Whether you file your taxes with the help of an accountant or yourself, taxes impact everyone. America’s tax code is notoriously complex; however, taxes break down into discrete categories that are easy to understand. To minimize the effect of taxes on your finances, you should work with a financial advisor.
What are Taxes?
Taxes are a form of mandatory financial contribution imposed by governmental bodies to fund public programs and services, such as infrastructure and public health care. Every taxpayer must pay different tax types based on their income level, and income tax is the most common tax for individuals, with a percentage based on their wages and salaries.
Most countries also have a value-added tax, gift tax, capital gain tax, and estate tax. Other taxes may apply depending on the location, such as real estate or property tax. There are multiple resources to help taxpayers learn more about these tax codes to reduce their expenses.
The Different Types of Taxes
1. Consumption Tax
Consumption tax is a tax on the money people spend, not the money people earn. Sales taxes, which state and local governments use to raise revenue, are a type of consumption tax. An excise tax on a specific good, such as alcohol or gasoline, is another example of a consumption tax. Various economists and presidential candidates have proposed a federal consumption tax for the U.S. that could offset or replace taxes on capital gains and dividends.
2. Progressive Tax
In progressive tax systems like the one in the United States, higher-income individuals pay taxes at a higher rate than those with lower incomes. This is why wealthy Americans are taxed more than middle-class Americans, and middle-class Americans are taxed at a higher rate than working-class Americans. Basically, a progressive tax involves a tax rate that increases as taxable income increases. This is achieved by creating tax brackets that put taxpayers in income ranges.
3. Regressive Tax
A regressive tax is not progressive, which can mean the tax is lower for wealthy individuals or the tax is a flat rate with everyone paying the same rate. Why is a flat tax regressive? Those with lower incomes would feel the effect of a flat tax more than people with higher incomes.
4. Proportional Tax
Similar to a flat tax is a proportional tax. Taxpayers at all income levels would pay the same “proportion” in taxes. These types of taxes are common in state-level sales taxes but not at the federal level. Those who remember the 2012 presidential campaign will remember a famous proportional tax proposal, the 9-9-9 Plan, which called for a 9% business transaction tax, a 9% personal income tax, and a 9% federal sales tax.
5. Property Tax
Property taxes are the taxes you pay on homes, land, or commercial real estate. If you are deciding whether you can afford to buy a home, you should take property taxes into account. Unlike a mortgage, property tax payments do not amortize. You have to keep paying them for as long as you live in a home unless you qualify for property tax exemptions such as those for seniors, veterans, or disabled residents.
6.VAT or Ad Valorem Tax
While the VAT tax is widely implemented in Europe, the U.S. has yet to adopt it. It is a tax on the “added value” of a product, the difference between the sales price and the cost of producing a good or service. It is a form of consumption tax buyers pay when they make a purchase, similar to a sales tax.
There is, however, a difference between sales tax and VAT. The purchaser of a product pays sales tax. Only that final stage in the product’s life is subject to taxation. In contrast, VAT is applied at each stage of the supply chain and then rolled up into the final purchase price. If you travel to a country with VAT you probably will not notice you are paying it because it is included in the prices. Sales tax, conversely, is listed separately on receipts.
7. Capital Gains Taxes
Capital gains taxes apply to investment income after an investment is sold and a capital gain is realized. Because many Americans do not invest at all, they don’t have to pay capital gains taxes. Capital gains are taxed on dividends and interests stemming from simple interest from a bank account or dividends and earnings from investments.
8. Real Estate Taxes
Real estate taxes are the taxes paid by property owners on real estate holdings such as land and buildings. These taxes are generally calculated based on the value of the real estate, although other factors may be taken into consideration. Real estate taxes can provide an important source of income for local governments, which can be used to fund many public services and projects.
However, these taxes are generally not kept in isolation from other forms of taxation, as real estate tax is often just one component of total tax revenue for a jurisdiction. Sales tax is another example of a taxation system that functions in tandem with real estate tax in many locations. It is important to understand the role real estate taxes play within your local system in order to determine how it can impact the overall burden of taxation you might experience from month to month or year to year.
9. Payroll Taxes
When you divide your annual salary by the number of times you get paid each year, chances are the total is higher than your actual paycheck. In addition to your healthcare premiums or 401(k) contributions, payroll taxes are deducted. These taxes cover your contributions to Medicare, Social Security, disability, survivor benefits as well as federal unemployment benefits. You’ll also have federal and likely state taxes and local income taxes withheld from your paycheck.
10. Income Taxes
Income taxes are the taxes on the income you earn. Federal income taxes are both progressive and marginal. Marginal means that different income brackets are taxed at different tax rates for different income brackets. The higher earners pay a high tax rate, but only on the amount of money they earn in that top bracket.
State governments also collect income taxes to help fund state programs and services. To assess what state income tax is owed, state governments base their taxes on the computed taxable income of the taxpayer. This taxable income figure is calculated after certain deductions and credits have been taken into consideration.
Personal income taxes may be levied at both the state and federal levels, so taxpayers need to remain mindful of what rates are applicable in their state as well as federally. Depending on the state taxpayers reside in, there may be several aspects surrounding state income taxes that must be understood. Learn more about tax credits and tax deductions and how they can impact your income taxes.
11. Inheritance/Estate Tax
Estate and inheritance taxes are the taxes paid after a loved one dies. An estate tax is paid from the net worth of the deceased. It’s a tax for passing along assets to heirs. Inheritance taxes do not exist at the federal level and are only law in six states. These taxes are paid by the heir and not the estate of the deceased.
What Happens If I Don’t Pay Taxes?
As a taxpayer, it is your responsibility to ensure that taxes are paid in full and on time. Failure to do so can result in significant consequences. By not paying the tax owed, you risk incurring fines from the Internal Revenue Service (IRS). Not only that, but tax penalties and interest charges can also be applied to any tax bill paid after its due date. Furthermore, if taxes go unpaid for a period of time, additional penalties such as liens on property or assets may be considered. Take all measures possible to pay your tax bill in full and on time each year – otherwise, you may find yourself with more than just an unpaid tax bill.
There are many different types of taxes in the U.S. Understanding how they work can be complicated. Working with a financial professional can help to answer your questions and ensure your tax strategy is working for you.
Tip for Filing Your Taxes
- Taxes are a major part of your overall financial plan. A financial advisor can also offer professional help with this. Finding a qualified financial advisor doesn’t have to be hard. If you’re wondering if what is a fiduciary financial advisor and why do you need one or 7 Questions You Should Ask a Financial Advisor.