What are taxes?

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Taxes are the mandatory payments corporations and individuals pay to the government. The government uses these tax revenues to finance projects, such as building infrastructure, schools, Medicare and Social Security programs.

Taxes are a part of every resident's life, but many people don’t know why they have to pay them. This guide will break down what taxes are, how they work and what the common taxes are to ensure you walk into the taxing season informed.

Key insights

Taxes are compulsory payments collected by the government.

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Tax evasion or deliberate underpayment of taxes is punishable by law.

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Taxes are the major source of government revenue in the United States.

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How do taxes work?

In the U.S., income tax is applied to money a taxpayer receives (taxable income) annually. The income could be from dividends, interest, salary or an inheritance. That tax revenue enforces laws, pays the national debt, develops and maintains infrastructure and caters for other government activities.

Tax revenue is used for the welfare of taxpayers, meaning the specific benefit received is independent of the individual’s payment. However, payroll taxes are an exception, as the taxpayer directly benefits from retirement benefits and medical coverage based on their contribution.

“Taxes are the mandatory cost that people and businesses pay to build our society and global system. This is the toll you pay to access the goods and services of (a) society,” said Tyler Weerden, financial planner and founder of Layered Financial. These goods and services include roads, education, public safety, and national and international security.

While most governments delegate agencies to collect taxes, in the U.S., the IRS handles tax collection.

» MORE: How to set up a payment plan with the IRS

Types of taxes

There are different types of levies imposed on residents. The federal government imposes corporate income and payroll taxes, and the state collects income and sales taxes. The local government also handles some levies, such as property taxes. Here are the most common types of taxes.

Income tax

Income tax is imposed on the taxpayer’s salaries, capital gains from an investment or wages. The U.S. has a progressive income tax system, meaning high-income corporations and individuals pay more taxes than low-income earners.

Payroll tax

Payroll tax is the tax employees and employers pay on tips, salaries and wages. It’s withheld from an employee’s paycheck by the employer, who remits the funds to the federal government, which uses them to cover Social Security and part of Medicare.

Sales tax

A sales tax is levied on the sale of goods and services, ideally to the final consumer. It’s collected when a customer buys a product online, at the store or pays for a service.

Estate tax

Estate tax is collected on inherited money or property. However, it’s uncommon since most estates aren’t wealthy enough to qualify for the federal estate tax.

In 2024, the federal estate tax applies to estates with a value exceeding $13.61 million, an increase from $12.92 million in 2023.

Property tax

A property tax is a semiannual or annual tax paid to the local government from real estate owners within its jurisdiction.

It’s levied on immovable possessions like land and structures. State governments also tax movable property, such as automobiles, boats, recreational vehicles and industrial equipment.

» MORE: Are personal loans taxable and considered income?

Who needs to pay taxes?

According to the IRS, most working U.S. citizens and permanent residents must file a tax return if their income exceeds a certain amount for the year. Paying taxes is involuntary, and tax evasion (failure to pay or a deliberate underpayment of taxes) is punishable by law.

Who is exempt from paying taxes?

Five main categories of taxpayers are exempted from paying tax. They include:

  • Not-for-profit organizations
  • U.S. citizens working abroad
  • Low-income taxpayers
  • Taxpayers with many deductions
  • Taxpayers with many dependents

» MORE: What is tax avoidance?

What happens if you don’t pay taxes?

If you don’t file your federal tax returns by the April deadline, the IRS will initiate its debt collection process. Your tax debt begins accruing interest and penalties.

If you still haven’t paid your taxes after a few months, you’ll receive a letter from the IRS showing how much you owe, followed by collection notices or calls.

Eventually, you’ll receive a Notice of Intent to Levy, a letter indicating the IRS is preparing to seize your assets to cover your tax debt. The IRS can claim a portion of your paycheck, home, car or bank accounts to cover that debt. Other consequences include having your passport revoked or going to jail.

It’s important to note that although tax evasion is punishable by law, you won’t go to jail for not having enough funds to pay your debt. There are tax relief programs to help taxpayers reduce their tax debt or come up with a payment plan.

» MORE: What is tax relief?

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Are U.S. taxes low?

Taxes in the U.S. are much lower than in other developed countries. Public spending in the U.S. is also relatively low compared to other rich nations.

How do income taxes work in the U.S.?

The U.S. has a progressive income tax system, meaning an increase in income increases your tax liability. Taxes are collected from individuals and corporations by state or city and credited to the government.

When can you start filing your taxes for the year?

The filing season started on Jan. 29 and ends on April 15. On years in which April 15 falls on a weekend, the tax deadline is typically extended to the next business day. This means if April 15 is a Saturday or Sunday, you'll have until the following Monday to submit your taxes.

Bottom line

Taxes fuel the economy, and tax revenue allows the government to provide its citizens with medical care, schools, infrastructure and security. While tax season isn’t everyone’s cup of tea, knowing how your tax contribution is spent can make the period bearable.

Understanding how taxes work can also help you file taxes better and manage your tax debt without straining your finances.

Article sources

ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:

  1. IRS, “Classification of Taxpayers for U.S. Tax Purposes.” Accessed March 2, 2024.
  2. IRS, “The agency, its mission and statutory authority.” Accessed March 2, 2024.
  3. IRS, “Activity 1: Progressive Taxes and You.” Accessed March 2, 2024.
  4. IRS, “Estate Tax.” Accessed March 2, 2024.
  5. IRS, “Who needs to file a tax return.” Accessed March 2, 2024.
  6. IRS, “Topic no. 201, The collection process.” Accessed March 2, 2024.
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