## What Are Taxes?

Taxes are mandatory contributions levied on individuals or corporations by a government entity—whether local, regional, or national. [Tax revenues](https://www.investopedia.com/tax-revenue-definition-5115103) finance government activities, including public works and services such as roads and schools, or programs such as Social Security and Medicare.

In economics, taxes fall on [whoever pays the burden of the tax](https://www.investopedia.com/terms/t/tax_incidence.asp), whether this is the entity being taxed, such as a business, or the end consumers of the business’s goods. From an accounting perspective, there are various taxes to consider, including payroll taxes, federal and state income taxes, and sales taxes.

### Key Takeaways

*   Taxes are mandatory contributions collected by governments.
*   The Internal Revenue Service (IRS) collects federal income taxes in the United States.
*   There are many forms of taxes and most are applied as a percentage of a monetary exchange (for example, when income is earned or a sales transaction is completed).
*   Other forms of taxes, such as property taxes, are applied based on the assessed value of a held asset.
*   Understanding what triggers a tax situation can enable taxpayers to manage their finances to minimize the impact of taxes.

![Taxes](https://www.investopedia.com/thmb/vFrGPlR5F7-lOgRcHqi0pe7dfa0=/1080x0/filters:no_upscale():max_bytes(150000):strip_icc()/taxes-4188113-1-fb27402db4ac4638875e56eefb0ba00d.jpg)

*— Investopedia / Joules Garcia*

## Understanding Taxes

To help fund public works and services—and to build and maintain the [infrastructure](https://www.investopedia.com/terms/i/infrastructure.asp) used in a country—a government usually taxes its individual and corporate residents. The tax collected is used for the betterment of the [economy](https://www.investopedia.com/terms/e/economy.asp) and all who are living in it.

In the United States and many other countries in the world, income taxes are applied to some form of money received by a [taxpayer](https://www.investopedia.com/terms/t/taxpayer.asp). The money could be income earned from salary, [capital gains](https://www.investopedia.com/terms/c/capitalgain.asp) from investment appreciation, [dividends](https://www.investopedia.com/terms/d/dividend.asp) or [interest](https://www.investopedia.com/articles/tax/10/interest-income.asp) received as additional income, or payments made for goods and services.

Tax revenues are used for public services and the operation of the government, as well as to fund [Social Security](https://www.investopedia.com/articles/retirement/06/socialsecurity.asp) and [Medicare](https://www.investopedia.com/articles/personal-finance/070914/medicare-101-do-you-need-all-4-parts.asp). As the large baby boomer generation has aged, Social Security and Medicare have claimed increasingly high proportions of the total federal expenditure of tax revenue. Throughout U.S. history, tax policy has been a consistent source of political debate.  

A tax requires a percentage of the taxpayer’s earnings or money to be taken and remitted to the government. Payment of taxes at rates levied by the government is compulsory, and [tax evasion](https://www.investopedia.com/terms/t/taxevasion.asp)—the deliberate failure to pay one’s full tax liabilities—is punishable by law. [Tax avoidance](https://www.investopedia.com/terms/t/tax_avoidance.asp)—actions taken to lessen your tax liability and maximize after-tax income—is perfectly legal, however.

Most governments use an agency or department to collect taxes. In the United States, this function is performed federally by the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp).

## Types of Taxes

There are several very common types of taxes:

*   [Income tax](https://www.investopedia.com/terms/i/incometax.asp): A percentage of generated income that is relinquished to the state or federal government
*   [Payroll tax](https://www.investopedia.com/terms/p/payrolltax.asp): A percentage withheld from an employee’s pay by an employer, who pays it to the government on the employee’s behalf to fund Medicare and Social Security programs
*   [Corporate tax](https://www.investopedia.com/terms/c/corporatetax.asp): A percentage of corporate profits taken as tax by the government to fund federal programs
*   [Sales tax](https://www.investopedia.com/terms/s/salestax.asp): Taxes levied on certain goods and services, varying by jurisdiction
*   [Property tax](https://www.investopedia.com/terms/p/propertytax.asp): Based on the value of land and property assets
*   [Tariff](https://www.investopedia.com/terms/t/tariff.asp): Taxes on imported goods, imposed with the aim of strengthening domestic businesses
*   [Estate tax](https://www.investopedia.com/terms/e/estatetax.asp): Rate applied to the [fair market value (FMV)](https://www.investopedia.com/terms/f/fairmarketvalue.asp) of property in a person’s estate at the time of death when the estate's total value exceeds thresholds set by state and federal governments

Tax systems vary widely among nations, and it is important for individuals and corporations to carefully study a new locale’s tax laws before earning income or doing business there. 

Below, we'll take a look at various tax situations in the United States. Generally speaking, the federal government levies income, corporate, and payroll taxes. States levy income and sales taxes, and municipalities or other local governments mainly levy property taxes.

### Income Tax

Like many nations, the United States has a [progressive income tax](https://www.investopedia.com/terms/p/progressivetax.asp) system through which a higher percentage of tax revenues are collected from high-income individuals or corporations than from low-income individual earners. Taxes are applied through marginal [tax rates](https://www.investopedia.com/terms/t/taxrate.asp).

A variety of factors affect the marginal tax rate that a taxpayer will pay, including their filing status—[married filing jointly](https://www.investopedia.com/terms/m/mfj.asp), [married filing separately](https://www.investopedia.com/terms/m/mfs.asp), [single](https://www.investopedia.com/terms/s/single.asp), or [head of household](https://www.investopedia.com/terms/h/head_of_household.asp). Which status a person is able to claim [can make a significant difference](https://www.investopedia.com/ask/answers/061515/what-difference-between-single-and-married-withholding-tax.asp) in how much they are taxed. The source of a taxpayer’s income also makes a difference in taxation. It’s important to learn the terminology of the different income types that may affect how income is taxed.

[Capital gains taxes](https://www.investopedia.com/terms/c/capital_gains_tax.asp) are of particular relevance for investors. Levied and enforced at the federal level, these are taxes on the profit generated when you sell an [asset](https://www.investopedia.com/terms/a/asset.asp) that's increased in value.

The rate of taxation on the profit depends on the length of time for which the asset was held. Short-term capital gains (on assets sold one year or less after they were acquired) are taxed at the owner’s ordinary income tax rate, whereas long-term gains on assets held for more than a year are taxed at a lower capital gains rate. This is based on the rationale that lower taxes will encourage high levels of capital investment. [Tax records](https://www.investopedia.com/ask/answers/020414/how-long-should-i-keep-my-tax-records.asp) should be maintained to substantiate the length of ownership when both the assets were sold and the tax return was filed.

### Payroll Taxes

Payroll taxes are withheld from an employee’s paycheck by an employer, who remits the amount to the federal government to fund Medicare and Social Security programs. Employees pay 1.45% into Medicare on all wages and 6.2% into Social Security. These rates are applied up to an income threshold or wage base which is adjusted annually to keep pace with inflation and generally rises each year.

> **Warning**
>
> Anyone who earns more than $200,000 as a single filer (or $250,000 for married couples filing jointly) pays an additional 0.9% into Medicare.

Payroll taxes have both an employee portion and an employer portion. The employer remits both the employee portion, described above, and a duplicate amount for the employer portion. The employer rates are the same 6.2% for Social Security up to the wage base limit, and 1.45% for Medicare on all wages. The total remitted is therefore 15.3% (6.2% employee Social Security + 6.2% employer Social Security + 1.45% employee Medicare + 1.45% employer Medicare).

Payroll taxes and income taxes differ, although both are withheld from an employee’s paycheck and remitted to the government. Payroll taxe specifically fund Social Security and Medicare programs. A self-employed individual must pay the equivalent of both the employee and employer portion of payroll taxes through [self-employment taxes](https://www.investopedia.com/terms/s/selfemploymenttax.asp), which also fund Social Security and Medicare, but they can claim a tax deduction for the employer's share.

### Corporate Taxes

Corporate taxes are paid on a company’s taxable income. The steps to calculate a company’s taxable income are:

*   Sales revenue: [cost of goods sold (COGS)](https://www.investopedia.com/terms/c/cogs.asp) = [gross profit](https://www.investopedia.com/terms/g/grossprofit.asp)
*   Gross profit: [operating expenses](https://www.investopedia.com/terms/o/operating_expense.asp) such as [general and administrative expenses (G&A)](https://www.investopedia.com/terms/g/general-and-administrative-expenses.asp), selling and marketing, [research and development (R&D)](https://www.investopedia.com/terms/r/randd.asp), [depreciation](https://www.investopedia.com/terms/d/depreciation.asp), etc. = [earnings before interest and taxes (EBIT)](https://www.investopedia.com/terms/e/ebit.asp)
*   EBIT: [interest expense](https://www.investopedia.com/terms/i/interestexpense.asp) = taxable income

The corporate tax rate in the United States is a flat rate of 21%. Before the [Tax Cuts and Jobs Act (TCJA)](https://www.investopedia.com/taxes/how-gop-tax-bill-affects-you/) of 2017, it was 35%.

The United States Congress passed a new 15% corporate minimum tax into law as part of the Inflation Reduction Act of 2022 in August of 2022. This new minimum tax only affects U.S. corporations with three-year average book values of $1 billion or more and foreign corporations with three-year average U.S. income over $100 million. 

### Sales Taxes

Sales taxes are charged at the [point of sale](https://www.investopedia.com/terms/p/point-of-sale.asp) when a customer executes the payment for a good or service. The business collects the sales tax from the customer and remits the funds to the government.

Each state can implement its own sales taxes, so they vary depending on location. There's even room for cities and counties to use their own rates, provided that they abide by the taxing rules of their state.

### Property Taxes

A common property tax in the United States is the real estate [ad valorem](https://www.investopedia.com/terms/a/advaloremtax.asp) tax. A [millage rate](https://www.investopedia.com/terms/m/millrate.asp) is used to calculate real estate taxes. It represents the amount per every $1,000 of a property’s assessed value. The property’s assessed value is determined by a property [assessor](https://www.investopedia.com/terms/a/assessor.asp) appointed by the local government. Reassessments are typically performed every one to five years.

Property tax rates vary considerably by jurisdiction and many states also tax [tangible personal property](https://www.investopedia.com/terms/t/tangible-personal-property.asp), such as cars and boats.

### Tariffs

A tariff is a tax imposed by one country on the goods and services [imported](https://www.investopedia.com/terms/i/import.asp) from another country. The purpose is to encourage domestic purchases by [increasing the price of goods and services](https://www.investopedia.com/penguins-and-trumps-tariff-war-11711309) imported from other countries.

There are two main types of tariffs: fixed fee tariffs, which are levied as a fixed cost based on the type of item, and ad valorem tariffs, which are assessed as a percentage of the item’s value like the real estate tax.

[Tariffs are politically divisive](https://www.investopedia.com/buffett-says-trump-tariffs-act-of-war-11689411), with debate over whether the policies work as intended.

### Estate Taxes

Estate taxes are levied only on [estates](https://www.investopedia.com/terms/e/estate.asp) that exceed an exclusion limit set by law. Surviving spouses are exempt from estate taxes.

The estate tax due is the taxable estate minus this exclusion limit. A $15.7 million estate would owe estate taxes on $0.7 million if the exemption was $15 million.  

The estate tax rate is a progressive marginal rate that increases from 18% to 40%. The maximum estate tax rate of 40% is levied on the portion of an estate that exceeds the exclusion limit by more than $1 million.

States may have lower exclusion limits than the federal government, but no state taxes estates worth less than $1 million. State rates are also different from the federal rate.  

> **Fast Fact**
>
> Some states levy their own additional estate or inheritance tax, with exclusion limits that differ from those of the federal government.

Estate taxes are different from [inheritance taxes](https://www.investopedia.com/terms/i/inheritancetax.asp). An estate tax is applied before assets are disbursed to any [beneficiaries](https://www.investopedia.com/terms/b/beneficiary.asp). An inheritance tax is paid by the beneficiary. There is no federal inheritance tax, and only a few states have an inheritance tax.

## Tax Delinquency

Every type of tax has a different due date or reporting requirement. Some are collected immediately at the time of a transaction or leading up to a transaction, such as sales taxes or tariffs. Others are on a fixed recurring schedule with a due date repeating on a specific date or specific day/month combination, such as property taxes that may be due by the first day of April. The due dates for similar types of taxes will vary across governing bodies. Different counties will have different property tax due dates.

Upon failure to remit the appropriate amount of a tax to the taxing authorities, various penalties may be incurred. They may include:

*   A penalty assessment resulting in a one-time fee or charge
*   An interest assessment resulting in an escalating penalty based on the duration of the delinquency
*   A [lien](https://www.investopedia.com/terms/l/lien.asp) placed on underlying assets in the event the delinquent party should be unable to satisfy their debts
*   A denial of access or service for transaction-related taxes, such as tariffs
*   A seizure of company property or placement of a lien on the company property for business-related taxes.

## Why Do We Pay Taxes?

Taxes are the primary source of revenue for most governments. Among other things, this money is spent to improve and maintain public infrastructure, including the roads we travel on, and fund public services, such as schools, emergency services, and welfare programs.

## How Do Income Taxes Work in the U.S.?

In the U.S., taxation progressively increases as an individual’s income grows. There are currently seven federal tax brackets in the U.S., with rates ranging from 10% to 37%.

## Who Has to Pay Taxes?

The taxpayer will depend on the type of tax and associated regulation for that tax. For example, federal income tax legislation usually only pertains to people who have earned a certain amount of income or adjusted gross income. Corporate taxes may be limited to companies that have performed business in a specific area or are incorporated to do business within a specific country. Each tax is handled differently, and there are often exceptions and qualifications for whom the tax pertains to.

## What Are Different Types of Taxes?

Taxes can be classified in different ways. Some taxes may be incurred on transactions, such as sales taxes or tariffs. Other taxes are incurred on net financial results, such as individual income taxes or corporate income taxes. There are also taxes that occur due to one-time or non-recurring events, including estate taxes and capital gains taxes.

## The Bottom Line

There are many types of taxes that are applied in various ways. Understanding what triggers a tax situation can enable taxpayers to manage their finances to minimize the impact of taxes. Techniques that can help include [annual tax-loss harvesting](https://www.investopedia.com/articles/financial-advisors/121914/pros-and-cons-annual-taxloss-harvesting.asp) to offset investment gains with investment losses, and [estate planning](https://www.investopedia.com/terms/e/estateplanning.asp), which works to shelter inherited income for heirs.

> **Article Sources**
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