Americans are subject to numerous taxes, not all of which are paid in the same way. Some are deducted directly from your paycheck, some are levied at the cash register, and others don't apply to everyone. Let's take a look at the basics of seven ways Americans pay taxes.
The United States federal government levies a tax on the worldwide income of US citizens and residents, which is deducted from one's paycheck. There are currently seven tax brackets, with the percentage of tax owed rising with increased income. Single taxpayer rates for the seven income tax brackets in 2021 range from 10% (for those earning up to $9,950) to 37% (for those earning more than $523,600.) The tax bracket that you fall into is considered your top marginal tax rate. Except for those who fall into the lowest tax bracket, your entire income is not taxed at your top marginal tax rate, but instead you are taxed on the amount of your income that falls with each bracket at that bracket's percentage. For example, if you earn $10,000, you fall into the 12% top marginal tax bracket, but the first $9,950 is taxed at only the 10% rate of the lower bracket, and just $50 is subject to the higher 12% tax. Most states and numerous local governments also impose income taxes on those who live or earn money in their jurisdiction. For more information on how income tax is levied, visit smartasset.com.
An employer withholds payroll taxes from an employee's paycheck. The employer then pays that withheld amount to the government on behalf of the employee. In the US, federal payroll taxes are used to fund Medicare and Social Security programs. Some local governments may also levy a small payroll tax to fund maintenance and improvements on local services and infrastructure. Certain elements of payroll taxes are imposed only up to the annual limit, and the percentage of these taxes is applied uniformly amongst all employees. Self-employed workers (who do not have an employer to collect and remit payroll taxes on their behalf) are responsible for both the taxes usually paid by employees and the portion paid by employers. Investopedia.com has great information on payroll taxes.
A sales tax refers to a tax on goods or services levied at the point of sale, meaning the consumer pays it. There is no federal sales tax, as it is governed at the state level, but in certain jurisdictions in the US, multiple different levels of government may impose a sales tax (i.e., state, city, county). Certain goods and services are often exempt from sales tax, including education, food, and medicine. The growth of remote sales (out-of-state catalog, mail-order, and e-commerce purchases) has increased the incidence of noncompliance with sales tax payments and has impacted state revenues. According to taxfoundation.org, where there is a significant difference in sales tax rate between neighboring jurisdictions, consumers will often make their major purchases in the lower-taxed adjacent area or online.
An excise tax is levied on specific items or activities that are generally deemed unhealthy, damaging to the environment, or morally objectionable. Tobacco, alcohol, and gasoline are prominent examples of goods subject to excise taxes, while gambling is an example of an activity subject to excise tax. Excise tax is levied at the time of the manufacture of goods rather than at the time of sale. The excise tax cost is then factored into the final sales cost of goods, effectively concealing the excise tax cost from the consumer. The funds derived from excise taxes are often funneled into programs to mitigate some of the harmful societal costs of the corresponding item or activity. If you're interested in more detail about the collection and use of excise taxes, check out taxpolicycenter.org.
Property taxes are administered at the local level, and rules can vary wildly depending on the jurisdiction. Properties subject to property tax include land, buildings, and permanent fixtures (or improvements) that would cause damage to the property if removed. Properties owned by religious, educational, or charitable organizations are typically exempt from paying property tax. Often multiple jurisdictions are authorized to tax the same piece of property. For example, one single property might be taxed by a town or city, plus a county or parish, plus a school district, and perhaps more. The amount of property tax due is calculated annually by computing the fair market value times an assessment ratio (giving you the assessed value), times the tax rate. Local officials determine the fair market value of a property. However, the property owner may dispute that value. Failure to pay property taxes can result in the taxing jurisdiction seizing and selling the property. Taxfoundation.org has a map showing property tax rates by state and ranking them from highest to lowest. See where your state ranks.
Most estates are far too small to be subject to the estate tax because in 2021, the federal estate tax applies only when the estate assets are worth $11,700,000 or more. See what CNBC has to say about how many people currently pay the estate tax. Estate taxes are assessed on the estate's fair market value, not what was initially paid for the assets by the deceased. The unlimited marital deduction allows a surviving spouse to inherit any value of asset with that value not counting toward the total value of the estate and not being subject to the estate tax. Charitable donations, debts, or fees associated with the estate are also exempt from inclusion in the total calculation of the estate's value. Some states levy an estate tax in addition to the federal estate tax, however, this is generally unpopular, and the number of states assessing estate taxes is dropping. Still, fewer states instead (or, in the case of Maryland, also) levy an inheritance tax, which the heir must pay.
The federal gift tax applies to a living person giving money or property of value to another individual. The gift donor is responsible for reporting the gift on his tax return and paying applicable taxes on that gift.
(Under particular circumstances, the receiver of the gift may pay the tax.)
The reason behind the federal gift tax is to deter taxpayers from distributing money or valuable items to other people to lower or avoid paying income tax. There are exclusions to the gift tax, both an annual and a lifetime amount. In 2021, the annual exclusion is $15,000 per recipient of a gift from a donor, and the lifetime exclusion is $11,700,000. There are also a couple of strategies one can use to avoid or minimize the gift tax. Spouses may each gift the same recipient $15,000 in 2021, effectively doubling the exclusion amount in a calendar year. That strategy is called gift splitting. By establishing a specific trust (typically a Crummy trust) through which the gift would be given, the gift recipient is permitted to withdraw the trust's assets within a given period non-taxed. In addition to the above exclusions and strategies, gifts made to the donor's spouse, a charitable organization, a political organization, or directly to cover medical or educational expenses of the recipient are generally exempt from the gift tax. But beware of triggering a gift tax return. Nerdwallet.com tells you what to watch out for.
Undoubtedly the tax system in the United States is complex, but understanding these basics is a crucial first step to your financial planning for now and in the future.