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5 Different Types of Taxes and How to Minimize Them

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Income taxes may be on your mind during this time of year, but they’re not the only taxes you’re required to pay. Americans are on the hook for several different types of taxes throughout the year.

While most of us would prefer to minimize the taxes we pay – or not pay any taxes at all – the truth is that paying taxes conveys several important benefits. Still, nobody wants to pay more than their fair share. Fortunately, there are opportunities to reduce your tax burden and spread out the impact taxes have on your overall financial picture.

Here are five types of taxes you may be subject to at some point, along with tips on how to minimize their impact.

1. Income Taxes

Income Tax Monopoly Board Game Dice

Most Americans who receive income in a given year must file a tax return. Only if you earned less than the IRS-designated gross income limits can you forego filing a federal income tax return. For 2018 returns (those filed during 2019), the gross income limits are as follows:

  • Single: $12,000 ($13,600 if age 65 or older)
  • Head of Household: $18,000 ($19,600 if age 65 or older)
  • Qualifying Widow(er): $24,000 ($25,300 if age 65 or older)
  • Married Filing Separately: $5
  • Married Filing Jointly: $24,000 ($25,300 if one spouse is age 65 or older; $26,600 if both spouses are age 65 or older)

Many taxpayers who file a return are lucky enough to receive a refund on their taxes because they overpaid as a result of paycheck withholding. Of course, it’s also possible to owe more money at the end of the year, in which case you may need to adjust your withholding so you don’t find yourself in the same position next year.

Although writing a check to the IRS is never fun, keep in mind your taxes serve a purpose. The funds you pay are an important source of revenue for federal, state, and local governments because they’re paid regularly throughout the year, thus helping to balance budgets and keep smaller governments from having budget crises.

So the next time you’re feeling down about how much you’re paying Uncle Sam, consider the roads you travel to work each day, the military members who protect our country, and your grandparents who depend on their Social Security check each month. That’s your tax dollars at work.

What You Can Do to Ease the Burden

If you’re looking for ways to reduce your federal income tax bill, you have several options.

Tax Credits & Deductions

One of the most effective ways to lower your tax bill is by taking advantage of tax deductions and tax credits.

Although not everyone qualifies for credits, and the tax breaks you’re eligible to claim may change from year to year, they’re worth looking into or asking your tax preparer about.

Some of the more popular tax credits include:

Some of the more popular tax deductions include:

Investing

Another way to offset your income tax burden is to make tax-advantaged investments. The Tax Code incentivizes investing in several ways:

  • Capital Gains. If you’ve invested before, you’re probably familiar with capital gains, or the profit you make when selling appreciated stocks, bonds, and property. If you hold an investment for one year or more, any gain you make on the sale is taxed at long-term capital gains tax rates. For 2018, those rates are zero, 15%, or 20%, depending on your income. That’s significantly less than the highest marginal tax rate on ordinary income, which is 37% in 2018. If you sell an asset you’ve owned for less than a year, any gain is considered short-term and is taxed at your ordinary income tax rate.
  • Capital Losses. Every stock pick isn’t a winner. And while nobody wants to lose money on their investments, at least you can use those losses to lower your tax bill. When you file your tax return, you can use long-term losses to offset long-term gains and short-term losses to offset short-term gains. If you have more gains than losses, you can deduct up to $3,000 of capital losses against ordinary income, such as wages or profit from a business. Any remaining losses can be carried forward to the following year.
  • Dividends. If you invest in stocks and mutual funds, you’ve probably received a Form 1099-DIV at year-end that breaks down your dividend income into qualified and ordinary income. Did you know you might pay a lower tax rate on those qualified dividends? Qualified dividends come from shares of domestic corporations and certain qualified foreign corporations which you have held for at least a specified minimum period. These dividends are taxed at long-term capital gains tax rates, while ordinary dividends are taxed at ordinary income tax rates.
  • Tax-Exempt Interest. Some investments pay interest that’s exempt from federal income taxes. The most common way to earn tax-exempt interest is to invest in municipal bonds. Keep in mind, though, that interest from municipal bonds may be subject to the alternative minimum tax (AMT) and may be taxable at the state level.

State Income Taxes

Speaking of state income taxes, you can avoid them entirely if you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming. While you can’t escape federal income taxes no matter where you live, these seven states levy no state income tax on their residents. However, they might make up for it with higher sales taxes, property taxes, and excise taxes.

2. Excise Taxes

Excise Tax Letters Blocks

Speaking of excise taxes, you pay these when you purchase specific goods, and they’re often included in their cost. So if the product you buy is subject to sales tax, you might be paying tax on a tax. A common example is the federal gasoline excise tax of 18.4% (24.4% on diesel fuel). States also impose excise taxes on gasoline, the highest being Pennsylvania at 57.6 cents. The lowest is Florida at 4 cents.

Excise taxes are also charged on products such as tobacco and alcohol and activities such as wagering, road use by trucks, and tanning salons. Some states charge an excise tax on the sale of a home, which is usually paid by the seller. Excise taxes are not sales tax, so you can’t claim them as an itemized deduction on your federal tax return.

What You Can Do to Ease the Burden

Excise taxes are difficult to avoid, and they’re not usually apparent because they’re included in the price of the product. If you’re not interested in tobacco, alcohol, wagering, or tanning salons, you can avoid federal excise taxes on these products and activities. Driving a hybrid or electric car or relying on public transportation will help you avoid excise taxes on gasoline, at least in part.

Even so, some states impose an excise tax on public utilities, which the utility companies pass along to consumers. Unless you want to move to a cabin in the woods with no power, phone, or running water, you’ll have a tough time avoiding these taxes entirely.

3. Sales Tax

Sales Tax Post Its

Otherwise known as consumption tax, sales tax is more heavily levied on the wealthy merely because the more you consume, the more you are taxed. Because sales tax is assessed as a percentage of a product or service’s sales price, it’s a simple equation: The more you buy, the more you pay.

The federal government doesn’t get involved in setting sales tax rates. Instead, each state and local government sets their own. If you’ve traveled the country at all, you may have noticed that sales tax varies from place to place. Every state except Alaska, Delaware, Montana, New Hampshire, and Oregon assesses sales tax.

While the income tax is considered a progressive tax (the higher your income, the higher your tax rate), sales tax is considered a regressive tax (the tax rate is the same, regardless of your income). To illustrate, consider the following example:

Consumer #1:

  • Income: $500 per week
  • Groceries: $150 per week
  • Sales Tax on Grocery Purchases: $9.00
  • Sales Tax as a Percentage of Income: 1.8%

Consumer #2:

  • Income: $1,500 per week
  • Groceries: $150 per week
  • Sales Tax on Grocery Purchases: $9.00
  • Sales Tax as a Percentage of Income: 0.6%

For Consumer #1, who has an income that’s one-third that of Consumer #2, the amount of sales tax they pay, expressed as a percentage of their income, is three times higher than Consumer #2’s for the same purchase amount. That’s what is meant by a regressive tax: It falls heavier on lower-income earners.

In most states that have a sales tax, prescription drugs are excluded to reduce the overall tax burden on essential items, as well as to reduce the regressive effect. Only two states are the exception:

  • Illinois taxes prescription drugs at the state level, but at a reduced rate of 1%. All prescription and over-the-counter medications are tax-exempt at the local level.
  • Louisiana does not tax prescription drugs at the state level, but local areas can opt to tax them.

Most states also exclude groceries, but the sales tax treatment of groceries varies from state to state. Some fully exempt groceries; some exempt most groceries but tax candy and soda. Some have credits or rebates to offset the tax on groceries, and some tax groceries at a lower rate than other goods.

What You Can Do to Ease the Burden

Unfortunately, there aren’t too many ways to escape sales tax apart from making fewer purchases, shopping at garage sales, or using the barter system.

However, you might be able to get a tax deduction for the sales tax you pay. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) made permanent the provision to claim general sales taxes instead of states’ income taxes as an itemized deduction. This may be especially helpful to taxpayers who buy a new car, boat, or home addition and end up paying more in sales taxes than in state income taxes in a given year. It’s also a benefit for people who live in those states with sales tax that do not have a state income tax.

4. Property Taxes

Property Tax Homes Coins Stack Chalk

Property taxes are one of the oldest forms of taxation. In the United States, the funds typically go toward local concerns, such as sewage treatment, road maintenance, drinking water, and schools.

Property taxes are calculated based on the value of your property, which includes the value of the land itself plus the value of any buildings you have on it. Property taxes go up by predetermined amounts set by your county assessor or equivalent office.

Property taxes vary widely from state to state and are most often expressed as a percentage of property value. In New Jersey, for example, property taxes are an effective 2.4% of a property’s value annually, while in Hawaii, the rate is just 0.27%.

What You Can Do to Ease the Burden

You could rent or lease instead of buying a home, but you’ll still pay property taxes indirectly through your rent.

If you’re considering buying a home but are flexible about where you live, it makes sense to do your homework and find out where the lowest property tax rates are. No matter where you own a home, you may be able to save money on property taxes by appealing your home’s assessment. You may need to get your home appraised by a professional appraiser to prove that it’s not worth the value the county is using to calculate your tax bill. The process for appealing your taxes varies from state to state, so check with your local tax assessor or board of equalization.

Also, don’t forget you can claim your property taxes as an itemized deduction on your federal income tax return. However, keep in mind the Tax Cuts and Jobs Act of 2017 (TCJA) limited the deduction for state and local taxes to $10,000 ($5,000 if married filing separately). That includes state income taxes, property taxes, and sales taxes.

5. Estate Taxes

Estate Tax Gavel Scale Planning House

Federal estate taxes are one area in which most people can rest easy, especially starting with the 2018 tax year.

The TCJA increased the exclusion amount for estate taxes to $11 million – up from $5,490,000 in 2017. That means that a person who dies in 2018 can leave up to $11 million to their heirs tax-free. A married couple gets twice that amount. Any money inherited beyond this amount is taxed at a top tax rate of 40%. The limit remains in effect through the end of 2025.

Of course, through gifting, trusts, and other estate planning strategies, many wealthy individuals structure their estate in such a way that they are subject to very little estate tax. The Tax Policy Center estimates that only about 1,700 U.S. estates would owe estate tax in 2018 under the new law.

What You Can Do to Ease the Burden

If you’re lucky enough to be worried about passing more than $11 million on to friends and family, it’s time to involve a professional. As mentioned above, you can avoid or at least minimize the impact of estate taxes by establishing a trust or taking advantage of the gift tax exclusion.

Final Word

Remember, the tax filing deadline in April isn’t the only day you’re taxed as an American citizen. By learning more about the types of taxes you pay, you can reduce the amount you pay all year long. Get educated and maximize your savings.

Have you taken advantage of any of these tax strategies to reduce your tax burden? How did it work out?

Janet Berry-Johnson
Janet Berry-Johnson is a Certified Public Accountant. Before leaving the accounting world to focus on freelance writing, she specialized in income tax consulting and compliance for individuals and small businesses. She lives in Omaha, Nebraska with her husband and son and their rescue dog, Dexter.

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