest and real-estate taxes paid. Get those statements together and review the numbers. They're not always right.

3. Put the numbers in IRS categories

Neither the IRS nor your CPA is going to add up those numbers for you.

You're going to want to have totals for the income and deduction categories the IRS provides. You'll need that final "number" if you're doing your own return, whether by hand or by computer. If you're having your return prepared, you'll want to give that number to your CPA to minimize his or her bill.

A good way to get organized is to use the "envelope" system. Create an envelope for each of the IRS income/deduction categories. There'll be an envelope for medical expenses, charitable contributions, job expenses, interest paid, etc. Find all the receipts, all the checks, all the invoices and put them in the appropriate envelope.

You can use this simple system all year. Throw all of your receipts into a file or even a shoebox. When you reconcile your checking account, on a monthly or at least a quarterly basis, you break down the checks and receipts according to the categories you selected.

By the end of January, you should have had all your checks and receipts broken down in each envelope by deduction category. You add up the receipts and checks (don't double count!), and that's the number you use on your return or give to your preparer.

That's how much you've spent in each deduction category. And, with this system, you never have to fear an audit.

An audit is nothing more than the IRS asking you to prove the numbers you put on your return. You've already done that. Just hand over the deduction-category envelope with the receipts and checks. After a series of matches, it's going to be a quick audit.

4. Analyze the numbers

Sometimes, the raw data you have is going to be wrong.

On the income side, you're required to report any and all interest and dividends received, even if you don't receive a Form 1099.

You'll have to match up the sales of stock with the cost of those shares. The number shown by your broker on Form 1099 B is only the sale price. You're not taxed on 100 percent of that number. You reduce it, on Schedule D of your return, by your cost, including broker's fees. You're only taxed on the net profit. (To automatically generate a Schedule D based on your investments, visit MSN Money at money.msn.com and check out the GainsKeeper service).

If you don't sell 100 percent of your position, you'll have to allocate your costs on a per-share basis.

On the deduction side, you may have deductions not reflected by the raw data. Say you made your Jan.1, 2004, mortgage payment on Dec. 31, 2003. The interest you paid won't be reflected on the Form 1098 sent by your mortgage company. That's because they didn't get the check until 2004.

But it's a 2003 deduction, and you should run an amortization schedule to compute the additional interest. That additional interest would be shown on line 11 of your Schedule A.

5. Call your accountant

If you're going to have your return professionally prepared, call your accountant now for an appointment.

Just make sure you've got the numbers in order when you show up. Your wallet will appreciate it.

6. Put ink to paper

Or, at least open the tax program on your computer. You've got your numbers. If you're doing your own return, put ink to paper. Go to your quiet place and actually do your return.

You've done the real work. Now you're just putting numbers in boxes. Relax; this is really the easy part.

7. Mail your return

A completed return on your desk that calls for a refund is the IRS's idea of heaven. It's your money. Don't leave it with the IRS. It's bad enough that they've held it all year without paying you any interest on your excess payment. Don't compound the pain by delaying the mailing.

Of course, the best way to speed up your return is to e-file -- available at Web sites such as MSN Money. The IRS appreciates the cost savings and claims it expedites your refund.

Electing a direct deposit of your refund will always get it into your hands faster than snail mail. More than 41 million taxpayers used direct deposit for their 2002 refunds, up from 39 million a year earlier.

Complete lines 70(b), (c), and (d) of your Form 1040, and, coupled with an e-filed return, in theory you could have your refund in your bank account in as little as 24 hours.

Alternately, the IRS now has a new refund assistance line, (800) 829-1954. It also has a new Web tool called "Where's My Refund?" that can tell you whether the IRS received your return and whether your refund was processed and sent to you

YORK (MONEY Magazine) - When you gather up your W-2s, 1099s and crumpled receipts to figure out your taxes this time of year, you're probably hoping for some shreds of good news. How's this: Because April 15 falls on a Saturday in 2006, you have two extra days to file. Okay, enough already. You get the picture. The best tax news you can get this year is the good news you make for yourself, by avoiding costly mistakes and unearthing the many opportunities to save money that are buried in your return. Follow our guide to find them -- and make sending less to the IRS the nicest news of all.

1. Embrace your computer

Why file electronically? How about a refund within two weeks and fewer errors? Your tax preparer can e-file for you (and likely will). If you're a do-it-yourselfer, you need to do your taxes with software or online.

Software Popular programs like TurboTax (turbotax.com), TaxAct (taxact.com) and H&R Block's TaxCut (taxcut.com) all support e-filing. Using them on the Web often costs less than buying the software.

You'll pay less than $10 for an easy federal return, or as much as $70 for a complex state and federal one, including e-filing.

Free file The IRS has partnered with a few dozen commercial preparers to offer free online tax prep as well as e-filing (go to irs.gov). The program is limited to those with an adjusted gross income (AGI) of $50,000 or less. To find out if your state has free online filing, check the list at taxadmin.org. Plus, there are 22 states with free online tax prep.

2. Retirees: Save money and save

You still have time to plump up your nest egg. The IRA limit for 2005 is $1,000 higher than it was in '04.

If you qualify for a deduction (income limits apply), funding an IRA will lower your tax bill. You can make Roth or traditional IRA deposits as late as April 17.

3. Hurricane relief for all

After the devastating fall hurricanes, Congress passed a tax bill that benefits those who live in the affected areas -- and all Americans who helped.

For hurricane victims only You can fully deduct your casualty losses, which normally must exceed 10 percent of your AGI and $100 per loss to qualify. You can also make penalty-free IRA withdrawals, and you have more time -- three years -- to pay tax on the earnings.

For everyone Hurricane volunteers who drove can deduct 34 cents a mile (vs. the typical 14 cents); if you housed victims for at least 60 days in a row, you can deduct $500 per person (four-person max); and gifts made to any charity after Aug. 28, 2005 are fully deductible, even if they exceed 50 percent of your AGI.

4. Kids count more than you think

What's a child? Any parent would consider that an easy question. Now the IRS thinks so too. This year there's finally a single (but still technical) definition of who qualifies as a child on your tax return.

Even if the new rule doesn't affect you -- it could if you're divorced, for instance, or the parent of an adopted child -- all the old benefits of parenthood still apply.

Child tax credit You can take the full $1,000 credit for a child under age 17 as long as your AGI is under $110,000 for a married couple or $75,000 for a single parent.

Child- and dependent-care credit If you pay someone to watch children under age 13 -- at home, in day care, at camp -- you may qualify. This credit is for as much as 35 percent of $3,000 in such costs, or $6,000 for two or more kids, making it worth up to $1,050 for one kid, $2,100 for two or more.

Sleepaway camp, alas, is seen as a luxury by the IRS (if not by some parents), so those fees don't qualify.

5. Help with college costs

If you have a student in college, a valuable tax perk is scheduled to disappear after this year: the ability to deduct up to $4,000 in tuition and fees.

To qualify for the entire deduction, your AGI can't exceed $130,000 if you're married, $65,000 if you're single. You can take a partial deduction with an AGI up to $160,000 (for married couples) or $80,000 (singles).

Fortunately, two potentially more precious breaks will stick around, and higher-income cutoffs this year increase the chance that you'll qualify for them. You can use the HOPE credit to recoup up to $1,500 in tuition during the first two years of college (a credit reduces your tax bill dollar for dollar); the lifetime learning credit is worth as much as $2,000 during college or graduate school (up to 20 percent of $10,000 in costs).

You cannot take both credits in the same year for the same student. You don't qualify for the full credits when your AGI hits $87,000 if you're married, $43,000 if single. You lose them entirely when your AGI hits $107,000 ($53,000 for singles).

6. When the sales tax pays

Also due to expire: the option to write off either your state and local income or sales tax. Use the IRS tables to figure your deduction (Publication 600, available at irs.gov).

If you bought a car, boat or plane last year,you can add the tax you paid to the IRS figure.

7. Profit from self-improvement

Think how much you spend trying to stay healthy, not to mention getting well once you're sick. If a sounder mind and body aren't reward enough, see if your good intentions can win you a break on your taxes too.

Qualified medical costs that exceed 7.5 percent of your AGI are deductible. That's a high hurdle, but consider what could put you over the top: prescribed weight-loss programs, stop-smoking classes, acupuncture, chiropractic care, therapy, braces, eyeglasses and lead-paint removal if you have a kid at home. See IRS Publication 502 for a full list.

8. Missing a write-off is like donating money to Uncle Sam. Don't overlook these.

Leftover losses Each year you can offset investment gains with losses. If your losers add up to more than your winners, you can deduct up to $3,000 from your regular income and carry forward the rest. Pull out last year's return and look for capital losses that you couldn't use.

Too much tax If you switched jobs last year, you might have had too much Social Security tax withheld. Check your W-2s. If more than $5,580 was docked from your paychecks, claim a credit for the overpayment.

Miscellany Certain costs that top 2 percent of your AGI are deductible. That includes what you pay to manage your money: safe-deposit box fees, calls to your broker, tax-prep fees and subscriptions to investment journals.

Old college costs It's easy to think that only mortgage interest is deductible. Not so. Student loan interest is deductible, even if you don't itemize.

9. New loan? Deduct this.

Last year was the third busiest ever for home loans. If you bought, borrowed or refinanced, don't forget to deduct your origination fees and discount points. When you refinance, you must spread the deduction over the life of the loan; on a second refi, though, you can deduct all remaining points from the first.

10. Home work, not homework

Work at home and you may be able to write off your home office. Tread carefully. This deduction is not only one of the trickiest breaks around, it's also one that could get you audited.

The rules For starters, your home office must be your principal place of business, not a backup for the cubicle your boss provides, and you generally can't use the room for anything else. So it can't be half TV room, half office. It's all office, all the time.

The math To calculate the size of the deduction, first determine what percentage of your home your office takes up -- by square footage or number of rooms. Apply that percentage to your housing costs (including mortgage interest, utilities and upkeep) to arrive at your deduction.

The downside What makes this deduction such a gold mine is that every year you can also write off a portion of what you paid for your house. But when you sell, all that depreciation is treated as a taxable gain.

Bonus: What's new

Two more months to do your taxes, a way to preview your AMT, and help with higher gas prices

More time to file Can't finish by April 17? Previously, you could automatically get four more months -- until smack in the middle of your August beach vacation. This year the IRS extended the extension to six months. File Form 4868 by mail or at irs.gov/efile.

Stingier rules for car gifts As of 2005, if a charity sells the car you donate (as most do), you can deduct only the proceeds from the sale, not the full fair market value.

An AMT fast forecaster An estimated 4 million taxpayers will owe the alternative minimum tax this year, so the least the IRS can do is help you find out if you're one of them. Its new AMT Assistant is a boon if you do taxes by hand -- the agency estimates that the calculator will take five to 10 minutes vs. an hour or more for the paper worksheet. Find it at apps.irs.gov/app/amt.

Gas relief If you drive your car for business, you're hurting at the gas pump. The IRS, it appears, feels your pain. It raised the standard mileage deduction from 40.5 cents to 48.5 cents a mile as of Sept. 1. For 2006, it'll be 44.5 cents.

Made out in the U.S.A.? Do you run a business that makes widgets, builds homes or develops software on these shores? Then you'll love the new domestic-production deduction: It's worth up to 3 percent of your net income.