Four Types of Taxes Charged to Americans

Posted By: Advisor Analyzer Team

A very wise man once said there are only two guarantees in life: death and taxes.  Taxes come in all shapes and sizes are applicable to various aspects of our financial circumstances.  There are four basic categories of taxes that have a significant impact on the modern day individual.  Taxes that are charged on what you make, have, transfer, and spend. 

Taxes on What You Make

The most widely applied tax in the United States is a tax on labor earnings or what’s more commonly known as income tax.  Every mid April, working Americans pay Uncle Sam a portion of their wages for his tireless efforts to make this country great.  The taxes are not uniformly applied (as a flat rate such as sales tax) but rather on a progressive scale.  So the more you earn, the more you pay on a percentage basis. 

 

In addition to tax income tax, we pay social security tax that is charged a flat rate on our annual earned income.  Usually, the flat rate is paid by both the employee and employer, up to a threshold wages earned that varies with legislation.  There are also Medicare taxes and payroll taxes for unemployment insurance.  Of course for wealthier individuals, Alternative Minimum Tax (AMT) became in affect as of tax year 2000.  When all’s said, taxes on what you make are the most applicable tax to most individuals. 

Taxes on What You Have

Even when individuals do not generate any income, they are subject to tax liabilities.  These taxes are applied regardless of returns, such as property, intangible and inheritance taxes.  So an individual who owns either appreciated or depreciated property will still be subject to taxes payable annually, irrespective of any gains or loss in the property’s value.  They are simply charged (by the state) for reason of ownership.  However, valuation discounts may be applicable, that can potentially reduce the value of a holding which reduces the tax liability associated with owning the asset. 

 

This is vastly different from say stock investments, where the taxes applicable are based on realized returns and income received from the investment.  An investor who never sells an appreciated position will not be liable for any capital gains taxes.  If the position is sold for a loss, the loss can be used to offset any capital gains taxes owed and any residual losses are carried forward indefinitely.  So taxes are not applied to an investor who simply owns a position and has unrealized gains, but property taxes will (for the most part) always apply regardless of the returns.

Taxes on What You Transfer

Taxes are also payable for transfers of wealth, such as gift taxes and estate taxes.  Gift taxes are charged when the transfer exceeds an annual exclusion amount designated by the IRS.  Estate taxes are imposed when an individual transfers one’s taxable estate to heirs upon death.  Gift and Estate taxes are two of the most common forms of taxes imposed on the transfer of wealth.

 

With both cases, taxes are applicable regardless of the unrealized gains or loss of the position.  The assets transferred usually get a step up in basis to the market value of assets on the date of transfer.  Therefore, there may be a tradeoff between estate taxes and capital gains taxes, but the benefits are marginal at best.  Investors often use tax credits, establishment of trusts and gifting under the annual permissible exclusion amount to avoid or reduce the impact of taxes imposed on asset transfers.

Taxes on What You Spend

While not very applicable to investors, sales, excise and value added taxes are also applied whenever an individual makes a purchase of or improvement to assets, goods and services.  They should not be ignored completely however, since these taxes are implicit expenses to consider when creating one’s Investment Policy Statement.  After all, the goal of an investment portfolio is to supplement an individual’s required and desired consumption habits, so taxes applied to consumption should not be disregarded completely.

Conclusion

While not even grazing the surface of the multitude of taxes that are prevalent in our society, it is important to understand the general types of taxes that are applied today.  As man continues to make advances in medicine, we get closer to cheating death and one of the guarantees of life.  However, with the variety and prevalence of the different types of taxes applied,  we may reach immortality before we see the day taxes is no longer have an absolute presence to mankind.