Understanding the intricacies of the United States tax system is crucial for citizens, residents, and non-resident aliens alike. With a focus on worldwide income, the US tax structure is multifaceted, involving various factors such as residency status, income sources, and connections to US trade or business. In this comprehensive guide, we’ll explore the key components of the US tax system, shedding light on how individuals are taxed and providing insights into critical considerations.

  1. Residency Status: Resident or Non-Resident

US citizens and residents, determined through tests like the “green card” or “substantial presence,” are subject to taxation on their worldwide income. However, a provision allows citizens or residents with a foreign tax home to exclude a portion of foreign earned income (up to $108,700 in 2021) from taxable income. This exclusion is a vital tool for those establishing financial ties abroad.

Conversely, non-resident aliens are taxed solely on their US source income, offering a simplified tax structure for individuals without substantial connections to the US.

  1. Source of Income

The US tax system distinguishes between various income sources, including compensation, interest, dividends, capital gains, rents, royalties, and more. This diversity necessitates a nuanced approach to taxation. Notably, the Internal Revenue Code defines gross income as “income from whatever source derived,” with specific exclusions and exemptions.

  1. Connected to US Trade or Business

Determining whether income is connected to US trade or business is a crucial factor. US citizens and residents are generally subject to individual income tax on worldwide taxable income. This includes income generated from US and foreign sources. However, certain deductions and exclusions can help mitigate the impact of this global taxation.

Tax Calculation Basics: Adjusted Gross Income (AGI) and Taxable Income

The calculation of an individual’s tax liability involves adjusting gross income (AGI) by subtracting “above-the-line” deductions. AGI serves as the starting point for determining taxable income, which is further reduced by standard deductions or itemized deductions.

2021 Standard Deduction Amounts

For the tax year 2021, standard deduction amounts vary based on filing status:

  • Single: $12,550
  • Married filing jointly and surviving spouses: $25,100
  • Married filing separately: $12,550
  • Head of household: $18,800

Understanding these deductions is crucial, as they directly impact an individual’s taxable income and, consequently, their overall tax liability.

Tax Liability in General and Alternative Minimum Tax (AMT)

Taxpayers face net income tax liability, which is the greater of regular individual income tax or tentative minimum tax reduced by applicable credits. The Alternative Minimum Tax (AMT) is a parallel system designed to prevent high-income taxpayers from evading income tax. It requires taxpayers to calculate their tax bill under both systems, paying the higher of the two.

2021 Federal Tax Brackets

Tax rates for 2021 vary based on filing status and income brackets. For example, single individuals face a 10% rate for income up to $9,950, rising to 37% for income exceeding $523,600. Similar brackets apply to heads of households and married individuals filing jointly or separately.

Navigating the Complexity: Considerations for Individuals

Understanding the US tax structure involves meticulous planning and consideration of various factors. For instance:

  • Foreign Tax Credits or Deductions: To avoid double taxation, individuals may elect to take a foreign tax credit or foreign tax deduction on taxes paid to foreign governments.
  • Itemized Deductions vs. Standard Deduction: Individuals must choose between itemized deductions and the standard deduction, selecting the option resulting in the lowest tax liability.
  • Exclusions and Exemptions: Leveraging exclusions, exemptions, and deductions is crucial for minimizing taxable income and optimizing tax outcomes.

Conclusion: Navigating the Terrain

The US tax structure is a labyrinth of rules and regulations that require careful navigation. For individuals, understanding residency status, income sources, and tax implications is paramount. Leveraging deductions, exclusions, and credits can significantly impact overall tax liability. Whether a US citizen, resident, or non-resident alien, staying informed about the ever-evolving tax landscape is essential for financial planning and compliance. As tax laws continue to evolve, seeking professional guidance is advisable to ensure adherence to regulations and optimal financial outcomes.