What Are Taxes?
Taxes are compulsory payments to people or businesses made by a government organization, whether local, regional, or federal. Public works and services like roads and schools, as well as Social Security and Medicare programs, are funded by tax income.
Taxes are borne by whoever bears the cost of the tax in economics, whether this is the entity being taxed, such as a business, or the final users of the items produced by the business. Taxes should be considered from an accounting standpoint, including payroll taxes, federal and state income taxes, and sales taxes.
Taxes: The Origin Story
Although today’s tax laws are complex and constantly evolving, many of the fundamental tax kinds on which modern governments rely, such as sales taxes, excise taxes, and property taxes, have existed since the dawn of civilization.
The first evidence of what are taxes and taxation dates back to ancient Egypt, where the Pharaoh levied a levy equal to 20% of all grain harvests around 5,000 years ago. Grain was a physical store of value that could be easily accumulated, exchanged, and circulated across society because Egypt lacked coined money.
As with many other contemporary innovations, the Greeks were responsible for bringing the concept of taxes to the developed world and spreading it there as their empire grew and civilization advanced.
A government typically taxes its individual and corporate inhabitants to help pay for public works and services and construct and maintain the infrastructure used in a nation. The money raised through tax services is utilized to improve the economy and the lives of everyone there.
Income taxes are levied on money a taxpayer receives in the United States and many other nations worldwide. The funds may originate from payments for goods and services, salary income, capital gains from rising investments, dividends or interest received as supplementary income, and so forth.
Public services, government operations, Social Security, and Medicare are all funded with tax dollars. Social Security and Medicare have taken up larger and larger percentages of the overall federal income tax revenue spent as the big baby boomer generation has aged. Tax policy has consistently been a topic of political contention throughout American history.
A tax entails taking a portion of the taxpayer’s income and remitting it to the government. It is required to pay taxes at the rates set by the government, and it is illegal to intentionally underpay taxes, known as tax evasion. (However, tax avoidance—measures meant to reduce your tax liability and increase your after-tax income—is completely permissible.)
Most governments employ a division or agency to collect taxes. The Internal Revenue Service handles this duty on a federal level in the United States (IRS).
Types of Taxes
There are several very common types of taxes:
– Money tax—A portion of the income is given to the state or federal government.
– Payroll tax—a portion of an employee’s salary deducted by an employer and paid to the government on the employee’s behalf to support Medicare and Social Security programs
– Corporate tax—a portion of corporate profits that the government withholds as tax to finance federal programs
– A sales tax is a tax on specific goods and services that varies by jurisdiction.
– Property tax—based on the value of the real estate and other tangible property.
– Tariff—Taxes levied on imported goods to support domestic enterprises
– Estate tax—A rate based on the fair market value (FMV) of the assets in a decedent’s estate at the time of death; the total estate must exceed state and federal thresholds.
Nations’ tax systems differ greatly; therefore, before earning money or conducting business in a new country, individuals and corporations should thoroughly research that country’s tax regulations.
We’ll look at a few different tax solution scenarios in the U.S. below. Generally, the federal, state and local governments collect income, corporation, and payroll taxes, whereas municipalities and other local governments mostly levy property taxes.
The United States, like many other countries, uses a progressive income tax solutions system, which means that higher-income individuals or corporations pay a larger share of the tax burden than low-income persons. Marginal tax rates are used to apply taxes.
The marginal tax rate a taxpayer will pay is influenced by several variables, such as their filing status (married filing jointly, married filing separately, single, or head of household). The filing status a person chooses can greatly impact their tax burden. Taxation is affected by a taxpayer’s income source as well. Understanding tax and the jargon associated with the various income streams is critical because it could impact how taxes are calculated.
For investors, capital gains taxes are very important. These are taxes on the profit made when you sell an item that has gained value and is imposed and enforced at the federal level.
The amount of taxation on the profit is based on how long the asset was held. According to the theory that lower taxes will encourage high capital investment, long-term gains on assets held for more than a year are taxed at a lower capital gains rate. In contrast, short-term gains (on assets sold one year or less after they were acquired) are taxed at the owner’s ordinary income tax rate. Tax records should be kept to prove the term of ownership when the assets were sold, and the tax return was filed.
Employers deduct payroll taxes from employees’ paychecks and send the money to the federal government to pay for Medicare and Social Security. Employees will pay 6.2% into Social Security on the first $160,200 earned in 2023, an increase from the $147,000 paid in 2022, and 1.45% into Medicare on all income.
Both the employer and employee portions of payroll taxes exist. In addition to the duplicate payment for the employer component, the employer also remits the employee portion, as mentioned above. Employer rates for Medicare are 1.45% on all wages and 6.2% for Social Security up to the wage base maximum. 15.3% (6.2% employee Social Security + 6.2% employer Social Security + 1.45% employee Medicare + 1.45% employer Medicare), is the total amount remitted.
Even though both are deducted from an employee’s salary and paid to the government, income, and payroll taxes differ. The purpose of payroll taxes is to pay for Social Security and Medicare. Self-employment taxes, which help support Social Security and Medicare, require a self-employed person to pay the equivalent of both the employee and employer portions of payroll taxes.
On a company’s taxable income, corporate taxes are paid. To determine a company’s taxable income, follow these steps:
• Gross profit – operating costs including selling and marketing, general and administrative (G&A), research and development (R&D), depreciation, etc. = earnings before interest and taxes (EBIT)
• EBIT minus interest costs equals taxable income. The corporate tax rate in the United States is currently a flat rate of 21%. Before the Tax Cuts and Jobs Act (TCJA) of 2017, the corporate tax rate was 35%.
As part of the Inflation Reduction Act of 2022, the U.S. Congress voted a new 15% corporate minimum tax into law in August of that year. Only American firms with three-year average book values of $1 billion or more and international corporations with three-year average U.S. incomes above $100 million are subject to the new minimum tax.
When a customer completes a good or service payment, sales taxes are applied at the point of sale. The company obtains the customer’s sales tax payment and sends the money to the government.
Sales taxes vary according to geography because each state can enact its own. There is room for towns and counties to set their rates as long as they follow their state’s tax laws.
Tennessee had the highest combined average state and local sales tax rate in 2022, at 9.55%. Although Alaska let local governments impose a local sales tax, five states—Delaware, Montana, New Hampshire, Oregon, and Alaska—did not have a state sales tax.
The real estate ad valorem tax is a typical property tax in the U.S. Real estate taxes are calculated using a millage rate, which is the sum per each $1,000 of an assessed value for a property. A property assessor chosen by the local government establishes the property’s assessed value. Typically, reassessments are carried out every one to five years.
Every jurisdiction has a different property tax rate, and many governments also tax tangible personal property like vehicles and boats.
New Jersey had the greatest per-capita property tax receipts in F.Y. 2018 ($3,378). (The District of Columbia, with a per capita income of $3,740, would be ranked higher if included with the 50 states.) Alabama had the lowest state ranking ($598 per capita).
A tariff is a charge a nation imposes on imports of goods and services from another nation. By raising the cost of goods and services imported from other nations, the intention is to promote domestic consumption.
The two primary forms of tariffs are ad valorem tariffs, assessed as a percentage of the item’s worth, and fixed fee tariffs, assessed as a fixed cost based on the type of item (like the real estate tax in the previous section).
Politicians have differing views on whether or not tariffs achieve their objectives, which causes political division.
Only estates that exceed the legal exclusion threshold are subject to inheritance taxes. The federal exclusion threshold increased from $12.06 million in 2022 to $12.92 million in 2023. Taxes on estates are not applied to surviving spouses.
The taxable estate less the exclusion amount is the amount of estate tax owed. For instance, $1.78 million of a $14.7 million estate would be subject to estate taxes.
With a progressive marginal rate, the estate tax ranges from 18% to 40%. The part of an estate that exceeds the exclusion limit by more than $1 million is subject to a 40% maximum estate tax rate.
No state taxes estates with a value under $1 million, even though states may have lower exclusion thresholds than the federal government. The $1 million exemption threshold only applies to Massachusetts and Oregon. Additionally, state rates vary from federal rates. The highest state estate tax rate in 2022 was 20%, implemented in Hawaii and Washington.
In contrast to inheritance taxes, estate taxes are imposed before any assets are distributed to recipients. The beneficiary is liable for paying an inheritance tax. Only six states—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania—have an inheritance tax as of 2022; no federal inheritance tax exists.
There is a different deadline or filing requirement for each sort of tax. Some taxes, such as sales taxes or tariffs, are instantly collected at the time of a transaction or in the days before one. Others have a predetermined recurring schedule where a due date repeats on a particular day or day/month combination (i.e. property taxes being due the first day of April). Depending on the regulatory body, different forms of taxes have varying due dates (i.e. different counties will have different property tax due dates).
Different penalties may be applied for failing to pay the correct amount of tax to the taxation authorities. What are Tax penalties for the different taxes stated above could consist of the following:
• The imposition of a fine that results in a one-time cost or levy.
• A calculation of interest that results in an increasing fine based on how long the debt is past due.
• A lien is positioned against underlying assets if the party in default cannot pay their debts.
• Refusal of service or access due to transaction-related taxes (i.e. tariffs).
• The taking of firm property or imposing a lien on it to pay business-related taxes.
Purposes of Taxation
The prevailing view in the 19th century was that taxes should primarily be used to fund the government. Governments have used taxes in the past and present for reasons other than just raising revenue. Separating the goals of resource allocation, income redistribution, and economic stability is one helpful method to look at the reason for taxation, according to American economist Richard A. Musgrave.
If you know what are taxes policies are and do not interfere with market-determined allocations, the first objective, resource allocation, is advanced without a compelling justification for interference, such as the need to prevent pollution. The second goal, income redistribution, aims to reduce income and wealth distribution disparities. Maintaining high employment and price stability is the goal of stabilization, which is accomplished through tax policy, government spending policy, monetary policy, and debt management.
The Bottom Line
There are numerous tax categories, and they are imposed in numerous ways. Taxpayers can manage their finances to lessen the effects of taxes by clearly understanding what are taxes situation is. Annual tax-loss harvesting, which equalizes investment gains and losses, and estate planning, which protects inherited income for heirs, are two strategies that can be helpful.
1. Why Do We Pay Taxes?
For the majority of governments, taxes are their main source of income. This money is used for a variety of purposes, including funding public services like schools, emergency services, and social programs as well as enhancing and maintaining public infrastructure, including the highways we use to get around.
2. How Do Income Taxes Work in the U.S.?
In the U.S., taxation gradually rises in line with an individual’s income. Currently, the United States has seven federal tax bands, with rates ranging from 10% to 37%.
3. Are U.S. Taxes Low?
In general, American taxes are lower than those in other industrialized countries. According to the Tax Policy Center, the average for the other 35 Organization for Economic Co-operation and Development (OECD) members was 34%. In contrast, U.S. taxable income in 2018 was 24% of the country’s GDP.
4. Who Needs to Pay Taxes?
The taxpayer will vary depending on the kind of tax and any related regulations. For instance, federal income tax laws often only apply to those with an adjusted gross income of a specific amount. Corporate taxes may only apply to businesses that have operated in a particular region or were incorporated to conduct business there. Every tax is handled differently, and there are frequently exclusions and requirements for those to whom the tax applies.
5. What Are the Different Types of Taxes?
Taxes can be categorized in a variety of ways. Transactions may result in some taxes (i.e. sales taxes or tariffs). The net financial performance is subject to additional taxes (i.e. individual income taxes or corporate income taxes). Other taxes are incurred due to singular or irregular events (i.e. estate taxes, capital gains taxes).