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Introduction to Common U.S. Taxes
Even when taxes are not the focus of the discussion, tax implications of business transactions and property transfers often are considered in the decision making process. For example, should a business order and pay for next year's input at this time, or should a married couple give some of their property to their grandchildren. This page briefly introduces several common forms of U.S. taxes, such as income, estate and gift taxes. This discussion, however, is not intended to offer tax management strategies.
Income, estate and gift taxes are imposed by several levels of government: federal, state and infrequently, local governments. This discussion focuses on federal law; however, the basic principles of these several taxes often are similar regardless of which level government is imposing the tax.
All statements on this page are general descriptors; each topic contains numerous details and exceptions that are beyond the scope of this introduction. Readers are urged to seek competent professional advice before making decisions that have major tax implications.
Income tax is imposed on the income earned by individuals and other taxpaying entities, such as estates, trusts, and some businesses. The tax is paid by the person or entity that earned the income. The amount of tax is calculated annually as a percent of the taxpayer's taxable income for that year.
Income is defined to include wages, salaries, profit from business activities, and earnings from investments, such as rent, interest and dividends.
Income also includes capital gains, that is, the profit or gain a taxpayer realizes when a capital asset is sold. Land or corporate shares, for example, are capital assets. A taxpayer may buy a tract of land for $15,000. This cost is considered the basis (for income tax purposes) for this land. Several years later when the taxpayer sells the land for $22,000, the taxpayer will report a capital (taxable) gain of $7,000; that is, the $22,000 selling price minus the $15,000 basis.
Proceeds from loans, inheritances, and gifts are examples of transactions that are not considered income.
In calculating taxable income, certain expenditures are subtracted (deducted) from total income, such as business expenses (including depreciation of business assets and interest on business loans) and an allowance for certain personal expenditures (such as, property tax, medical expenditures and charitable contributions).
In summary, income tax is an annual tax imposed on income earned by individuals and other taxpaying entities.
Estate tax is based on the value of property held at time of an individual's death. The tax is paid by the estate before the property is distributed to heirs. The amount of tax is calculated as a percent of the value of the taxable estate.
The decedent's property that transfers to the decedent's surviving spouse or to charitable entities is not included in the taxable estate. Accordingly, an individual can assure no tax on their estate by arranging before death that all their property goes to the surviving spouse or charities at the time of death. Many individuals, however, want some or all of their property to pass to someone other than a spouse or charities. Accordingly, these persons will have property that is subject to an estate tax.
To further reduce the burden of an estate tax, federal law provides a tax credit. Restated, the personal representative of the decedent's estate will calculate the amount of estate tax on the decedent's property, but then subtract the amount of tax credit provided by federal law. For persons who die in 2009, the credit has the effect of allowing $3,500,000 of property to pass to heirs (other than the spouse and charities) without the estate having to pay a federal estate tax.
Several other points about inherited property.
A gift tax is based on the value of the property that is being given away. Any gift tax is the responsibility of the donor, and the amount of tax is a percent of the amount of the taxable gift.
This section introduces several other common taxes.
Property tax -- Property tax is generally imposed by local governments, such as cities, counties, school districts, and other local taxing authorities. The tax is based on the value of the taxpayer's property, such as their residence, business property, and land. The tax is calculated based on the appraised value of the taxed property and the "mil rate" imposed by the taxing authority (that is, a specified number of "tenths of a cent" in tax for every dollar value of property).
An individual's property may be subject to several property taxes, such as the school district, the city, the county, the local airport authority, and a special district assessment for a flood protection project. It is a common practice for each taxing authority to collect their tax through the county which then distributes the appropriate amount to each taxing authority. Thus, the property owner often pays the tax to the county for all the local taxing authorities.
Real property (land, buildings and fixtures) are often subject to property tax; it is not common for government to impose a property tax on personal property (such as, vehicles, home furnishings, jewelry). Property tax is generally collected each year.
Sales tax -- A sales tax is generally imposed by state and local governments to be paid by consumers for items they purchase, such as vehicles, meals away from home, furniture, and appliances. The tax is usually calculated as a percent of the retail selling price. The tax is paid by the consumer at the time of the retail purchase; the merchant tracks the tax collection and submits the proceeds to the taxing authority on a regular basis (e.g., monthly, quarterly).
Laws vary among jurisdictions; for example, some states do not impose sales tax on consumer items that are considered necessities, such as food, clothing and prescription medicine. Taxpayers need to familiarize themselves with sales tax laws in their jurisdiction due to the wide variation in practices among state and local governments.
Self-employment tax -- Self-employment tax is a federal tax imposed on earned income received by self-employed persons. It is comparable to employment taxes (Social Security and Medicare taxes) paid by employed persons and their employers. Earned income includes profit from a business that the self-employed person is operating (that is, a business in which the taxpayer is materially participating in operating the business). Earned income generally does not include rent, interest or dividend income.
This page introduced several types of U.S. taxes. An income tax is imposed on the taxpayer's income, whereas gift and estate taxes are based on the value of property that is transferred by the taxpayer during his or her lifetime and at the time of his or her death. Other common taxes include property tax (based on the value of property owned by the taxpayer), sales tax (based on the item's retail selling price) and self-employment tax (based on a self-employed taxpayer's earned income).
Last updated November 30, 2009
This material is intended for educational purposes
only. It is not a substitute for competent legal counsel. Seek appropriate
professional advice for answers to your specific questions.
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