Taxes: Definition, Types, and How They Work

Taxes are mandatory contributions levied by governments on individuals and businesses. They fund public goods and services—roads, schools, emergency services, Social Security, Medicare—and support the operation of government. Understanding how taxes are assessed and collected helps taxpayers manage finances and reduce tax burdens legally.

Key takeaways

• Taxes are compulsory payments collected by governments at local, state, and federal levels.
• Different taxes apply to transactions, income, property, corporate profits, imports, and estates.
• U.S. federal income tax is progressive (marginal tax rates); payroll taxes fund Social Security and Medicare.
• Legal tax avoidance (planning) differs from illegal tax evasion.
• Maintaining records and using planning techniques (e.g., tax-loss harvesting, estate planning) can reduce tax impact.

Who ultimately bears a tax

In economics, tax incidence describes who actually bears the burden—sometimes the entity legally taxed (a business) and sometimes end consumers (via higher prices). The accounting and legal taxpayer may differ from the economic bearer.

How income taxes work (U.S. overview)

U.S. federal income tax uses marginal rates: income is taxed across brackets so higher income portions face higher rates. Filing status (single, married filing jointly, head of household, etc.) and the source of income (wages, capital gains, dividends, interest) affect tax liability. Capital gains are taxed differently based on holding period:
* Short-term capital gains (assets held ≤ 1 year): taxed at ordinary income rates.
* Long-term capital gains (> 1 year): taxed at lower preferential rates.

Common types of taxes

Income tax

A tax on earned and unearned income. Progressive systems collect a larger share from higher-income taxpayers. Income sources that are commonly taxable include wages, business income, capital gains, dividends, and interest.

Payroll taxes

Withheld from employee paychecks to fund Social Security and Medicare:
* Social Security: 6.2% withheld from employees (matched by employers) up to an annual wage base.
* Medicare: 1.45% withheld from employees (matched by employers) on all wages.
* High earners pay an additional 0.9% Medicare surtax above specified thresholds.
Self-employed individuals pay both the employee and employer portions via self-employment tax, though they may deduct the employer-equivalent portion.

Corporate taxes

Taxes on corporate taxable income. Corporate taxable income is generally calculated as:
1. Sales revenue − cost of goods sold = gross profit
2. Gross profit − operating expenses (G&A, R&D, depreciation, etc.) = EBIT
3. EBIT − interest expense = taxable income
U.S. federal corporate tax is a flat rate (21% currently), with a minimum corporate book tax applying to very large corporations.

Sales taxes

Levied at the point of sale on goods and services. Rates and rules vary by state, county, and city; businesses collect the tax from customers and remit it to authorities.

Property taxes

Typically ad valorem taxes based on assessed value of real estate or tangible personal property (cars, boats). Local assessors determine values; rates (often expressed as mills per $1,000 of assessed value) and assessment frequency vary by jurisdiction.

Tariffs (import taxes)

Taxes on imported goods intended to protect domestic industries by raising the price of foreign goods. Tariffs can be ad valorem (percentage of value) or a fixed fee per item. They are often subjects of political debate.

Estate and inheritance taxes

Estate tax: levied on an estate’s taxable value above statutory exemptions; rates are progressive (federal rates currently rise up to a high marginal rate on amounts above the exemption). Inheritance tax: levied on beneficiaries receiving assets (fewer jurisdictions levy this). State rules can differ markedly from federal rules.

Tax delinquency and penalties

When taxes are not paid or reported by the due date, governments may impose:
* Penalties (fixed or percentage-based)
* Interest on unpaid amounts
* Liens on property
* Seizure of assets in severe cases
Deadlines vary by tax type and jurisdiction—sales taxes may be collected at the transaction, while income and property taxes have scheduled due dates.

Who has to pay taxes?

It depends on the tax and applicable rules. Examples:
* Federal income tax typically applies to those with income above set thresholds.
* Corporations pay corporate tax on taxable income subject to jurisdictional rules.
* Residents or property owners may owe state or local taxes where they live or hold assets.

Managing and minimizing tax impact (legal strategies)

• Maintain accurate records and documentation for income, deductions, and ownership periods.
• Use tax-loss harvesting to offset investment gains with losses.
• Engage in estate planning to structure transfers and reduce estate tax exposure.
• Use available credits, deductions, and tax-advantaged accounts appropriately.
• Consult tax professionals for complex situations and to ensure compliance.

Bottom line

Taxes take many forms and are applied in different ways depending on the transaction, income source, asset, and jurisdiction. Understanding which events trigger tax liabilities and the rules that apply enables better financial planning and legal tax minimization.