Alex GoodmanTaxes are mandatory contributions levied on individuals or businesses by a government entity, whether local, regional, or national. Tax money pays for public works and services like roads and schools, as well as government programs like Social Security and Medicare.
In economics, taxes fall on whoever pays the burden of the tax, whether it is the entity being taxed, such as a business, or the ultimate consumers of the business’s goods. From an accounting standpoint, there are several taxes to consider, such as payroll taxes, federal and state income taxes, and sales taxes.
In a Nutshell
- Taxes are required payments made by people or companies to the government.
- Public projects, services, and government initiatives like Social Security and Medicare are paid for by taxes.
- In the US, taxes are collected on a taxpayer’s earnings in a variety of ways, including dividends, capital gains, wage income, and so on.
- The U.S. has a progressive tax system for income taxes, which implies that those with higher incomes pay more in taxes than those with lower incomes.
- Profits from the sale of an asset with an enhanced value are subject to capital gains taxes in the United States.
- Payroll taxes are deducted from employees’ paychecks in the US and are used to fund the Medicare and Social Security programs.
- There are many different forms of taxes, including estate tax, corporate income tax, payroll tax, sales tax, and payroll tax for businesses.
- Before conducting business or generating money in a new country, it is crucial to understand the tax regulations there because tax systems vary from one nation to the next.
- In the United States, state and local governments generally levy sales and income taxes, but the federal government also collects payroll, corporation, and income taxes.
Understanding Taxes
To help finance public works and services, and to build and maintain the infrastructure used in a country, a government typically levies taxes on its individual residents and businesses. The taxes collected are used to improve the economy and everyone who lives in it.
In the United States and many other countries around the world, income taxes are levied on some type of money received by a taxpayer. This can include wage income, capital gains from investments, dividends or interest received as extra income, payments for goods and services, and so on. Tax revenues are used for public services and government operations, as well as for Social Security and Medicare. As the baby boom generation has gotten older, Social Security and Medicare have used more and more of the tax money that the government gets. Throughout U.S. history, tax policy has been a constant source of political debate.
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A tax requires that a percentage of the taxpayer’s income or money be collected and remitted to the government. Payment of taxes at the rates set by the government is mandatory, and tax evasion the deliberate failure to pay the full amount of tax liability is punishable by law. (On the other hand, tax avoidance actions taken to reduce tax liability and maximize after tax income is perfectly legal). Most governments use an agency or department to collect taxes. In the United States, this job is done by the Internal Revenue Service (IRS) at the federal level.
Tax Rates
There are several common types of taxes:
- Income tax Percentage of income generated that is ceded to the state or federal government
- Payroll tax Percentage withheld from an employee’s pay by an employer, which pays it to the government on the employee’s behalf to fund Medicare and Social Security programs
- Corporate income tax Percentage of corporate profits that the government takes as tax to fund federal programs
- Sales tax Tax imposed on certain goods and services; varies by jurisdiction
- Property tax Based on the value of land and real estate assets
- Tariff Tax on imported goods; imposed for the purpose of strengthening domestic businesses
- Equity tax Tax applied to the fair market value (FMV) of assets in an individual’s estate at the time of death; total estate must exceed thresholds set by the state and federal governments.
Tax systems vary widely from country to country, and it is important for individuals and companies to carefully study the tax laws of a new country before earning income or doing business there.
We will now examine various tax situations in the United States. Generally speaking, the federal government collects income, corporate and payroll taxes; the state collects income and sales taxes; and municipalities or other local governments collect primarily property taxes.
Income Tax
Like many other countries, the United States has a progressive income tax system. This means that more money is taken in from people and businesses with high incomes than from people with low incomes. Taxes are levied at marginal tax rates.
There are several factors that influence the marginal tax rate a taxpayer will pay, such as marital status (married filing a joint return, married filing a separate return, single, or head of household). The type of return can significantly influence the amount of tax. The source of the taxpayer’s income also influences taxation. It is important to learn the terminology of the different types of income that can affect how income is taxed.
Capital gains taxes are particularly important for investors. They are levied at the federal level and tax the profits generated by the sale of an asset that has increased in value.
The tax rate on the gain depends on the length of time the asset has been held. Short term capital gains (on assets sold one year or less after acquisition) are taxed at the owner’s ordinary income tax rate, while long term capital gains on assets held for more than one year are taxed at a lower capital gains rate, based on the reasoning that lower taxes will encourage high levels of capital investment. Tax records should be kept showing the duration of ownership when the assets were sold and the income tax return filed.
Payroll Taxes
Payroll taxes are withheld from an employee’s paycheck by an employer, who remits the amount to the federal government to fund Medicare and Social Security programs. In 2023, employees will pay 1.45% to Medicare on all wages and 6.2% to Social Security on the first $160,200 earned, up from $147,000 in 2022.
Anyone earning more than $200,000 as a single filer (or $250,000 for married couples filing jointly) pays an additional 0.9% to Medicare.
Payroll taxes have an employee’s portion and an employer’s portion. The employer pays the employee’s share, as described above, and a duplicate amount for the employer’s share. The employer’s contributions are the same: 6.2% for social security up to the limit of the wage base and 1.45% for Medicare on all wages. Therefore, the total remitted is 15.3% (6.2% for employee social security + 6.2% for employer social security + 1.45% for employee Medicare + 1.45% for employer Medicare).
Payroll taxes and income taxes differ, although both are withheld from an employee’s payroll and remitted to the government. Payroll taxes are specifically earmarked to fund Social Security and Medicare programs. A self employed person must pay the equivalent of both the employee’s and employer’s share of payroll taxes through self employment taxes, which also fund Social Security and Medicare.
Corporate Income Tax
Corporate income tax is paid on the taxable income of the company. The steps to calculate the taxable base of a company are:
- Sales revenue – cost of goods sold (COGS)= gross profit
- Gross profit – operating expenses such as general and administrative (G&A), sales and marketing, research and development (R&D), depreciation, etc. = earnings before interest and taxes (EBIT)
- EBIT – interest expense = taxable income
The U.S. corporate tax rate is currently a flat rate of 21%. Prior to the Tax Cuts and Jobs Act (TCJA) of 2017, the corporate tax rate was 35%.In August 2022, the U.S. Congress passed a new 15% corporate minimum tax as part of the Inflation Reduction Act of 2022. This new minimum tax only affects U.S. corporations with three year average book values equal to or greater than $1 billion and foreign corporations with three year average U.S. income greater than $100 million.
Emily RobertsSales Taxes
Sales taxes are collected at the point of sale when a customer makes payment for a good or service. The company collects the sales tax from the customer and remits the funds to the government.
Each state can apply its own sales taxes, which means they vary by location. There is even room for cities and counties to use their own rates, as long as they follow their state’s tax rules.In 2022, the highest average state and local sales tax rate was in Tennessee, at 9.55%. Five states Alaska, Delaware, Montana, New Hampshire, and Oregon did not have a state sales tax, although Alaska allowed municipalities to levy local sales taxes.
Real Estate Taxes
A common property tax in the United States is the ad valorem property tax. A levy rate, which represents the amount per $1,000 of a property’s assessed value, is used to calculate property taxes. The local government hires an appraiser to figure out how much the property is worth. Reassessments are usually made every one to five years.
Property tax rates vary considerably by jurisdiction and many states also tax tangible personal property, such as cars and boats.In FY 2018, the state with the highest property tax revenue per capita was New Jersey, at $3,378. (The District of Columbia would rank higher if all 50 states were counted, at $3,740 per capita.) The lowest state ranking was $598 per capita in Alabama.
Tariffs
A tariff is a tax that one country puts on goods and services from another country that are brought into the country. The goal is to get people to buy more things made in their own country by making goods and services from other countries more expensive.
There are two main types of tariffs: fixed tariffs, which are levied as a fixed cost based on the type of item, and ad valorem tariffs, which are calculated as a percentage of the value of the item (like the property tax in the previous section).Tariffs are politically divisive, with debates over whether the policies are working as intended.
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Wealth Taxes
Estate taxes are only levied on inheritances in excess of the statutory exclusion limit. In 2023, the federal exclusion limit will be $12.92 million, up from $12.06 million in 2022. Surviving spouses are exempt from estate tax.
The estate tax payable is the taxable amount minus the exclusion limit. For example, an estate of $14.7 million would have to pay estate tax on $1.78 million.The estate tax rate is a progressive marginal rate increasing from 18% to 40%. The maximum rate of 40% applies to the portion of the estate that exceeds the exclusion limit by more than $1 million.
States may have lower exclusion limits than the federal government, but no state taxes inheritances worth less than $1 million. Massachusetts and Oregon have the $1 million exemption limits. State rates also differ from the federal rate. In 2022, the highest state estate tax rate, applied in Hawaii and Washington, was 20%.
Some states levy their own additional estate or inheritance tax, with exclusion limits that differ from those of the federal government.Estate taxes differ from inheritance taxes in that the former is levied before the assets are distributed to the beneficiaries. The estate tax is paid by the beneficiary. There is no federal estate tax and, as of 2022, only six states have an estate tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.
Tax Arrears
Each type of tax has a different due date or reporting requirement. Some are levied immediately at the time of a transaction or prior to a transaction, such as sales taxes or tariffs. Others have a fixed recurring schedule with a due date that repeats on a particular date or on a particular combination of day and month (e.g., real estate tax is due on the first day of April). Due dates for similar types of taxes vary among governing bodies (e.g., different counties will have different property tax due dates).
Failure to remit the corresponding amount of a tax to the tax authorities may result in various penalties. In connection with the various taxes mentioned above, tax penalties may include:
- Penalty penalty resulting in a one time fee or charge.
- Interest penalty resulting in an increasing penalty based on the duration of the delinquency.
- Security interest on the underlying assets in the event the delinquent party is unable to satisfy its debts.
- Security interest on the underlying assets in the event the delinquent party is unable to satisfy its debts.
- Denial of access or service for transaction related taxes (i.e., tariffs).
- Seizure of company assets or imposition of a lien on company assets for business related taxes.
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Why do we Pay Taxes?
Taxes are the main source of revenue for most governments. Among other things, this money is spent on improving and maintaining public infrastructure, including the roads we drive on, and funding public services such as schools, emergency services and social welfare programs.
How does Income Tax Work in the United States?
In the United States, taxes increase progressively as a person’s income increases. There are currently seven federal tax brackets, with rates ranging from 10% to 37%.
Are Taxes Low in the United States?
In general, U.S. taxes are lower than in other developed nations. In 2018, total U.S. tax revenues accounted for 24% of gross domestic product (GDP), according to the Tax Policy Center, while the average among the other 35 member countries of the Organization for Economic Cooperation and Development (OECD) was 34%.
Who has to Pay Taxes?
The taxpayer will depend on the type of tax and the regulations associated with the tax. For example, federal income tax legislation usually affects only individuals who have earned a certain amount of income or adjusted gross income. Corporate taxes may be limited to companies that have done business in a specific area or are incorporated to do business in a specific country. Each tax is handled differently, and there are often rules and exceptions that help figure out who needs to pay the tax.
Jackson MitchellWhat Types of Taxes are There?
Taxes can be classified in different ways. Some taxes are levied on transactions (e.g., sales taxes or tariffs). Other taxes are levied on net financial results (e.g., personal income tax or corporate income tax). There are also taxes that arise due to one time or non recurring events (i.e. wealth taxes, capital gains taxes).
Wrap Up
There are many types of taxes that apply in a variety of ways. Knowing what causes a tax situation can help taxpayers manage their money so that taxes don’t hurt them as much. Techniques that can help include annual tax loss carryforwards to offset investment gains against investment losses, and estate planning, which serves to protect inherited income for heirs.
FAQs
Taxes are mandatory payments made by people or companies to the government that are used to fund public projects, services, and policies.
Taxes are paid by either the taxed entity (company) or the customers who purchase the commodities produced by the firm.
Some of the common tax types include income tax, payroll tax, corporate income tax, sales tax, property tax, tariff, and estate tax.
In the US, taxes are collected at the federal level by the Internal Revenue Service (IRS).
A progressive tax system is one in which those with higher incomes are subject to greater taxation than those with lower incomes.
In the US, marginal tax rates are based on things like marital status and income source.
Federal capital gains taxes are imposed on gains resulting from the sale of an asset whose value has increased.
Employers deduct payroll taxes from employees’ paychecks and then send the money to the federal government to pay for Medicare and Social Security.
Tax evasion is illegal since it involves purposefully not paying the full amount of taxes due.
Before making money or conducting business in a new country, people and businesses should familiarize themselves with that nation’s tax regulations because they differ greatly from those of other nations.
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- Council on Foreign Relations – The Truth About Tariffs
- Tax Policy Center – Are Federal Taxes Progressive?
- Social Security Administration – Contribution And Benefit Base
- Tax Policy Center – How Did the Tax Cuts and Jobs Act Change Business Taxes?
- U.S – Department of the Treasury – Economics of Taxation
- Tax Foundation – How High Are Property Taxes in Your State?
- Mass.gov – A Guide to Estate Taxes
- Tax Foundation – Does Your State Have an Estate or Inheritance Tax?
- Tax Policy Center – How Do U.S – Taxes Compare Internationally?
