Taxes are a significant part of our financial and estate planning. A deeper understanding of the tax system is a valuable tool for each individual living in the United States. Although paying taxes may be unpleasant, it is a necessary step to ensure that we live in a civilized society.
We have created an overview of the general tax system to guide you through your economic planning. These provisions are current as of 2021 and may change as early as next year or future years.
Types of Taxes
There are numerous types of taxes and these vary from state to state. This is due to the different services they offer and their local needs. Some taxes are automatically deducted from your monthly paycheck and others apply to specific transactions or events.
There are three main categories of taxes in the U.S:
This is one of those taxes that are automatically subtracted from your salary to cover national service providers. It can be imposed on either a federal, a state, or a local level. The income tax is a progressive one, meaning that the higher your income is, the higher the tax rate.
The rates of the payroll tax (another name for the income tax) vary from time to time. It is based on the current economy and adjusts accordingly. For example, the federal tax rate for 2021 was between 10% and 37%. In any case, there are possible reductions, credits, and allowances for local taxpayers.
Both employers and employees must contribute to payroll taxes as follows:
- 65% for the Federal Insurance Contribution Act (FICA)
- 2% for the national Social Security System - doubled by the employer to a total of 12.4%
- 45% for Medicare - also matched by the employer (2.9% in total)
Self-employed individuals must contribute the full amount of 15% themselves.
Property (real estate or ad valorem) taxes are based on the property’s value, the purpose of which is to fund local services. Homeowners are liable for property taxes on an annual or monthly basis. When there is a mortgage, owners can include the tax in their mortgage repayments; they may also qualify for a mortgage interest deduction.
Capital gains taxes apply to any profits that emanate from the sale of an asset, e.g. a house, a stock, or bond transactions. The capital gains tax rates vary from 0%, 15%, to 20%, depending on the taxable income amount.
An estate includes both tangible and intangible assets, such as cash, real estate, insurance and securities, cars, boats, and business interests. Estate taxes are imposed on the transfer of any such asset upon the owner’s death. Tragically, they are called ‘death taxes’ - people feel that this is some sort of penalty for dying.
Nevertheless, less than 1% of the population is liable for the estate tax because it exempts the first $11.7 million for an individual and $23.4 million for a married couple. The highest estate tax rate is 40%.
There is also a potential gift tax when you transfer assets to someone during your life. The first $15,000 of any gift is exempt from tax and does not require a gift tax return. The gift-giver is responsible for any taxes owed on a gift. However, there is a lifetime gift tax exemption that applies to gifts up to $11.7 million dollars that can be made before gift tax would be paid. Even if the gift is over $15,000, you generally won’t owe tax (unless the value of gifts over your lifetime is greater than $11.7 million), but still would be required to file a gift tax return to show your use of the exclusion.
Taxes on Goods and Services
Another common tax is sales tax which is imposed on purchases of products or and sometimes on services. The rate of sales taxes depends on the tax rates of each state, county and even individual cities or towns. Some states exempt certain products from sales tax, but this varies greatly between states.
Similarly, excise taxes apply to specific products, like gasoline, cigarettes, or airline tickets. You can avoid certain excise taxes if, for example, you don’t smoke cigarettes, though many excise taxes may be harder to avoid, like hotel accommodation, gasoline, or cell phone services.
Who Is The IRS & Why Do I Owe The
The International Revenue Services (IRS) is the main government body of statutory law. It’s part of the Department of the Treasure and is responsible for:
- Collecting taxes
- Providing assistance to taxpayers
- Pursuing and resolving cases of erroneous or fraudulent tax filings
- Overseeing various benefits programs (e.g. the Affordable Care Act)
When there is an issue with your tax filing, the IRS will send a letter to let you know of the issue. The reasons they may contact you can vary from verifying your identity, requesting you pay your due balance or file tax returns, or questioning items on your tax return.
When receiving an IRS letter, it’s best to respond as soon as possible, especially in case of an unpaid amount or an audit. Any delays are likely to cause an increase in interest or penalties due. If you do not respond, the IRS can seek payment through liens or garnishments. If you are unable to pay the full amount due there are options. Depending on the amount due and your circumstances, you can apply for an online payment agreement, an installment agreement, or an Offer in Compromise where you can potentially reduce the amount you owe. You can also request a reduction in penalties that have been applied to your account.
Refunds or Tax Returns
If you are due for a refund, you can track your refund status online, by using your social security number or ITIN, your filing status, and your exact refund amount.
Once you file your return, the timing of your tax refund depends on various elements, such as whether the form contains an error or is incomplete, includes further claims (e.g. Earned Income Tax Credit or Additional Child Credit), or needs further review because of fraud suspicions.
Consequences of Not Paying on Time
The longer you leave your taxes unpaid the higher the amount will rise due to penalties and interest charged by the IRS and individual states.
Penalty fees start accumulating right after the payment due date passes, starting with a 5% increase each month and can rise up to 25%. In extreme cases, typically involving fraud, taxpayers may even face criminal charges. The IRS can access your bank accounts and claim the tax amount you refuse to pay, can garnish your wages or place liens on your assets. This can go on until you pay the full amount or come to an agreement with them.
McGann Law Group are specialists in all tax issues and can advise you on your tax planning. We can work with the IRS to get any issues resolved on your behalf.