Taxes

What Are Taxes?

Taxes are required contributions imposed upon individuals or corporations to the federal, state, or local government. They are used to finance public goods and services such as education, public transportation, healthcare, social security, and the military.

Taxes exist in a variety of different formats. They might be paid directly from your paycheck or they might be included in the price of an item you buy. These are some of the most common types of taxes:

1. Income Tax

Income taxes are taxes imposed on income generated by individuals or businesses. There is a federal income tax that is imposed on all income generated in the U.S. Most states have a state income tax, and some local municipalities impose a local income tax in addition to the federal and state income taxes.

2. Payroll / FICA Tax

The Federal Insurance Contributions Act is a law that demands a payroll tax on employee’s paychecks as well as from the employers. Your FICA Taxes are taken directly from an employee’s gross pay. You may not subtract any adjustments, exemptions, or deductions when calculating these taxes. FICA taxes are used by the federal government to fund social security and medicare. FICA taxes are paid by both employers and employees in equal shares. Both employees and employers pay 6.2% of the employee’s gross wage for social security and 1.45% for medicare. However, for social security taxes, the federal government set a maximum wage base. A wage base is the maximum amount of earned income that an employee must pay social security taxes on. For 2022, the wage base is $147,000. This means that even if you earn more than $147,000, you are only taxed on $147,000 of your gross wage.

3. Sales Tax

4. Property Tax

Property taxes are taxes paid by individuals or corporations on homes, land or commercial real estate. Property tax is based on the value of the property (the real estate), yet some jurisdictions also tax tangible property like boats and cars. Property taxes are imposed and collected by the local government where the property is located and they are used to fund local public utilities (schools, sewage, law enforcement, etc.)

Click here for a tool to help calculate your property tax

In the U.S., these different types of taxes fall into three major categories: regressive, proportional, and progressive taxes.

1. Regressive Taxes

Regressive Taxes have a uniform tax rate that is unrelated to an individual's income level. Everyone is taxed at the same rate.

2. Proportional Taxes

Proportional taxes are flat taxes. In a proportional tax system, everyone is taxed at the same rate regardless of income or wealth. Proportional taxation is intended to decrease the disparity between marginal tax rates and average tax rates paid. Advocates of proportional taxes argue that they encourage people to earn and spend more, thus stimulating the economy, because there is no tax penalty for earning more.

3. Progressive Taxes

Progressive Taxes are based on a taxpayer's ability to pay (or––an individual's amount of taxable income.) This means that the tax rate increases as an individual's income increases. Resultantly, high income earners contribute a larger percentage of their taxable income than low income earners.

Personal Income Tax in The U.S.

The U.S. federal income tax is a progressive tax system. This means that there is a higher income tax rate on people with higher incomes, and a lower income tax rate on people with lower incomes. You are placed into a tax bracket (a range of income taxed at a given rate) depending on the amount of taxable income you earn. The percentage tax rate increases at intervals (tax brackets) as taxable income increases.

Gross Income: All income for the year (wages, tips, profits from a business, interest or dividends from investments)

Adjusted Gross Income(AGI): (Some of your income (typically contributions to savings and retirement plans) may not be taxed. These untaxed portions of gross income are called adjustments.) Adjusted gross income is your gross income minus any adjustments to your income.

Filing Status: When you file your taxes, you must indicate your filing status. You choose between these four categories:

1. Single - unmarried, divorced, legally separated

2. Married filing jointly - married and you and your spouse file a single tax return together

3. Married filing separately - married but you each file your own separate tax return

4. Head of household - unmarried and paying more than half the cost of supporting a dependent child or parent or sibling

Dependent: A dependent is a person who relies on someone else for financial support

Exemptions

A tax exemption is the right to exclude all or some income from taxation. Some taxpayers are entitled to exemptions that reduce their taxable income, and some individuals and organizations are completely exempt from paying taxes.

Personal exemptions: prior to 2017, taxpayers were able to deduct a personal exemption if they were not listed as a dependent on anyone else’s income tax return.

Dependent exemptions: taxpayers may claim exemptions for dependents filed on their income tax return. (Approximately $2,000 per dependent)

Deductions

A tax deduction is an item you can subtract from your taxable income to lower the amount of taxes you owe. You can choose between the standard deduction or an itemized deduction.

Standard Deduction: the standard deduction is a fixed amount you can subtract from your adjusted gross income. It is dependent on your filing status.

Itemized Deduction: Certain expenses are exempt from income tax. Itemized deductions are made up of a list of eligible expenses that are subtracted from your adjusted gross income.

So, how do I calculate my income taxes?

Tax Table: A tax table allows you to determine how much tax you owe on your taxable income. The rate at which your income is taxed depends on your adjusted gross income, exemptions, deductions, and your filing status.