We all know that we have to pay taxes and I'm sure we all know that there's a lot of different taxes that we have to pay. This article will help you understand the various taxes as they're broken down into their related categories: income taxes, investment taxes, and other taxes.
As their name suggests, income taxes are taxes that you pay on your income. So if you make any money from a job that you might have, the government expects you to give them a portion of your income. They use a number of different taxes to ensure that they get a share of it.
Federal Income Tax: The government uses a federal income tax to raise money for government programs like defense and education. The United States has a progressive tax system, which means that people who make more money pay higher tax rates. So someone who makes very little money may only pay 10% in federal income taxes while someone who has a very high income can pay as much as 35% in just federal taxes. In order to determine how much money you have to pay in federal income taxes, you can find out what tax bracket you are in. If you're a young investor, you'll probably be in the 10% tax bracket but you can use this table to find out what you will be paying in federal taxes.
State Income Taxes: When you receive a paycheck, you'll also probably pay state taxes on the money you've made. Most states tax their citizens to help pay for state projects such as education. If you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming, consider yourself lucky because your state does not require you to pay state taxes. However, for those of us who do not live in these states, we're required to pay this tax, but it's considerably lower than the federal tax rates. Consult your state for more information on your state tax rate, as it varies from state to state.
Local Income Taxes: Some towns and cities impose local income taxes for their citizens. The money raised is typically used for things such as public schools, fire and police protection, and other local projects.
Medicare Income Taxes: Medicare taxes are taxes withheld from your paycheck to go towards aiding citizens over 65 years of age with their medical expenses. The standard Medicare tax rate is about 1.45% of your income.
Social Security Taxes: The Federal Insurance Contributions Act (FICA) tax, more commonly known as the "social security tax", is a tax on a person's income that is used to help fund social security. The money is used to help aid retired persons and disabled persons. The tax rate for this is generally about 6.2% and is withheld from your paycheck.
Seeing as how this is an investment book, it wouldn't be complete without a section on investment taxes. It's important to realize that if you make over $750 in one year from your investments that you will be responsible for filing an income tax return (which will explain in a little bit) and paying taxes on your profits.
When you sell a stock for a profit, the amount of money that you made is considered your capital gain. Along with dividends, the periodic payments you might receive from a stock you invest in, capital gains are seen as income and you are expected to pay taxes on this money.
You only pay taxes once you sell the stock. So if you buy a stock in 2004 and sell it in 2020, you will only have to pay taxes on it when it's sold in 2020. The tax rate that you pay also varies. If you hold the stock for less than one year, you will pay taxes based on your income tax bracket that you saw in the last table. However, if you hold the stock for more than one year, you qualify for a reduced rate. Use this table to determine your reduced rate:
So by looking at this table, it's pretty obvious that there are tax benefits for holding the stock longer than one year. If you buy a stock that soars immediately afterwards and you're thinking about selling it, it might not be wise to wait a year just for the tax benefit. But if you've held a stock for 10 or 11 months and you feel like it might be a good time to sell it, it might be advantageous to hold it for another month or two to save you on your tax bill. And, of course, you only pay taxes on money you've made from investments so if you lose money in an investment, you can sell it at any time.
It sometimes seems like there's no limit to the amount of taxes we face in our everyday lives. Luckily, as young investors, we're probably not faced with all of the taxes listed below but they're important to know nonetheless.
Sales Tax: Unless you're an Oregon resident, you probably have extensive experience with sales taxes. Local governments establish sales taxes to raise money for local projects like schools, prisons, fire departments, and police departments. The rate varies from city to city and some states actually allow certain products to be exempt from the tax.
Property Taxes: Property taxes are taxes that you pay on your real estate. The local government assesses the value of your real estate and determines how much money you should pay in property taxes. The money the local government raises is usually used for building schools, building and repairing roads, and snow removal. Until you own a house, building, or land, you won't have to worry about this tax.
Corporate Taxes: These are the taxes that companies pay on their profits. The rate ranges from as low as 15% up to as high as 39.5%, and is determined by how much the company makes in one year.
Excise Taxes: Excise taxes are commonly referred to as "sin taxes" because they tax things such as alcohol, tobacco, and gambling. Also, the tax we pay on gasoline for our cars is also considered an excise tax. The government issues these taxes to raise revenues and, at the same time, discourage the purchase or certain immoral items. Excise taxes actually tax the middleman who sells these items to us, rather than taxing us directly. However, they usually increase the price of the good in order to make up for the tax.
So, as you can see, there are a lot of different taxes out there. It's important to know which taxes you'll be responsible for paying so it's good that you've gotten a chance to learn about each one.
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