Taxes to fund government operations come from a variety of sources. Understanding how much you pay, to whom, and what you have control over is a big part of the tax strategy in your wealth management process. Being able to manage around high-income years, years with large capital gains taxes, or understanding the tax-deductibility of property taxes is a detailed process that can make a substantial difference in your tax bill and therefore also in your net income! Below is a high-level breakdown of the major tax areas by type and gives some insight into when they come into play in your strategy.
Income taxes are most visible around tax time and dominate the headlines largely because of their ability to be imposed on what you earn with relatively few exceptions. They also change depending on the type and amount of income earned which promotes lots of opportunities to try and minimize how much you pay. Managing your income taxes is one of the areas of taxation where you have the most control, especially as a business-owner.
Payroll taxes also hit your income as it is earned but where income taxes are geared toward general operating revenue for the government, payroll taxes are typically earmarked for specific programs like Medicare and Social Security. They are also generally a flat rate structure so planning geared toward minimizing how much you pay is largely ineffective.
Value added taxes (VAT) or sales taxes are a tax on consumption, rather than income. The US has relatively low sales tax rates compared to much of the European Union and most of these levies are put on by state and local governments to fund their operations. There is no national sales tax (yet) here in the US.
Property and use taxes show up for specific activities and are typically levied again by state and local governments. Your vehicle registration fees would be a personal example or the severance tax levied on an oil and gas company based on how much oil they pump out (or sever) from the ground.
So now that we have gone through all the various major sources of taxation the real question becomes what to do about it? Having your financial team in place is a big start. Your advisory team should include both your financial advisor and CPA as well as possibly legal counsel depending on your needs. Being proactive in forecasting your income for the next year or two and designing your financial strategy around your tax needs is much more effective than being reactionary and just handing documents to your CPA. Also be sure to read our previous blog on potential business tax rate changes and what it means for your tax strategy.