What are the different types of taxes in the USA?
Taxes are the foundation on which this great nation of ours was built, and it remains the backbone of our society, with nobody being above paying taxes. However, there are different types of taxes out there. By understanding them, people would be in a better position to handle them accordingly. Of course, for those that don’t want to commit to this task, there is the option of handing it over to top tax relief advocates and consultants. But all others, we have an insightful article that will offer all the necessary information right here.
In the undying words of Benjamin Franklin (1789), “In this world, nothing can be said to be certain, except death and taxes”. This idiom actually has its origins even before Franklin said it, as similar words were documented in Daniel Defoe’s The Political History of the Devil (1726), where Defoe said that “Things as certain as death and taxes, can be more firmly believ’d”. And before that, Christopher Bullock’s The Cobbler of Preston (1716) also said that “‘Tis impossible to be sure of any thing but Death and Taxes”.
But why do we pay taxes in the first place? And what are the different types of taxes in the USA today? If you want to understand more about tax relief, these are the questions that you need to answer first.
Why do we pay taxes?
One thing is absolutely certain, taxes were, and never will be, popular. But they are the key to fostering the economic growth of a nation, as well as its development. They serve the goal of achieving a fully-functional and prosperous society. For most of us, taxes are a common topic at the start of a new year, when we have to deal with the start of the federal income tax season. But we interact with taxes every single day, mostly without even noticing it.
Taxes in the US amount to trillions of dollars every year, funding just about everything, from Social Security and trash removal to military spending. These taxes also pay for essential goods and services that the country needs, its infrastructure, health care, as well as education. They are a key ingredient in the “social contract” between the citizens of the country and the economy of the country.
Now that you know why it is important for everyone to pay their taxes, let’s take a look at the different types of taxes in the USA.
Three different types of taxes in the USA
In a nutshell, all taxes can be categorized into three types:
- Taxes on what you earn
- Taxes on what you buy
- The taxes on what you own
With that being said, you need to realize that every single cent you pay in taxes starts as a cent you’ve earned. The main difference between these tax types is when you actually pay the tax. Let’s say that your state has a flat income tax rate of 10% and that you’ve earned $2,000 this month. You will not even see the full $2,000, but $1,800. The remaining $200 will be withheld from your paycheck once the income is earned.
Then, let’s say that a week later, you take another $200 from your remaining $1,800 and purchase a new phone in a jurisdiction that has a 10% sales tax. At the exact moment of the purchase, you will pay the sales tax on the phone. The total amount of money collected in taxes is now $220. But you did not pay them at the same time.
To be an educated taxpayer, you need to realize that there are many different types of taxes in the USA, all of which stem from the above three categories. To fully understand the USA tax system, you need to take a look at each individual type.
Taxes on what you earn
Income taxes branch out into the following four types:
- Individual income taxes
- Corporate income taxes
- Payroll taxes
- Capital gains taxes
Individual income taxes
The personal income tax (aka individual income tax) is levied by the government on any salaries, wages, investments, or any other income forms that are earned by an individual or a household. Many of these personal taxes are “progressive”, which means that if your income increases, the taxes go up as well. This results in the fact that people who learn less money pay less in taxes and those who earn more pay more. In the U.S., the income tax rates range from 10% to 37%, depending on the income threshold. These thresholds (usually referred to as tax brackets) dictate how much of the taxpayer’s income needs to be levied as tax.
There are nine states in the U.S. that do not collect income tax from its residents, Alaska, Texas, Washington, Wyoming, Nevada, New Hampshire, Tennessee, and Florida. However, these states have a different tax structure, usually taxing dividends and interests more than the other states. Or the sales taxes are higher. In any case, you can be certain that each state is collecting its fair share of taxes. The fact that the state does not collect income tax just means that other tax types might be higher to compensate. There are many different types of taxes in the USA, after all, you can be sure that the government is constantly tweaking the numbers on each.
Corporate income taxes
A corporate income tax (or CIT), is the tax that the government levies on business revenues, or what businesses make in sales. They are reduced by the cost of doing business, which varies by the corporation.
The U.S. businesses fall into two categories, broadly speaking: The “C corporations” who pay the corporate income tax, and “Passthroughs” which are LLCs, sole proprietorships, S corporations, as well as partnerships. The ‘passthroughs’ get their name due to the fact that they basically pass their income through to their owner’s individual income tax returns, having them pay the individual income tax instead.
While you may think that high corporate taxes are the way to go, it is important to note that the tax burden of C corporations is shared by their employees and consumers as well. Higher corporate taxes mean lower wages and higher prices. Due to this negative effect, most countries collect less than 30% on corporate taxes. The U.S. lowered the federal corporate income tax rate to 21% in 2017, as part of the Tax Cuts and Jobs Act.
The payroll taxes are levied from the salaries and wages of employees and are used to finance social insurance programs. Most of us are very familiar with this tax type, as it is commonly listed on our paystub at the end of each month. Every employer has this tax clearly listed.
The largest combined payroll taxes in the U.S. amount to 15.3%. This is a combination of the 12.4% Social Security tax, and 2.9% Medicare tax. Half of these taxes are paid from the employee’s paychecks, while the other half is paid by the employers themselves. However, the reality of the situation is that most of the tax burden is actually on the employees, as higher taxes usually mean lower wages. For example, if the government raises the payroll tax, most companies would simply reduce the wages to compensate.
Capital gains taxes
Capital assets amount to just about everything you own, use for personal purposes, investment, or even pleasure. They include homes, cars, jewelry, stocks, art, and the like. Once any of your assets increase in value, you get capital gain. And this gain is taxed by the government.
Let’s say that your stocks have gone up and you sell them at an increased value. The government collects tax on this profit, meaning that you can easily have the same money taxed twice. This mostly affects corporations, as they already pay the corporate income tax. But it can also affect individuals in some cases.
Taxes on what you buy
The next category of taxes has to do with the things we purchase. There are three different types of taxes in the USA when it comes to the things we buy:
- Sales taxes
- Gross receipts taxes
- Excise taxes
This is the tax type that we are most familiar with. Sales taxes are levied by the government on the sales of services and goods. These taxes are printed at the bottom of store receipts, and they are an unavoidable part of the purchase price.
The U.S. relies on a traditional sales tax as its major source of local and state revenue. There are only five states that do not collect statewide sales taxes: Alaska, Montana, New Hampshire, Oregon, and Delaware. All other states have the traditional retail sales tax structure.
Gross receipts taxes
GRTs, or gross receipts taxes, are always applied to the company’s gross sales, without any regard for profitability, not accounting for business expenses. This is, incidentally, the key difference from the other tax types that businesses are expected to pay. These taxes are imposed on a business at every stage in the production chain and they compound the effect the taxes have on the business. The tax burden multiplies all through the production chain and eventually gets passed down to the customers themselves.
This tax type is quite harmful to new startups who are usually operating under a loss in their early years, as well as businesses that have extremely long production chains.
Excise taxes are the most benign of all tax types. The government usually imposes on a specific activity, or particular goods, and is using them in addition to the broad consumption tax. The common examples of excise taxes are those found in sodas, betting, cigarettes, and gasoline. Excise taxes can also be utilized as a form of “sin tax”, where the government is trying to reduce the consumption of harmful substances or curb pollution.
One exception is the gas tax, as that is employed as a “user fee”. The amount of gas you purchase directly reflects your contribution to road wear and tear, as well as traffic congestion. By taxing gas, the government essentially puts a price on using public roads.
Taxes on what you own
The last one of the different types of taxes in the USA is the tax on what you already own. In this regard, we can observe the following three categories:
- Property taxes
- TPP (Tangible Personal Property) taxes
- Estate and inheritance taxes
If you have any immovable property, such as land or buildings, the government is going to tax you for it. Property taxes are an essential revenue source for the government. They account for over 30% of the total state/local tax collections, as well as 70% of local tax collections. The revenue gained from these taxes is helping fund all public services such as police, fire department, emergency medical services, schools, roads, and similar. Of course, there are property tax relief solutions that can help deal with this type of taxes.
Residential property taxes on land and structures are also one of the most stable, transparent, and neutral tax types in the U.S. But many states also tax TPP, which is tangible personal property.
TPP (Tangible Personal Property) taxes
The basic definition of TPP is any property that you can move or touch. This includes automobiles, furniture, business equipment, heavy machinery, etc. While these taxes do not have as large of a share as some other tax types, they are extremely complex. In some cases, they can even create very high compliance costs. Furthermore, they are the opposite of neutral, as they heavily favor some industries over others. Meaning that they also distort investment decisions.
These taxes are a heavy burden to any business that wants to grow, as investing in new equipment and machinery is more expensive. This usually has a negative economic growth impact. However, as of 2019, as many as 43 states have the TPP as part of their tax structure.
Estate and inheritance taxes
The government imposes these taxes on the total value of the property that is left after an individual dies. The estate taxes basically pay themselves before the estate assets are divided between heirs. But the people who inherit property need to pay an additional inheritance tax.
Inheritance taxes are also paired with gift taxes in most cases, making them unavoidable even if there was a transfer of the property prior to the individual’s death. But the main issue with this tax type is that it is very complex, as well as hard to administer. It can result in wealthy individuals simply leaving the state. Or they can plan their estates extremely inefficiently to lower the value. Due to these reasons, most states choose to forgo the collection of estate and inheritance taxes.
And there you have it, those were all of the different types of taxes in the USA, brought to you by the Consumer Opinion Guide. If you want to know more about taxes, tax relief, and the best tax relief companies, all you need to do is explore our selection of guides.