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What You Need To Know About 6 Common Types of Taxes
What You Need To Know About 6 Common Types of Taxes
It’s everyone’s favorite time of year: Tax season. While there’s still time to file, you can also use this time to make sure you’re up to date on the different taxes you may have to pay. Here’s a quick rundown of six common types of taxes and what they’re used for.
Individual income tax
Individual income tax, also known as personal income tax, is imposed on the income an individual or household earns, including unemployment benefits. Individual income taxes are one of the largest sources of revenue for the U.S. government, and they go to the general U.S. Treasury fund. If you’re an employee at a company, these taxes are typically withheld from your paycheck by your employer. However, if you’re self-employed or work as an independent contractor, you will likely be responsible for reporting and paying these taxes yourself.
In the U.S., individual income taxes are levied or collected on a federal level, and by some state and local governments. On a federal level, these taxes are progressive, which means the tax rate increases as taxpayer income increases. However, there are a number of exemptions and deductions available, so many Americans do not have to pay taxes on all of their income. Most states also levy income taxes on the state level, although the rates and structure vary.
Payroll tax
Similar to individual income taxes, payroll taxes are deducted from an employee’s paycheck based on the income earned. The difference is in what these taxes support: Payroll taxes go to Social Security and Medicare funding, while individual income taxes are for general government funding. Like individual income taxes, many states also impose payroll and unemployment taxes.
Unlike income taxes, federal payroll taxes have a flat rate, which means everyone pays the same tax rate, regardless of income. However, you only pay the Social Security portion of payroll taxes to a certain limit set by the IRS. This limit can vary year to year ($142,800 in 2021, $147,000 in 2022 and 2023), but any income that exceeds that limit is not subject to the Social Security portion of the tax. This makes payroll taxes regressive, which means low-income and moderate-income earners pay a larger percentage of their income than high-income earners.
Capital gains tax
Capital gains taxes are applied to the profit made on an investment when it is sold, including stocks, property, land, and businesses. This only applies to profits from the sale of assets held for more than one year, which are known as long-term capital gains and taxed at preferential rates. Profits from assets and investments held for less than one year are referred to as short-term gains and are taxed as ordinary income.
Capital gains can be reduced by capital losses incurred in that year, which occurs when you sell an investment for less than you purchased it for. Your capital gains tax is assessed based on your total long-term capital gains minus capital losses. The tax rates on long-term capital gains vary based on your tax bracket and range from zero, 15%, or 20%.
Property taxes
Property taxes are paid on property you own, calculated by the local government where the property is located. Cities, counties, and school districts all have the power to levy property taxes. Many states also impose property taxes. These taxes help fund local and state governments, education, transportation, parks and recreation, and more.
Property taxes are typically based on the overall value of your home, and in many areas, the rates are recalculated annually. Property taxes are determined by multiplying the property tax rate of the local government where the property is located by the current market value of the property, including any land owned. Property taxes are regressive and, because they are determined by the value of the asset, have no relation to income level.
Estate taxes and Inheritance taxes
Estate taxes are levied on the fair market value of a deceased person’s estate, which includes cash, real estate, insurance, and other assets. These taxes are paid out before any money is distributed to the beneficiaries. However, assets passed to a spouse, or a qualified charitable organization, are not subject to estate taxes. Similar to the Social Security taxable maximum, estate taxes are only levied on assets up to a certain limit, which varies from year to year.1
Inheritance taxes are state taxes paid by the beneficiaries of an estate on the amount inherited. Seventeen states and the District of Columbia currently levy an estate or inheritance tax, and the rates and regulations vary from state to state.
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1. “Estate Tax,” Internal Revenue Service, Updated October 26, 2022, https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax.