All You Need To Know About Types of Taxes and How They Work
Taxes are mandatory contributions individuals are required to pay to a regional, state, or national governing authority. These taxes are used to finance government programs, buildings, and services. 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.
In the United States, the general public is the biggest group of people affected and burdened by these contributional expenses. The tax collected is used for the betterment and improvement of the economy, and the various government resources residents have the ability to utilize. Taxes are often applied to income received by the taxpayer. This income can come from a salary or hourly wage, investment dividends or interest, and other payments from goods or services. Failure to make payments on taxes levied by the government is illegal and can be punishable by law.
Types of Taxes and How They Work
Taxes can vary widely among nations; however, the tax system in the United States has alot of nuances and regulations individuals and corporations need to study and understand before reporting their income. Like most countries, the United States has income tax which means that a percentage of generated income is sent and relinquished to a state or federal government. This tax is under a progressive system, meaning that high-income earners and corporations are taxed at higher percentages than low-income individuals and corporate earners. This tax is applied through a marginal tax rate determined by an individual’s income level. This income level also determines an individual’s tax bracket, which establishes the tax rate percentage they fall under and must compensate the government. Larger shares of income from high-income individuals and families go to tax 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).
A variety of factors can affect the marginal tax rate that an individual would have to pay to the government. Factors such as filing status, married filing jointly, married filing separately, single, or head of household can make a significant difference in how much they are taxed. Including dependents on an individual’s tax forms or individuals that are under the care of the head of household can also affect the amount a taxpayer would owe to the government. Specific professionals like accountants or tax planners can help individuals or families limit or lessen the required amount of tax needed to satisfy governmental requirements.
Capital Gains Tax
Capital gains taxes are particular taxes that affect the profit generated from an investment. This tax is applied to assets that have been sold but have increased in value since their purchase. The specific rate of taxation depends on the length of time the asset was held before its sale. Short-term capital gains tax is applied to assets that were held for a year or less and are taxed heavily at the asset holder’s ordinary income tax rate. Long-term capital gains tax, on the other hand, is applied to assets that were held for longer than a year and are taxed at a much lower rate. Tax records should be maintained and updated in order to provide evidence of the length of ownership. The reason for this capital gains tax system is to encourage a high level of capital investment. Investment funds that stay in the market without being withdrawn for personal benefit can aid in preserving the growth and strength of an economy.
Payroll tax is a specialized form of tax that is withheld from an employee’s paycheck by an employer. The purpose of this tax is to solely fund the Medicare and Social Security governmental programs. While income taxes are also similarly withheld from an employee’s paycheck, the tax differs from the payroll tax due to its vast area of funding. In the United States, the standard payroll taxes are a 12.4% Social Security tax and a 2.9 % Medicare tax for a combined rate of 15.3%. Roughly half of all payroll taxes are paid by employers. Lower-wage employees mainly take on the economic burden of payroll taxes.
Corporate and Gross Receipts Tax
Corporate taxes are taxes paid by companies from their taxable income. This tax is taken by the federal or state government from profits earned by the corporation. 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 Corporations, S Corporations, and Limited Liability Companies (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.
Gross receipts tax is a similar tax applied to a corporation’s gross sales. Because this tax is based on sales and not income, the tax is applied regardless of profits and without deductions from business expenses that could otherwise be tax-exempt. This differentiates this tax from other forms of corporate taxation that are based on profits or net income.
Sales and Excise Tax
Sales tax is a common tax charged when a commercial sale of a good or service is processed. The business collects the sales tax from the consumer at an additional charge and then remits it to the government. Each state has its own sales tax laws. In 2022 the highest average sales tax was reported in the state of Tennessee at 9.55%, while five U.S states: Alaska, Montana, New Hampshire, Delaware, and Oregon, did not have a state sales tax.
Excise Taxes, on the other hand, 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.
Another common tax throughout the United States is property tax. This tax is applied to the value of an individual’s real estate, which is assessed and determined by a property assessor appointed by the local government. 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 Tax
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.
Why are Taxes Important?
Taxes are important because they foster economic growth and help with the development of governmental, social, and public programs. These taxes are used as an investment into these programs that provide immense public benefits to United States residents. These benefits include health, infrastructure, education, and other services important in a prosperous functional society. These programs cannot be solely funded by the government and need additional revenue in order to operate. Taxes also acts as a social contract between its citizens and the economy. Taxes help hold government officials accountable in their administration of funds and tax revenues, making sure that proper financial management is in place and that the taxes are not being misused. Without taxes, the U.S government would not be able to meet the demands that U.S residents uphold from their government.
Who Can Help with Taxes
Filing one’s own taxes can be a struggle, especially with complexities involving property ownership. In order to save one’s time and stress, hiring a tax manager, tax accountant, or tax planner can help to make sure one’s taxes are filed correctly with the IRS. Tax professionals ensure that taxes are filed on time and accurately by conducting all of the tax producures regulated by the IRS. These professionals can also help lower the tax amount owed to the government by reviewing discrepancies in one’s finance and adjust them accordingly. This helps in preventing excessive loss and financial risks associated with tax planning, often not found when individuals file their own taxes.
Helping you achieve your evolving financial objectives
- National Archives. “Records of the Internal Revenue Service [IRS]”. Accessible From: https://www.archives.gov/research/guide-fed-records/groups/058.html
- Internal Revenue Service. “Historical Highlights of the IRS.”. Accessed July 15, 2021. Accessible From: https://www.irs.gov/newsroom/historical-highlights-of-the-irs
- World Population Review. “Highest Taxed Countries 2022”. Accessed July 15, 2021. Accessible From: https://worldpopulationreview.com/country-rankings/highest-taxed-countries