5 Different Types of Taxes and How to Minimize Them
Income tax may be uppermost in your mind at the beginning of the year, but it’s not the only tax you’re required to pay. In fact, Americans are on the hook for several different types of taxes over the course of the year.
Most of us would prefer not to pay any taxes at all, but the truth is, there are several benefits to paying different types of taxes, as well as the opportunity to reduce your burden and spread out the impact taxes have on your financial picture. Here are five types of taxes many of us are subject to at some point, along with tips on how to minimize their impact.
Most Americans who receive income in a given year must file a tax return. Only if you earned less than the IRS-designated gross income limits can you forego filing a return. For the 2018 tax filing season – filing for 2017 – the gross income limits are as follows:
Many of us who file a return may be lucky enough to get a refund on our taxes because we overpaid – a result of paycheck withholding. Of course, you might find that you owe money at the end of the year, in which case you may need to adjust your withholdings so you don’t find yourself in the red come tax day next year.
Even though writing that check to the IRS hurts, keep in mind that your taxes serve a purpose. The funds you pay are an important source of revenue for federal, state, and local governments because they are paid regularly throughout the year, thus helping to balance budgets and keep smaller governments from having budget crises. Also, the next time you’re feeling down about how much you’re paying Uncle Sam, look around at the schools in your community, your police department, and the roads on which you’re driving – that’s your tax dollars at work.
If you’re looking for ways to ease your tax burden, you can do the most to affect your personal income taxes through personal tax deductions and credits. Although not everyone qualifies for credits, and your situation may change from year to year, it’s worth looking into or asking your tax preparer if you might qualify.
Some of the more popular tax credits include the following:
And, here are some of the more popular tax deductions:
Another way to offset your tax burden is to make smart moves with investments. If you’ve invested before, you’re probably familiar with capital gains taxes, which are taxes on the profit from the sale of stock, bonds, or property.
Long-term capital gains tax rates vary depending on your annual income and how long you held the investment. If you hold an investment for one year or less, a gain is considered short-term and is taxed as ordinary income at your current income tax rate.
If, however, you hold an investment for longer than one year, the maximum net capital gain tax rate is 28%, in the case of collectibles. The maximum long-term capital gains for most securities (stocks, bonds) is 20%, but may be as low as 0% if your marginal tax bracket is 10% or 15%. Remember, before you sell a stock or bond, take a look at how long you’ve held the investment – hanging onto something a bit longer could save you significant money.
If you make a bad investment and you have capital losses that total more than your capital gains, you can deduct the difference on your tax return. Keep in mind, these losses are limited to $3,000 per year (for the 2017 tax year), or $1,500 for people married and filing separately.
Also, if you’re interested in completely avoiding state income taxes – and who wouldn’t be? – it’s always an option to pack up and move to Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming. While you can’t escape federal income tax no matter where you live, none of the above states charge state income tax, though they may make up for it with higher rates for sales tax, property tax, or excise tax.
Speaking of excise taxes, these are taxes paid when purchases are paid on a specific good. They are often included in the price of the good. So, if the good is subject to sales tax, you may be paying tax on a tax. A common example is federal gasoline excise tax of 18.4% (24.4% on diesel fuel).
States also impose excise taxes on gasoline, the highest being assessed in Pennsylvania at 58.2 cents, in addition to the federal tax. The lowest rate is 12.25 cents in Alaska. Excise taxes are also imposed on activities, such as wagering, road use by trucks, and tanning salons. Some states charge an excise tax on the sale of a home, usually paid by the seller. Excise taxes are not sales tax, so they are not deductible as an itemized deduction on your federal tax return.
Excise taxes are difficult to avoid, and not usually apparent because they are included in the price of the product. However, moving to a hybrid or electric car might help to avoid the taxes on gasoline, at least in part. Even so, some states impose a public utility excise tax, which would typically be passed along to consumers.
This being said, the tax on utilities might well be less than on gasoline. Taking public transportation would reduce your gasoline tax, though you would pay some of it indirectly, if the public transportation is gasoline or diesel powered. Tanning in the sun, rather than at a tanning salon, would help you avoid the 10% excise tax imposed there, which, curiously enough, is part of the Affordable Care Act.
Otherwise known as sales tax, consumption taxes are more heavily levied on the wealthy in the sense that the more you consume, the more you’re taxed. Because this tax is assessed as a percentage of the sales price, it’s a simple equation: The more you buy, the more you pay. The Federal Government doesn’t get involved with setting sales tax; rather, all rates are set by state and local governments. If you’ve traveled the country at all, you can probably attest that these taxes vary greatly from place to place. Every state except Alaska, Delaware, Montana, New Hampshire, and Oregon assesses sales tax.
While the income tax is considered a progressive tax, the sales tax is considered a regressive tax. What this means is that for income tax, the higher your income, the higher your tax rate. For sales tax, the tax rate is the same for each purchase amount, regardless of the purchaser’s income. To see how sales tax works as a regressive tax, consider the following example:
Consumer One, with an income that is one-third of Consumer Two’s, pays a sales tax percentage-of-income three times higher than Consumer Two on the same purchase amount. That’s what is meant by a regressive tax; it falls heavier on lower-income earners.
In most states that have a sales tax, groceries and prescription drugs are excluded to reduce the overall tax burden on essential items, as well as reduce the regressive effect. The only state that taxes prescription drugs is Illinois, at 1%. Thirteen states tax groceries, three fully (Alabama, Mississippi, South Dakota), four with credits or rebates to offset the tax on groceries (Hawaii, Idaho, Kansas, Oklahoma), and six tax groceries at a lower rate (Arkansas, Illinois, Missouri, Tennessee, Utah, and Virginia).
You may have noticed that sometimes you don’t pay sales tax on items bought over the Internet via online shopping. As long as the retailer doesn’t have a physical presence in your state, they don’t have to charge sales tax. If, however, the retailer does have a storefront in your state, you’re taxed just as if you were shopping in-store. However, states look at Internet sales as a prospect for sales tax revenue growth. States with a sales tax typically also have a “use tax,” which people who buy out of state are supposed to pay.
Unfortunately, there aren’t too many ways to completely escape sales tax. Of course, you could make fewer purchases, look to use the barter system, or always make a point to shop from online retailers that don’t maintain a presence in your state, but even in this last case, you should declare the purchases and pay use tax.
Also, per the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act), the provision to claim general sales taxes instead of state income taxes as an itemized deduction was made permanent. This can be especially helpful to someone who perhaps purchased a new car, boat, or home addition and ended up paying more in sales taxes than in state income taxes in a given year. It is also of benefit to folks who reside in those states that do not have an income tax (hence, no state withholding tax).
Property taxes are the oldest form of taxation, and in the U.S., the funds usually go toward local concerns, such as sewage treatment, road maintenance, and drinking water. They’re calculated based on the value of your property, which includes the value of the land itself plus the value of any buildings you have on it, such as your home. Property taxes go up by predetermined amounts set by your county assessor or equivalent office.
Property taxes vary widely from state to state, and are most often expressed as a percentage of property value. In New Jersey, for example, property taxes are an effective 2.38% of a property’s value annually, while in Hawaii, the rate is just 0.28%. If you’re considering buying a home, but are flexible about which state you choose to purchase in, it makes sense to do your homework and find out where the lowest property tax rates are.
One thing you can do is rent or lease instead of own. This way, the property tax is paid indirectly through your rent. But if you do own, you may save money on your property taxes by appealing the property tax assessment on your home. You must get your home appraised by a professional appraiser to prove that it is not worth the value the county is using to set your tax amount.
It’s especially important to get an appraisal if the value of your home has declined – or at least if the value of comparable homes in your neighborhood have declined. The process for appealing your taxes varies from state to state, so check with your local tax assessor or board of equalization.
Also, don’t forget that you can deduct your property taxes on your annual tax return. However, keep in mind that you can only deduct these taxes if you are the owner of the property. If, for example, your spouse owns the property, the taxes are only deductible on your spouse’s separate return, or on your joint return.
Federal estate taxes are one area in which the “average” person can rest easy – and the wealthy may sweat a little bit. For the 2017 tax year, the exclusion amount for estate taxes is $5,490,000. This means that a person who dies this year can leave almost $5.5 million to their heirs, tax-free. Any monies inherited beyond that amount are taxed at 40%. The exclusion rate for 2018 increases to $5.6 million per individual.
Of course, with judicious use of gifting, trusts, and other financial wizardry related to estate planning, many wealthy individuals secure their estate in such a way that they are subject to very little estate tax. For example, you can give a gift of up to $14,000 in 2017 without the recipient having to declare that income on their taxes. If a couple is giving a gift to a child or grandchild, the exclusion is $14,000 per giver, for a total of $28,000 tax-free. The exclusion amount increases to $15,000 in 2018.
If you’re lucky enough to be worried about passing more than $5.5 million on to friends and family, it’s time you involved a professional. As mentioned above, you can establish a trust or gift the money gradually to avoid taking a 40% hit. Thankfully, the majority of us don’t have to worry about paying estate taxes, and we can rest easy knowing that whatever we leave our loved ones can go to them without anyone having to pay a toll.
Remember, the tax filing deadline in April isn’t the only day you’re taxed as an American citizen. You can reduce the amount of taxes you pay all year long by learning more about the rules and regulations of sales, property, and estate taxes. Educate yourself and maximize your savings.
How are you minimizing your tax burden?
Gary’s extensive professional background varies from small business owner to school administrator. Most recently, he has been involved in taxes, first as a certified preparer, and later as a tax software developer. He is currently licensed to practice before the IRS, volunteers as an instructor for AARP’s Tax-Aide program, and has his own tax practice.
5 Different Types of Taxes and How to Minimize Them
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