Seven types of taxes you should know about

7 types of taxes

For better or for worse, taxes and the tax system in the United States are complex. 

Some taxes come directly out of your paycheck, others you pay without even realizing it while shopping, and some others you’re required to pay once a year. And, much of this differs from state to state. Confused yet?

Understanding the basics of taxes will help in your financial planning in the long run – don’t underestimate the power of this type of knowledge! 

Federal Income Taxes 

If you roll your eyes or sigh out of frustration when you think about taxes and all of that money coming out of your paycheck, try to reframe it like this: your taxes are an investment into your country and your community. 

Federal income tax (sometimes referred to as the IRS tax), that is, the tax that is taken directly from your paycheck, is used for necessities such as:

  • Maintenance of infrastructures such as roads and bridges
  • Social programs like food stamps
  • Improvement of education
  • Emergency disaster relief programs
  • Pensions of government workers

The largest source of income for the federal government comes from your paycheck. You’re probably already aware of the concept of gross and net income. Your gross income is what you earn before taxes, and your net income is what you actually take home. 

The federal income tax is a “progressive tax system,” which means that those who make more money pay more taxes. Your “tax rate” is determined by which “tax bracket” you fall into. Tax rates are in the form of percentages which range from 10%-37%. 

State Taxes

Most states have their own tax systems as well. This may include sales tax, state income tax, fuel tax, and property (also known as real estate) tax. Some states have inheritance and estate taxes and some have corporate income taxes. A handful of states have no income tax at all, which is usually the most significant tax on a household after federal tax. Just like laws can differ by state, taxes do as well. Before you plan to relocate, it may be worth looking into the tax regulations first!

On an even smaller level, taxes can change between localities and counties as well.

Self-Employment/1099 Tax

If you’re self-employed (which includes freelancers, small business owners, and 1099 independent contractors), you’re not only required to pay federal income tax but an additional self-employment tax. The self-employment tax rate is 15.3%, 12.4% goes to Social Security and 2.9% goes to Medicare. The tax applies only to your “net earnings,” or, your profit. Your net earnings are your gross income after your business expenses. 

The major difference between the federal income tax that comes out of paychecks and the federal income tax for the self-employed comes down to who pays for what. Those with regular jobs (meaning those with an employer) split Social Security down the middle. That means that the employer pays 7.65% and the employee pays 7.65% to make up the total 15.3%. 

A standard employee doesn’t see this on their W2 or paystub as the employer is shouldering the fee. This is called payroll taxes (which you’ll read about below), so just know the government is still taking its share. 

Long-Term & Short-Term Capital Gains Taxes

Not everyone is subject to capital gains tax, only those who buy and sell capital assets. Capital assets include real estate, stocks, bonds, and even jewelry. If you sell a capital asset for more than you bought it, you’re required to pay a capital gains tax on it. The amount of tax you’re required to pay depends on how long you owned the asset before you sold it. The difference is called “long-term” and “short-term,” and each is taxed differently. The tax rates change yearly.

Long-term capital gains are taken from assets that you’ve held onto for more than 1 year. Tax rates and tax brackets come into play here as well. Long-term gains are taxed according to your income (your tax bracket) and are subject to tax rates of 0%, 15%, or 20%. 

Short-term capital gains are taken from assets that you’ve had for less than 1 year. These gains effectively have no tax advantage and “flow” into your topline income, which is then, of course, taxed at the federal, state, and perhaps local level. It is very wise to plan ahead so that you can achieve long terms gains on things such as stocks or flipping houses to decrease the tax you will owe at the end of the year.  

Payroll Tax

You may not know it, but if you’ve made it this far you already know what payroll tax is! Payroll tax simply refers to the Social Security (12.4%) and Medicare taxes (2.9%) that are taken directly out of your paycheck, half is paid by and visible to your employer, the other half comes out of you, the employee’s, gross earnings.

Payroll tax is only collected on income up to a certain amount of your salary, and this number changes every year. In 2021, the limit is up to $142,800

Sales Tax

When you buy goods and services, you’re likely paying sales tax on them. This tax varies state by state and in some cases by municipality. Some states don’t have sales tax at all! This tax is calculated as a percentage of the price you paid for the good or service.

Photo by Kelly Sikkema on Unsplash

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