Most taxes can be divided into three buckets: taxes on what you earn, taxes on what Read this article you buy, and taxes on what you own.
It’s important to remember that every dollar you pay in taxes starts as a dollar earned as income. One of the main differences among the tax types outlined below is the point of collection—in other words, when you pay the tax.
For example, if you earn $1,000 in a state with a flat income tax rate of 10%, $100 in income taxes should be withheld from your paycheck when you earn that income.
If, a week later, you take $100 from your remaining earnings to purchase a new smartwatch in a jurisdiction with a 5% sales tax, you’ll pay an additional $5 in taxes when you purchase that item.
Altogether, $105 of your initial $1,000 in income has been collected in taxes, just not at the same time.
With that in mind, below is a brief overview of the main types of taxes you should know to be an educated taxpayer.
Taxes on What You Earn
Individual Income Taxes
An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns.
Many individual income taxes are “progressive,” meaning tax rates increase as a taxpayer’s income increases, resulting in higher-earners paying a larger share of income taxes than lower-earners.
Corporate Income Taxes
A corporate income tax (CIT) is levied by federal and state governments on business profits, which are revenues (what a business makes in sales) minus costs (the cost of doing business).
Businesses in U.S. broadly fall into two categories: C corporations, which pay the corporate income tax, and passthroughs—such as partnerships, S corporations, LLCs, and sole proprietorships—which “pass” their income “through” to their owner’s income tax returns and pay the individual income tax.
Payroll Taxes
Payroll taxes are taxes paid on the wages and salaries of employees to finance social insurance programs. Most taxpayers will be familiar with payroll taxes from looking at their paystub at the end of each pay period, where the amount of payroll tax withheld by their employer from their income is clearly listed.
In the U.S., the largest payroll taxes are a 12.4 percent tax to fund Social Security and a 2.9 percent tax to fund Medicare, for a combined rate of 15.3 percent. Half of payroll taxes (7.65 percent) are remitted directly by employers, with the other half withheld from employees’ paychecks.
Capital Gains Taxes
Capital assets generally include everything owned and used for personal purposes, pleasure, or investment, including stocks, bonds, homes, cars, jewelry, and art. Whenever one of those assets increases in value—e.g., when the price of a stock you own goes up—the result is what’s called a “capital gain.”
In jurisdictions with a capital gains tax, when a person “realizes” a capital gain—i.e., sells an asset that has increased in value—they pay tax on the profit they earn.
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