Income Tax Fundamentals - Why Are Taxes So Important?

Taxes are an everyday expense of life that allow your local, state, and federal governments to provide important services. Taxes pay the bills for those services such as Medicare, Medicaid, the military, the national debt, police and fire protection, public schools, road maintenance, parks, libraries, and safety inspection of foods, drugs, and other products.

You pay some type of tax every time you get a paycheck, buy a new CD, or fill up your car’s gas tank. Each year the Tax Foundation, an independent public policy research group, determines how much of the year the average person works to pay taxes. In recent years, “Tax Freedom Day” came in early May. This means that from January 1 until early May, all the money you earn goes toward paying taxes.

Effective tax planning can help you to have money left after paying taxes and living expenses. Use several strategies to plan for taxes. First, find out how the current tax laws and regulations affect you. Second, maintain complete and accurate tax records. Third, learn how to make decisions that can reduce your tax liability, which is the total amount of taxes owed. If you follow these strategies, you will pay a fair share of taxes while taking advantage of tax benefits that allow you to owe less money.

Types of Taxes, What are the different types of taxes?

Throughout your life, you will pay different types of taxes in four major categories: purchases, property, wealth, and earnings.

Taxes on Purchases

You probably already pay sales tax each time you buy a product. These taxes are added to the prices of most products you purchase and are collected by state and local governments. Many states do not charge sales tax on food and medicine. Another type of sales tax is an excise tax, a tax on specific goods and services (such as gasoline, air travel, and telephone service) collected by federal and state governments.

Taxes on Property

Real estate property tax is a major source of income for local governments. This tax is based on the value of land and buildings. As the value of any real estate, such as a home, goes up, the amount of tax advantages on property may increase as well. In some areas of the country, state and local governments may assess taxes on the value of property, such as automobiles, boats, furniture, and farm equipment.

Taxes on Wealth

An estate tax is a federal tax collected on the value of a person’s property at the time of his or her death. Unfortunately, that is not always the end of tax liability. States may collect an inheritance tax. An inheritance tax is a state tax collected on the property left by a person to his or her heir(s) in a will. Therefore, before heirs can claim their inheritance, they have to pay the inheritance tax.

Another type of federal tax on wealth is the gift tax. A gift tax is a tax collected on money or property valued at more than $11,000, given by one person to another in a single year. However, gifts of any amount that are designated for educational or medical expenses are not subject to gift taxes.

Taxes on Earnings

Income tax is the tax on wages, salaries, and self-employed earnings. Wages are payments received for hourly work, but salaries are payments received for weekly or monthly work, regardless of the number of hours worked. The personal income tax, or tax you pay on the income you receive, is the federal government’s main source of revenue (money). Social Security funds are also collected as a tax. These funds finance retirement, disability, and life insurance benefits of the federal government’s Social Security program. Current and future revisions to the Social Security program may affect amount of benefits.