Boundless Economics

Taxes and Public Finance

Deploying and Measuring Taxes

How Taxes Work in the United States

Tax laws are passed by Congress and enforced by the Internal Revenue Service (IRS) at the federal level.

Learning Objectives

Discuss the United States taxation process and the legislature involved

Key Takeaways

Key Points

  • There are federal, state, and local taxes in the US.
  • Congress passes federal tax laws that are then interpreted and enforced by the IRS.
  • The US judicial system is employed to handle tax disputes by companies or individuals.

Key Terms

  • Congress: The two legislative bodies of the United States: the House of Representatives, and the Senate.
  • Internal Revenue Service: The United States government agency that collects taxes and enforces tax laws.

There are three levels of government in the United States: the federal government, state governments, and local governments. Each has its own authority to tax. For example, states can set their own sales and payroll taxes that apply only within the state. Similarly, local governments can impose a variety of taxes, such as property taxes. Since the taxation process varies on the state and local level, we will focus on the federal level.


IRS: The IRS is responsible for interpreting and enforcing tax legislation passed by Congress. The IRS taxes only realized returns, though financial reports must also include unrealized returns on the balance sheet.

Federal taxes are created by the US Congress, which passes laws mandating what is taxed and the amount of the tax. One of the most well-known taxes, the federal income tax, wasn't created until the passage of the 16th amendment in 1913 explicitly gave the US Congress the authority to tax income. Congress then takes the tax revenue and apportions it through its power to create and manage the federal budget.

Congress is not the body, however, that actually collects taxes. That duty is charged to the Internal Revenue Service (IRS), a part of the Department of the Treasury. The IRS is responsible for ensuring that companies and individuals pay the taxes they are legally obligated to.

The IRS also has some power in determining exactly how the tax laws passed by Congress are interpreted and enforced. For example, Congress may say that depreciation will be an allowable expense "in accordance with regulations to be established by the IRS. " This allows the IRS to articulate the conditions under which depreciation is considered an allowable expense. At the same time, the IRS must also interpret the laws passed by Congress to determine what the law was intended to mean for a given organization or individual.

As would be expected with any law or interpretation of a law by a government body, there are disputes. Disputes over tax rules are generally heard in the United States Tax Court before the tax is paid, or in a United States District Court or United States Court of Federal Claims after the tax is paid. Tax laws are treated like any other piece of legislation in that there is a judicial process for resolving disputes.

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