All You Need to Know About Different Types and Classes of Taxation
Taxation is an essential part of a country’s economy and is the driving force behind the economic decisions of nearly all nations in the world. Particularly in the United States, taxation is a very crucial element that keeps many governmental programs and systems in place like Medicaid, Social Security, Welfare programs, Subsidized Housing, and many more. With the general public being the biggest group of people affected by these contributional expenses, it is vital for them to understand the different types of taxes they are paying on a daily, monthly, or yearly basis and their various classifications.
When looking at the U.S tax system, one can see various forms of taxes with varying degrees of effectiveness. Daily taxes, like sales tax, affect individuals on a daily basis but don’t have the most significant impact on one’s finances. Yearly taxes, like income tax and state tax, have a much larger impact on an individual’s overall expenses and need to be analyzed carefully so that one could adequately prepare to soften the burden the contribution may take on.
Progressive, Proportional, and Regressive
The United States tax system can be summarized under three categories: regressive, proportional, and progressive. Proportional taxes affect all individuals in the same way with a flat tax that is proportional to the income an individual earns. Progressive taxes have a more significant impact on high-net-worth individuals, while regressive taxes affect lower-income individuals the greatest. The United States mainly operates under a progressive system where a person’s tax situation is based on the level of income they can provide. The higher the income of an individual, the higher the tax bracket they are in, and the more taxes they pay to the government. Income tax falls under this category. Regressive taxation is also a fairly common taxation method in the United States. Items taxed under regressive taxation include property tax, sales tax on goods, and excise tax on items like gasoline and airfare. Many also consider Social Security tax to be regressive as well.
Taxes can be divided into three types: taxes on earnings, taxes on purchases, and taxes on ownership. These three types of taxes are all unique and have various rules and regulations surrounding them. One of the main differences can be seen in the point of collection, or the moment in which you pay the tax, and the amount that is required to be paid. This determines if the tax is regressive, progressive, or proportional and which group of people they benefit based on their socioeconomic status and income level. Below is an overview of the different types and classifications of taxes and how they work.
Individual Income Tax
Individual Income Tax, or personal income tax, is a prevalent form of tax levied on salaries, wages, investments, or other forms of income an individual or household earns. This is a widespread “progressive tax,” meaning that the tax rate increases as a taxpayer’s income increases. This results in larger shares of income going to tax from high-income individuals and families rather than low-income earners. The U.S, for example, levies tax rates from 10 to 37 percent that activate at various income thresholds outlined by the Internal Revenue Service (IRS). These income thresholds, or income ranges, are known as tax brackets, and income that falls within each tax bracket is taxed at its corresponding rate, which is also outlined by the IRS.
Corporate Income Tax
Corporate Income tax is taken by the federal or state government from business income, specifically profits. This income applies to revenue after all costs have been covered. Different tax regulations and rules apply to various business organizations. In the United States, a business can fall under Partnerships, Sole Proprietorship, C Corporation, S Corporation, and Limited Liability Company (LLC). C Corporations pay corporate income tax. While liability does not fall under any individual owners, the burden of the tax falls not only on the business but also on its consumers and employees through lower wages and higher prices. Owners can also be double taxed, where their corporation will get taxed, and any profits they personally receive and pocket can also get double taxed. Due to adverse economic effects, most countries have shifted to taxing their corporations at rates lower than 30 percent. The United States, for example, has lowered its federal corporate income tax rate to 21 percent. On the other hand, S Corporations, LLCs, sole proprietorships, and partnerships all pass their income and profits through their owner’s income tax returns and pay individual income tax.
Payroll taxes are taxes paid on employee wages and salaries to finance various social insurance programs. In the United States, the standard payroll taxes are a 12.4 Social Security tax and a 2.9 percent Medicare tax for a combined rate of 15.3 percent. Roughly half of all payroll taxes are paid by employers. Lower-wage employees mainly take on the economic burden of payroll taxes.
Capital Gains Tax
Capital assets are usually everything an individual owns for personal purposes, entertainment, or investment value. These assets include stocks, bonds, properties, vehicles, jewelry, art, and more. Whenever these assets increase in value, the difference is called a “capital gain.” When an individual sells an asset and “realizes” those capital gains (receives a profit increase from the purchase and sale of the asset), they are required to pay capital gains tax on the profit they earned.
Sales Tax is a common form of tax seen every day through the sale of goods and services. This form of tax can be found on the receipt at every store and restaurant in the United States. The United States is still one of the few industrialized, first-world countries that still rely on traditional retail sales taxes. This tax is a significant source of value for state governmental revenue.
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Gross Receipts Tax
Gross receipts taxes are applied to a company’s gross sales. This tax is applied regardless of profitability and without deductions for business expenses that could be tax-exempt. This differentiates this tax from other forms of taxation that are based on profits or net income. This tax can often be felt by the consumer as businesses have to raise the prices of goods and services to be able to afford to contribute to this tax and still keep a profit. This tax can hurt companies with long production cycles because the tax is imposed at each stage in the production chain. Because early-stage startups often face losses in their early years, they are often not taxed based on profits. However, taxes like the gross receipts tax can be quite harmful. This is because they do not look at profits but instead look at sales to determine the amount of taxes needed for contribution. Despite being dismissed for decades as an inefficient tax policy, policymakers have recently begun considering GRTs again as they seek new revenue streams.
Value-added Tax is a consumption-based tax that looks at the value added in each stage of the production cycle of a good or service. This tax is deducted from each business along the production chain of a particular product or service. If the value is added to a product or service along the chain, then it is added to the tax. The final consumer pays the tax making it a tax that is paid on the final consumption of the product or service. This avoids tax pyramiding which is when the final good or service is taxed multiple times during the production process. More than 140 countries levy this tax, including all OECD countries besides the United States. This makes it a significant revenue source for most of the world and one of the most common global taxes.
Excise Taxes are imposed on specific goods or services. This tax often supplements a broad consumption tax and is relatively small compared to other taxes. Everyday items that are taxed in this manner are cigarettes, soda, alcohol, gasoline, and gambling/betting. Often known as “sin” taxes, these taxes are often put in place to discourage people from using certain unhealthy products and to reduce their consumption. As for gas, many governments employ this tax as the “price” of using public roads. The effect is to reduce traffic congestion, automotive pollution, and road wear-and-tear.
Property Taxes and Tangible Personal Property Taxes
Property taxes are primarily levied for physical property like land and buildings. This is the primary source of tax revenue for most state and local governments in the United States. Property taxes in the United States account for over 30 percent of total state tax collections and over 70% of local tax collections. These taxes help fund public services like school districts, police and fire departments, public roads, and emergency medical services. While these taxes are considered “real” property taxes, many states also issue “tangible personal property” taxes which can be deducted from vehicles and equipment owned by individuals and businesses. Real property taxes are relatively neutral, stable, and transparent. In contrast, tangible personal property taxes are more problematic, complex, and make up a much smaller share of total state and local tax collections.
Estate and Inheritance Taxes
Estate and Inheritance taxes are deducted from the value of an individual’s property at the time of their death. Estate taxes are paid by the estate itself, while inheritances taxes are paid by those who inherit property. Both taxes are designated as “gift taxes,” meaning they cannot be avoided even when transferring property prior to death. Estate and inheritance tax has come under controversy in recent years due to the poor economic policy surrounding the tax. Due to the high deductible and contribution, estate and inheritance tax often discourage high-net-worth investors from investing in certain assets with the fear of profits getting minimized due to the tax. Because of this, estate and inheritance taxes are very complex, hard to administer, and can incentivize high-net-worth individuals to leave a state or country altogether.
Income taxes can be both proportional and progressive. Progressive taxes impose low tax rates for low-income earners and higher tax rates on high-income earners, while individuals are charged the same tax rate regardless of how much income they earn.
Regressive taxes can be controversial. They may seem fair from the outside because they are imposed on everyone regardless of income. However, they often hurt low-income earners more than high-income earners to do the proportion of income taxed. A larger portion of income is taxed for low-income earners than those with high-income for regressive tax.
The primary function of the tax system is to fund government expenditures. Many United States government programs are funded solely by certain taxes. These programs include Medicaid, Social Security, Welfare programs, Subsidized Housing, and many more. Without taxes, the U.S. government would not be able to afford to keep running these programs, which help many individuals in need. Taxes also fund and support many other public services like school districts, police and fire departments, public roads, and emergency medical services.
A minimum failure-to-file penalty will be added to your account if you file a tax return more than 60 days late. The failure-to-pay penalty is 0.5% of your balance due for each month (or part of a month) in which your taxes remain unpaid. You will be charged up to a maximum of 25 percent of the amount still owed. This penalty is included on top of the already due amount required to satisfy the taxed amount.
The minimum amount for a single filing status (non-married) if under age 65 is $12,550. If your income is below that threshold, you generally do not need to file a federal tax return.
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