In this article, we'll break down the most common types of taxes—income, sales, property, and capital gains—in simple, easy-to-understand terms. Whether you're trying to determine your paycheck deductions, planning a big purchase, or want more info about how taxes work, this guide will clear things up.

Defining Tax

In simple terms, a tax is a mandatory payment that individuals or businesses make to local, regional, or national governments. Taxes are a significant part of nearly every economy by providing[MB1] the main funding for public works like roads, schools, and government programs like Social Security and Medicare.

Taxes are mandatory payments that fund essential public services.[MB2] So, while you might not directly connect your taxes to a particular benefit you receive, they play a key role in improving the overall quality of life and keeping the economy on track for success.

Types of Taxes

Income Tax

Income tax is the money that is deducted from your paychecks, which is money that both individuals and businesses must pay based on their earnings. For individuals, this means taxes on wages, salaries, and other income. For businesses, it covers everything from corporations to small businesses and self-employed people.

In the United States, the Internal Revenue Service (IRS) handles all federal income taxes. Many states and local areas have their own income tax rules. For example, Florida and Tennessee are among the nine states that don’t charge a state income tax. In contrast, states like California and New York have high marginal tax rates, often exceeding 10%.

Sales Tax

Sales tax is the type of tax that’s added to your bill when you buy groceries or hire a cleaning service. Sales tax is a consumption tax on the sale of goods and services imposed by the government. Typically, this tax is added at checkout, collected by the retailer, and then passed on to the government.

Sales tax is only charged to the final buyer of a product or service. Since many products go through several stages of manufacturing, there’s a lot of behind-the-scenes paperwork to figure out who ultimately pays the sales tax. Sales tax rates usually range from 5% to 7%, with California having the highest at 7.25% and Colorado the lowest at 2.9% as of February 2024.

Property Tax

Property tax is a charge that local governments impose annually or semi-annually on real estate owners within their jurisdiction. This is called an “ad-valorem” tax, which means the amount you owe is based on a percentage of your property's assessed value.

In simpler terms, property tax is a tax on immobile property, like buildings or land. However, some local governments also tax movable property, like cars and industrial equipment. As most personal property values are high, property taxes are a major revenue source for most local governments in the US.

Capital Gains Tax

Capital Gains Tax comes into play when you sell an asset, and it is based on the increase in value during the time you owned it. The profit you make from selling stocks or other investments is called a capital gain. Importantly, this tax is only triggered when the asset is sold; if you hold the investment, no tax is due, regardless of how much its value has increased.

In the US, the tax rates for capital gains depend on the length the asset has been held. Short-term capital gains, from assets held for less than a year, are taxed at your ordinary income tax rate, up to 37%. Long-term capital gains, on assets held for more than a year, are taxed at a more favorable rate, typically between 0% and 20%, as of the 2023 tax year.[MB3]

The Bottom Line

Taxes are a fundamental part of financial planning, but understanding the basics can make managing your finances much easier. By understanding how income, sales, property, and capital gains taxes work, you can improve the decisions for your financial future. For more in-depth learning, visit Webull Learn, where you will find educational resources on stocks, options, ETFs, bonds, and more.