Americans pay different types of taxes, and most people discuss taxes in routine conversations. But how many people actually know what even the most basic terms and concepts mean?
As one indication of confusion and uncertainty, most people do not prepare their own returns, and rely on them and pay for help.
“Most Americans lack a basic understanding when it comes to tax policy,” the Tax Foundation said. “Taxes are complex and politicized.”
That’s why the foundation unveiled a free online “Tax Basics” guide to taxfoundation.org this month to help people make sense of common terms and concepts, warn them of common misconceptions, and provide other insights.
It comes at a good time, when the presidential election campaign has shifted in high gear, along with those for senate and house race scores – ripe environments for candidates to misinterpret tax bases and for horrific crowds to nod to.
Here are some important terms discussed in the Tax Foundation’s manual, as they relate to individuals (rather than companies). Two or three related terms are grouped together to help differentiate their meaning and pack it into more definitions.
Average tax rates vs. marginal rates
In the federal income tax system and that of many states, people pay taxes at successively higher rates because they make more money. On federal returns, the first dollars you earn in a year are taxed at a rate of 10%, followed by 12% on extra income and so on, up to a top rate of 37%, which triggers a few people. These are marginal rates.
If you divide your total tax revenue by your taxable income, you get the average rate, “the total share of income paid in taxes,” the foundation explained. The marginal rate, in contrast, is the tax rate that applies to the next, if last, dollar earned.
Marginal rates come in handy when you are thinking about taking a second job or when you are considering different investments. For example, the interest paid on municipal bonds is typically tax-exempt. Hence, those tax-free revenues are more valuable to people who pay taxes at high marginal rates than they are to those with lower marginal rates.
Deductions vs. credits vs. refuse credits
A deduction is a rule or provision that allows you to reduce your taxable income, possibly by making an expense or taking other actions (such as paying real estate taxes on a home).
Most taxpayers choose to take one standard deduction, as allowed in the federal tax code, instead of tracking and reporting all of their costs separately as specified deductions. But if you have a lot of deductible expenses – mortgage interest costs, charitable donations or state income taxes, for example – it may be wise to claim them separately.
Credits are more valuable than deductions because they cut your tax bills directly, dollar for dollar, instead of just the amount owed in tax. Credits are also less common than deductions, which means there are fewer chances for tax credit to choose compared to deductions.
Refundable credits, such as the earned tax credit for income, are even more valuable. With them, you can receive the entire dollar amount of the credit, even if it is larger than your tax deduction. With a non-refundable credit, you only get the benefit until your tax return falls to zero.
Deductions and credits are both typically transferred in law for the purpose of pursuing some social or economic cause, such as home ownership (mortgage interest and property tax deductions) or low-emission transportation (credits for buying electric cars). Deductions and credits therefore subsidize certain products as behavior.
Sales tax vs. rates vs. BTW
All three of these charges increase the cost of purchases. VAT, paid by most states and thousands of municipalities, but not by the federal government, applies to many retail goods and some services. Ideally, sales tax should apply equally to all products, the Tax Foundation argues, but governments usually issue exemptions for political or social reasons. Messages, for example, are not taxed.
You might think of rates as a completely different kind of animal, but they are also taxes that increase costs for consumers, businesses or both. Tariffs are imposed by the federal government on foreign imports. Their impact is less transparent to end-users, because middlemen absorb some of the costs, and because sales receipts do not charge tariffs.
Value added tax is another consumer tax. “The global average VAT rate is around 15%, with regional averages ranging from around 12% in Asia to 20% in Europe,” the foundation said. It described the US as “unique among large countries in that it levies state and local sales taxes instead of a national VAT.”
The average combined state and local sales tax rate in the U.S. is 6.6%, the foundation said, but it could be more than 9% in areas with high rates such as subway Phoenix and states including Tennessee and Louisiana.
Estate Tax Vs. inheritance taxes vs. wealth taxes
Three categories of taxes are or can be levied on the property of wealthy individuals. Estate taxes are fixed on a person’s net profit (assets minus liabilities) at the time of death and are paid before assets are distributed to beneficiaries. Inheritance taxes are equal, but are usually paid directly by beneficiaries. The federal government is introducing an estate tax, but few people oppose it, thanks to a current exemption of $ 11.6 million per person. There is no federal inheritance tax, although there has been in the past.
Several states impose these taxes, which can affect the willingness of rich people to live in those locations and thus an economic competitiveness of the state.
Twelve states, including New York, Illinois, Oregon and Washington, plus the District of Columbia, have had an estate tax since 2019, according to the foundation. Six, including Pennsylvania and New Jersey, had an inheritance tax. However, most states have moved away from these taxes or have increased exemption amounts so that fewer people are taxed.
Wealth taxes are levies on the net worth of a person while they are alive, with very wealthy individuals being targeted. According to the foundation, the US has never had a wealth of wealth, but the idea sometimes arises during election campaigns. Past Democratic presidential candidates Elizabeth Warren and Bernie Sanders, for example, each advocated the idea of imposing a wealth tax on multimillionaires and billionaires.
Contact Wiles at [email protected].
