What Are Taxes?

Understanding Taxes

Taxes are mandatory payments paid to a government by individuals, agencies, or corporations, whether local, regional, or federal. Taxpayers fund certain government programmes like Social Security and Medicare as well as public infrastructure and services like roads and schools.

In economics, taxes are paid by anyone who pays the burden of a tax associated; it can be levied on an entity, such as a corporation, or the consumer of goods produced by the company. Taxes, such as payroll taxes, federal and state income taxes and sales taxes, must be taken into serious consideration from an accounting perspective.

Taxes on individual and corporate residents are regularly imposed by governments to defray the cost of public programmes and services as well as the construction and maintenance of the nation's infrastructure. Tax money is utilised to improve everyone's quality of life and the local economy.

Income taxes are levied on money that a taxpayer earns through his/her services in the United States and many other nations around the world. Taxes are directly paid to a government agency of the respective nation. The income money might come from a variety of sources, including purchases of goods and services, salary income, capital gains from increased investments, dividend or interest payments received as additional income, and so on.

Tax money is used to pay for Social Security, Medicare, and other public programmes as well as government operations.

Social Security and Medicare have accounted for an ever-increasing percentage of overall federal tax income over time. Tax policy has often been the cause of political controversy throughout American history.

In order to pay taxes, a taxpayer must withhold a percentage of their income and send it to the government. Taxes must be paid at the rates determined by the government, and it is against the law to knowingly underpay taxes, a practice known as tax evasion. However, tax avoidance, or taking legal action to pay less in taxes and earn more after taxes, is totally acceptable. The majority of governments use a department or agency to collect taxes. The Internal Revenue Service (IRS) in the United States is in charge of this duty at the federal level.

Different Types of Taxes

There are numerous highly popular tax forms, including:

• Income Tax: A specified percentage of earnings is given over to the state or federal government as income tax.
• Payroll Tax: A payroll tax is the part of an employee's paycheck that the employer deducts and pays to the government on their behalf to support Medicare and Social Security programmes.
• Corporation Tax: The government withholds a specified percentage of company profits as tax in order to fund government initiatives.
• Sales Tax: Taxes imposed on certain goods and services is known as a sales tax; they vary by jurisdiction.
• Property Taxes: Property taxes are determined by how much the land and other assets are worth. This is levied on profits earned by the property seller.
• Tariffs: These are taxes imposed on imported goods intending to support domestic companies.
• Estate Tax: The Fair Market Value (FMV) of the assets in a decedent's estate is taxed at a predetermined rate; the real estate must meet certain requirements outlined by the state and federal governments.

People and corporations should carefully investigate the tax laws of a new nation before investing money or doing business there because the tax systems of different countries vary substantially.

Below, we'll examine a few various tax scenarios in the United States. In general, property taxes are mostly levied by municipalities and other local governments, but federal, state and local governments also collect income, corporate, and payroll taxes. Let us discuss each kind of above-listed tax in detail:

Income Tax

The United States has a progressive income tax system, like many other nations. In accordance with this structure, high-income individuals or enterprises contribute a larger share of tax revenues than low-income individual earners. Marginal tax rates determine how taxes are applied to everyone.

One aspect that influences a taxpayer's marginal tax rate is their filing status (married filing jointly, married filing separately, single, or head of household). A person's tax liability can be significantly impacted by the filing status they select. The source of a taxpayer's income has an impact on taxes as well. It's important to comprehend the terminology used to describe the different revenue sources since it might affect how taxes are computed.

Capital gains taxes are crucial for investors. These are federal taxes that are levied and enforced on the profits produced when you sell an object that has increased in value.

The length of time the asset was kept determines how much of the profit is taxed. According to the presumption that lower taxes will encourage significant levels of capital investment, long-term earnings on assets held for more than a year are taxed at a lower capital gains rate. The owner's standard income tax rate is applied to short-term earnings (on assets sold within a year after acquisition). To demonstrate the period of ownership at the time the assets were sold, and the tax return was submitted, tax records should be retained.

Payroll Tax

Payroll taxes are taken out of employees' paychecks by employers, who then transmit the money to the federal government to cover Social Security and Medicare costs. Employees will pay 6.2% into Social Security on the first $160,200 earned in Employer and employee contributions are both included in payroll taxes. The employer additionally remits the employee share, as described above, in addition to the duplicate payment for the employer component. Medicare employer rates are 1.45% on all earnings and 6.2% up to the maximum permitted by the wage base for Social Security. So, the total amount that is sent equals 15.3% (6.2% employee Social Security plus 6.2% employer Social Security plus 1.45% employee and 1.45% employer Medicare). Income taxes and payroll taxes are two separate taxes, even though both are taken from an employee's pay and given to the government. Payroll taxes are gathered to pay for the costs of Medicare and Social Security. Due to self-employment taxes, an individual who works for themselves must contribute the same amount to Social Security and Medicare as an employee would.

Corporate Tax

Corporate taxes are paid on the taxable income of a firm. Use the following procedures to figure out a company's taxable income:

• Sales revenue minus the cost of goods sold (COGS) equals a gross profit.
• Earnings before interest and taxes (EBIT) are the operating expenses such as selling and marketing, general and administrative (G&A), research and development (R&D), depreciation, etc., which are subtracted from gross profit.
• Taxable income is the same as EBIT with fewer interest expenses.

The United States now has a flat corporation tax rate of 21%. The corporation tax rate was 35% prior to the Tax Cuts and Jobs Act (TCJA) of 2017.

As part of the Inflation Reduction Act of 2022, the US Congress voted a new 15% corporate minimum tax into law in August of that year. Only American companies with three-year average book values of $1 billion or more and international corporations with three-year average US earnings surpassing $100 million are subject to the new minimum tax.

Sales Tax

When a client completes the purchase of an item or service, sales taxes are levied at the point of sale. The company receives the customer's sales tax payment and distributes it to the proper authorities.

Since each state is allowed to implement its own rates, sales taxes differ geographically. As long as they abide by their state's tax regulations, cities and counties can even set their own rates. At 9.55%, Tennessee had the highest average combined state and local sales tax rate in 2022. Five states-Delaware, Montana, New Hampshire, Oregon, and Alaska-did not have a state sales tax, despite Alaska allowing local governments to implement a municipal sales tax.

Property Tax

The real estate ad valorem tax is a common type of property tax in the US. A millage rate, which is the amount for each $1,000 of an assessed value for a property, is used to compute real estate taxes. A property assessor is chosen by the local government to determine the property's assessed value. In general, reassessments take place every one to five years.

Different jurisdictions have different rates for property taxes, and many states and localities additionally charge additional fees for tangible personal property like vehicles and boats. In FY 2018, New Jersey had the highest per-person property tax collections ($3,378). (The District of Columbia would be rated higher if it were included with the 50 states, with a per capita income of $3,740.) The state with the lowest ranking was Alabama ($598 per capita).

Tariffs

A tariff is a fee a country imposes on the importation of goods and services from another country. By raising the price of products and services imported from other nations, the aim is to promote home consumption.

The two primary forms of tariffs are ad valorem tariffs, which are imposed as a fixed price depending on the category of products, and fixed fee tariffs, which are imposed as a percentage of the item's worth.

Estate Tax

Only estates that are sold for more than the legal exclusion limit are subject to estate taxes. The federal exclusion level increased from $12.06 million in 2022 to $12.92 million in 2023. Taxes on estates are not applied to surviving spouses.

The amount of property tax payable is equal to the taxable estate minus the exclusion amount. For example, a $14.7 million property would require property taxes of $1.78 million.

The estate tax ranges from 18% to 40% and has a progressive marginal rate. The part of an estate that exceeds the exclusion limit by more than $1 million is subject to a 40% estate tax rate.

Despite the fact that some states may have lower exclusion levels than the federal government, no state taxes estates with a value of less than $1 million. Only Massachusetts and Oregon are subject to the $1 million exemption level. State rates differ from federal rates in addition. In Hawaii and Washington, there was a 20% state estate tax rate that went into effect in 2022.

Estate taxes, in contrast to inheritance taxes, are levied prior to the transfer of any assets to beneficiaries. An inheritance tax must be paid by the receiver. As of 2022, there is no federal inheritance tax; just six states-Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania-have an inheritance tax.

What does Tax Delinquency mean?

Each type of tax has a specific due date or filing requirement. Some taxes, like sales taxes or customs, are immediately collected during or in the days before a transaction. For some people, a due date repeats on a certain date or day/month combination according to a predetermined recurring cycle (i.e., property taxes being due the first day of April). Depending on the organisation that regulates a certain tax, different due dates apply (i.e., different counties will have different property tax due dates). If the proper amount of tax is not paid to the taxing authorities, several penalties may be imposed. Tax penalties for the various taxes mentioned above might include the following:

• As a kind of punishment, a fee or charge is imposed.
• A method of calculating interest that yields a rising penalty based on how long the loan is past due.
• If the party in default is unable to pay its debts, a claim is brought against the underlying assets.
• Refusing to provide a service or provide access due to transaction taxes (i.e. tariffs).
• To seize company property or place a lien on it in order to pay for business-related taxes.

Why is tax taken by the government?

Taxes are the principal source of revenue for the majority of governments. This money is used for a variety of things, such as paying for social programmes, emergency services, and public services like schools. It is also used to improve and maintain public infrastructure, such as the highways we use to travel.

How does the American tax system work?

Taxes in the US steadily increase in accordance with an individual's income. The United States now has seven separate federal tax brackets, with rates ranging from 10% to 37%.

Do Americans pay low taxes?

Taxes in the United States are often lower than those in other developed nations. The average tax revenue for the 35 member nations of the Organization for Economic Co-operation and Development (OECD), according to the Tax Policy Centre, was 34%, whereas the total amount of taxable income in the United States in 2018 alone was 24% of the nation's GDP.

To whom does the tax liability apply?

The taxpayer will be determined by the kind of tax and any associated restrictions. For instance, federal income tax requirements sometimes only apply to those with an adjusted gross income at or above a certain amount. Only companies that have operated in a certain area or are incorporated to operate inside a specific country may be subject to corporation taxes. Each tax is administered in a particular way, and there are frequently exceptions and limitations to who is subject to it.

What types of taxes are there?

There are several methods to classify taxes. For instance, the transactions might lead to certain taxes (i.e., sales taxes or tariffs). Taxes must be paid in addition to the net financial performance (i.e., individual income taxes or corporate income taxes). Other taxes could be due as a result of irregular or sporadic occurrences (i.e., estate taxes, capital gains taxes).

The Bottom Line

There are many different types of taxes, and they are enforced in many different ways. By having a comprehensive grasp of what leads to a tax situation, taxpayers may manage their finances to decrease the consequences of taxes. Two measures that might be useful are annual tax-loss harvesting, which equalises investment gains and losses, and estate planning, which safeguards inherited income for heirs.