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It’s a new year and with that comes the hope that everything is just plain going to get better. We all hope that. That means everything including your finances, especially after what will go down as a disastrous 2020 and so many who have suffered economically. But with a new year also comes the reality that “tax season” is now upon us. April’s due date is just a few months away and January is the start of your prep time for that event. But while your income tax returns get all the fanfare, there are different types of taxes we are subject to.
Taxes affect just about every facet of your life, even if you don’t realize it. Learning the different types of taxes you pay can help you understand the true cost of your financial fortunes. Here’s what may be a shocker to you. Income tax isn’t the only tax that you will be paying this year. In fact, you will be paying taxes every year…wait for it…forever!
Different Types of Taxes
1. Income Tax (The Obvious One)
The federal government and most state governments impose income taxes on the income you earn during the year just because you earned it. These taxes hit not only your wages, salaries, and bonuses, but also side hustles, gambling income, interest income and even bartering income. Even if you “barter” services that you do in exchange for someone doing work for you worth money, you must pay income taxes on whatever that service is worth and declare it as income!
Who pays income taxes?
Everyone that receives any income must pay taxes on it. This includes income from a small business, salaries, stocks or capital gains, and gambling income.
Although income taxes serve an important social and economic purpose, you want to make sure you’re only paying the portion you truly owe. That’s why income tax preparation is essential for achieving that goal. Using a trained tax professional or an online tax filing service such as TaxAct or FreeTaxUSA can help you get there.
There are 7 states with no income taxes
They are: Alaska, Florida, South Dakota, Texas, Nevada, Washington, and Wyoming. Nothing is free, however, because states still have to collect enough revenue to fund services and infrastructure. If you aren’t paying income tax, you’re likely paying more in other taxes in these states.
2. Capital Gains Tax
Income taxes also include capital gains taxes. A capital gains tax is a tax on the profit realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property. Yes, your home counts as a taxable asset.
If you hold the capital assets for a year or less, any gains are taxed at the same rates as ordinary income on your federal income taxes. If, however, you hold the property for more than one year, you pay the lower capital gains rates, which are in most cases a maximum of 20%.
Capital gains are the profit you make when you sell a capital asset for more money than its cost to you. When you sell a capital asset, such as real estate, furniture, precious metals, vehicles, collectibles or major equipment, you have a capital gain that is subject to tax.
You can avoid paying capital gains taxes on some assets. If you can’t completely avoid the taxes, there are ways to minimize the amount of taxes you pay.
3. Payroll Taxes
Payroll taxes are another federal tax that is imposed on the income you earn like wages and bonuses. The payroll tax is made of two separate taxes: the Social Security tax and the Medicare tax. The Social Security tax is 12.4%, but it only applies to a maximum amount of earned income each year known as the contribution and benefit base. The Medicare tax is 2.9% and applies to all earned income. Each tax is split in half by the employer and the employee, but if you’re self-employed, you pay it all.
Payroll taxes that are imposed on employers or employees are usually calculated as a percentage of the salaries that employers pay their staff. Payroll taxes generally fall into two categories: deductions from an employee’s wages, and taxes paid by the employer based on the employee’s wages.
4. Property Tax
A property tax or millage rate is tax on the value of a property, usually levied on real estate. The tax is levied by the authority of the jurisdiction in which the property is located. This can be a national government, a federated state, a county or geographical region or a municipality. Multiple jurisdictions may tax the same property.
Property taxes levied by state and local governments are taxes that include both real estate such as your home or an office building and your personal property, such as your car. But, sometimes different rates apply to different assets.
There’s no such thing as states with no property taxes. So whether you’re a new homeowner or have been paying taxes on your home for years, you should know how to properly calculate your property taxes and ways you can pay those taxes. In addition, make sure that if you’re buying a home, you take every tax deduction you can.
5. Estate Taxes
Estate taxes are taxes charged against the estates of people after they die. The current federal estate tax exemption is $11.18 million, meaning very few people have to worry about filing estate taxes.
However, several states have estate tax exemptions that are smaller or impose an inheritance tax which is a tax that is levied when you inherit property or money from someone.
The 6 states with inheritance tax are: Iowa, Kentucky, Nebraska, New Jersey, Maryland, and Pennsylvania.
6. Sales Taxes and Consumption Taxes
Unlike an income tax where you pay taxes as you earn money, consumption taxes apply when you spend money. Sales tax is a common type of consumption tax, which increases the cost to purchase items. Excise taxes are similar, except that they apply to very specific items, such as a fuel tax on gasoline.
Why You Must Pay Taxes
Besides taxes being the law of the land, and the threat of fines or even jail time for tax evasion, the different types of taxes are used to pay for the expenses of maintaining a government. Some taxes are collected for general use, while other taxes are used for specific purposes like for Social Security or Medicare benefits.
Some taxes are also known as “sin taxes” and were and are intended to discourage use of a particular item, such as cigarettes or beer. It’s not certain that these taxes discourage anyone from using these items, but it certainly provides quite a bit of income to government where it is imposed.
There’s an old saying that the “nothing can be said to be certain, except death and taxes”! It appears everything else is a choice we make, but on those two counts we seem to be stuck. And ironically, even when we pass on there will still be some sort of tax on that.
These different types of taxes from which we will never fully escape require all of us to know and understand the best ways to minimize our obligations and still fully meet the requirements of the law when we face them. That might mean getting professional help or just being more attuned to practical ways to handle them depending on how complicated your financial situation becomes. Don’t ever look back and see that your lack of information has cost you hundreds or even thousands in taxes. That’s a sure fire way to prevent you from any kind of financial prosperity.
Have you started to prepare your 2020 taxes? Do you understand the new changes that tax laws make almost every year? Have you considered your capital gains taxes, adjustments to your payroll taxes, and future considerations like where you will live in retirement to help limit or eliminate some of your tax obligations? How important are taxes to you now and in your future?