Types of Taxes
Types of Taxes
Taxes affect pretty much everyone, everywhere. Even if you aren’t in the workforce, you’ve likely benefitted from services funded by tax dollars, such as roads, hospitals, and public education. But what exactly are they and who has to pay them? Read on to find out.
What are Taxes?
Taxes are money that people have to pay to the government. The government then uses this money for government employee salaries (police, military, politicians…), services like education and health care, building and maintaining infrastructure, etc.
Two important taxes that affect nearly everyone are income tax and sales tax. However, there are also many other types of taxes, such as corporate taxes, payroll taxes, property taxes, and more.
Income taxes are taxes on your income during one calendar year, that is, between January 1 and December 31. Typically, every time you receive a paycheck, the government takes a percentage of it as income tax. This percentage is called an income tax rate.
Federal income taxes are taxes on your income that the United States government levies. The federal income tax is a progressive tax, which means that people have to pay taxes to the IRS based on how much money they earn. More money earned equals more money paid in taxes.
For example, in 2018, the federal income tax for your first $9,525 was 10%, the following $9,526 to $38,700 was taxed at 12%, then from $38,701 to $82,500 it was 22%, and so on. These are called tax brackets. The full table can be found online.
Confused? Here’s an example. John earned $45,000 in 2018. Therefore, the total federal income tax he had to pay was ($9,525 – 0) * 10% + ($38,700 – $9,526) * 12% + ($45,000 – $38,701) * 22% = $5,840. But if you don’t want to do the math by hand, there are many tax calculators online that will do it for you!
Apart from paying federal income tax, you may also be subject to state income tax. However, a handful of states don’t require that you pay any state income tax at all! These are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
As mentioned above, the US federal income tax is a progressive tax. But this isn’t the only way to levy income tax. Some countries use regressive or flat taxes instead.
- Progressive taxes are taxes in which the more money a person makes, the higher percentage of their income they have to pay. Most countries have progressive income taxes, including the U.S.
- Regressive taxes are the opposite of progressive taxes, that is, the less money a person makes, the higher percentage of their income they have to pay. Sales taxes are usually considered regressive since low-income people spend a higher percentage of their income than rich people.
- Flat taxes are in between progressive and regressive taxes. With a flat tax, everybody pays the same percentage. Several states have flat income taxes, such as North Carolina, and some countries as well, such as Russia.
The advantage of a progressive tax is that it makes people who can afford it pay more of their income while leaving more money in the pockets of low-wage earners, who are more likely to need it and spend all their money, which makes the economy work. Critics of progressive taxes say that they discriminate against the rich.
Once you have found your income tax rate, you know your income tax liability. A tax liability is the total amount of tax owed by an individual, company, or other entity to a taxing authority like the Internal Revenue Service (IRS) in the U.S. Income tax liability is the total amount of tax you have to pay to the taxman based on your income.
If you’ve ever bought, well, anything, chances are you paid a sales tax. A sales tax is a tax on the purchase of goods and services. It is levied at the point of sale (the cash register), collected by the retailer, and then passed on to the government. The government depends on businesses to tell the truth about the amount of sales tax they have collected.
In the U.S., it is not the federal government that charges sales taxes, but the states and local governments. Therefore, different places have different sales taxes. For example, the highest sales taxes are levied in Louisiana at 10% and Tennessee at 9.5%, while some states don’t have a sales tax at all, like Delaware, Montana, New Hampshire, and Oregon.
Take, for example, the sales tax of Louisiana, 10%. If you purchase a pair of jeans with a $60 price tag, the sales tax added will be 10% of $60 (or $60*0.1) which is equal to $6. Therefore, the total price you must pay is $60+$6 = $66.
Outside the U.S., many places have a different form of sales tax called the Value Added Tax (VAT). In many of these countries, the VAT is much higher than the sales tax in the U.S. Countries in Europe levy over 20% on average in sales taxes! The difference with a VAT is that it is often already added to the price tag. So those same $60 jeans in Louisiana would say $66 on the price tag at a VAT of 10%.
In 2016, states and local governments collected a combined $377 billion in revenue from sales taxes! So what do they do with all this money? Similar to the federal government, states spend their tax revenue on employee salaries and valuable public services, like education, healthcare, and building roads and bridges.
Property tax is a tax on property paid by the owner on a yearly basis as long as she still owns the property. It is levied by states and local governments, which means it can vary from place to place. When buying a house, you should consider the property tax you will pay every year for owning it.
Corporate taxes are taxes that are levied on companies. While an individual’s income taxes are based on their income, corporate taxes are usually based on their profit, that is, their revenue (income) minus expenses. The federal corporate tax rate in the U.S. is fixed at 21%. However, some states add a state corporate tax on top of that.
Payroll taxes are an added tax on your income in addition to federal and state taxes. This tax covers contributions to Medicare, Social Security, disability, survivor benefits, and federal unemployment benefits. Payroll taxes are also called FICA taxes, after the Federal Insurance Contributions Act. Taxpayers need to pay 6.2% of their income to Social Security and 1.45% to Medicare. These are government programs that help people who have lower incomes.
Capital gains taxes are taxes on the positive difference between the sale of an asset and its original price, or the profit of a transaction. It’s usually applied to investments. For example, if Simon buys stocks for $20,000 and sells them for $30,000, he will pay capital gains tax on the difference, $10,000.
There are two types of capital gains taxes. Short-term capital gains taxes apply to assets sold less than a year after being bought, and they are taxed as normal income. Long-term capital gains taxes are taxed at 0%, 15%, and 20%. The tax rate that you pay depends on your tax bracket, which you can find online.
If you made it to the end of this article, congratulations! Taxes might not be the most exciting topic, but it’s important to understand what they are, who pays them, and the different types. This article covers the most common ones, but there are many other, more specialized taxes that you may have to pay depending on your specific circumstances.