Every April we have to go through filing federal income taxes, on our own or with the help of a tax accountant. Unless we happen to be tax policy wonks we don’t dwell too much on the theory and practice of taxation. While America’s tax code may be notoriously complicated, the taxes break down into discrete categories that are easy to understand. Below is our guide to the different types of taxes in the U.S. And if you’re looking for an expert who can help guide you through the intricacies of taxes, check out SmartAsset’s financial advisor matching tool to get paired up with a professional who meets your needs.
A 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 also an example of a consumption tax. Some 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.
A progressive tax is one that gets steeper for tax-payers with more money. In a progressive tax system like the U.S. federal income tax, wealthy individuals pay tax at a higher rate than less wealthy individuals. In the U.S., wealth American are taxed more than middle-class Americans and middle-class Americans are taxed at a higher rate than working-class Americans.
A regressive tax is a tax that it is not progressive. This could either mean that the tax is lower for wealthy individuals or that the tax is flat (everyone pays the same rate). Why would a flat tax be regressive? People with lower incomes would feel the effect of a flat tax more strongly than people with higher incomes. To a multi-millionaire, a 15% tax wouldn’t translate to a substantial decrease in quality of life. To someone making $30,000 a year, a 15% tax would mean a serious dent in spending power.
A proportional tax is the same as a flat tax. Taxpayers at all income levels would pay the same “proportion” in taxes. As explained above, proportional taxes are regressive taxes. These types of taxes are common in state-level sales taxes but not common at the federal level. Anyone who remembers the 2012 presidential campaign will remember a famous proportional tax proposal, the 9-9-9 Plan. That plan was for a 9% business transaction tax, a 9% personal income tax and a 9% federal sales tax.
VAT or Ad Valorem Tax
The VAT tax is big in Europe but hasn’t been adopted in the U.S. It’s 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’s a form of consumption tax that buyers pay when they make a purchase, similar to a sales tax.
So what’s the difference between sales tax and VAT? Sales tax is paid by the purchaser of a product. Only that final stage in the product’s life is subject to taxation. VAT, in contrast, is applied at each stage of the supply chain and then snowballed into the final purchase price. If you travel to a country with VAT you probably won’t notice you’re paying it because it will be included in the prices you pay. Sales tax, on the other hand, is listed separately on receipts.
Property taxes are taxes paid on homes, land or commercial real estate. If you’re deciding whether you can afford to buy a home you should take property taxes into account. Unlike a mortgage, property tax payments don’t amortize. You have to keep paying them for as long as you live in a home – unless you qualify for property tax exemptions for seniors, veterans or disabled residents.
Capital Gains Taxes
Capital gains taxes are taxes on investment income after an investment is sold and a capital gain is realized. Because so many Americans don’t invest at all, they don’t pay capital gains taxes. There are also taxes on dividends and interests stemming from simple interest from a bank account or dividends and earnings from investments.
Estate and inheritance taxes are taxes paid after someone dies. An estate tax is paid from the net worth of the deceased. It’s a tax on the privilege of passing on assets to heirs. There is a federal estate tax, and some states levy their own estate taxes as well. Inheritance taxes don’t exist at the federal level and are only law in a handful of states. They’re taxes on the privilege of inheriting assets, and so are paid by the heir, not the estate of the deceased.
If you take your annual salary and divide it by the number of times you get paid each year, chances are that number is higher than your actual paycheck. One reason could be that your healthcare premiums or 401(k) contributions are deducted from your paycheck. Another reason is payroll taxes. These taxes cover your contribution to Medicare, to Social Security retirement, disability and survivor benefits and to federal unemployment benefits. You’ll also have federal (and maybe state and local) income taxes withheld from your paycheck. You can learn all about payroll taxes with this article.
Income taxes do what the name implies. They tax the money you earned. Federal income taxes are both progressive and marginal. Marginal means that there are different tax rates for different income brackets. The top earners pay a high tax rate, but only on the amount of money they have in that top bracket. Their first roughly $9,000 are taxed at the 10% rate. They pay 10% of $9,225, then 15% of $9,226 to $37,450 and so on. So if you read that someone is being taxed at the 39.6% rate, it’s not their entire income multiplied by 0.396 that they end up paying.
President Trump and Congress have been negotiating a tax bill in 2017. One feature of their plan includes changing the federal income tax brackets. You can learn more about Trump’s tax plan and how it will affect you here.
Taxes are here to stay. Even staunch libertarians tend to think some level of taxation is necessary to provide for national defense and maintain roads and bridges. If paying taxes is a consistent source of stress for you, you may want to change your approach. That could mean starting earlier, using different tax preparation software or enlisting professional help, like a financial with tax expertise. SmartAsset’s financial advisor matching tool makes it easier to find an advisor to work with who meets your needs. Simply answer a series of questions about your situation and your goals. Then the program matches you with up to three advisors who meet your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while doing much of the hard work for you.
Tips for Saving Money
- Open a high-yield savings account. This kind of account allows you to save money and earn over 15x the national average in interest, depending on your balance and contributions. Check out the American Express National Bank Personal Savings Account. Grow your savings with no fees/minimum balance and 24/7 access. Learn more. Sponsored
- Having a monthly budget can help you avoid overspending. Factoring taxes, like income and property taxes, into your budget can also help you plan your spending throughout the year. If you need help getting started, here’s a step-by-step guide on how to make a budget.
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