Taxes: Understanding the Essentials
Navigating the tax system can be challenging for everyone, whether you're an adult who hasn't paid much attention to paycheck deductions or a young person starting your first job. A crucial first step in managing taxes is knowing when to seek help, which begins with understanding what can be taxed.
Here are some key points to help you or someone you know better understand the basics of our tax system.
Different types of taxes
When you think about taxes, income tax is often the first to come to mind. Income tax is what you pay on the earnings from your job or from selling products and services. However, many other types of taxes exist. Here are some of the most common:
• Payroll Taxes. Unlike income taxes, which can fund various government programs, payroll taxes specifically support Social Security and Medicare. This tax amounts to 15.3% of most employees’ paychecks, but half is typically covered by the employer.
• Property Taxes. These taxes are applied to property ownership, such as your home or vacation property.
• Sales Tax. This tax is levied on goods and services you purchase. While state and local governments primarily collect sales taxes, certain items like gasoline are also subject to federal sales taxes.
• Capital Gains Taxes. If you sell an investment or property for a profit, you may owe capital gains taxes. Selling stocks, homes, or rental properties at a profit could trigger these taxes.
• Estate Taxes. These are taxes applied to the assets within your estate after you pass away.
• Inheritance Taxes. As opposed to estate taxes, inheritance taxes are applied when you inherit money or assets after someone else passes away.
Not all income is taxable
While most of your income is taxable, some forms of income are exempt from taxation:
• Interest from municipal bonds is generally tax-free.
• Life insurance benefits often aren't taxed.
• Capital gains on the sale of your primary residence may be excluded up to a certain limit.
• Estate tax exclusions mean only estates exceeding a set dollar amount are subject to tax.
• Many employee benefits, such as health insurance, Health Savings Account (HSA) contributions, commuter benefits, and small employer-provided gifts, are also tax-free.
The tax rules governing these various types of income can be complex. That's why it's often helpful to have a professional guide you through your particular situation. Having a basic understanding of how taxes work, though, will help you to ask the right questions.
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