Sunday, 13 August 2017

Investopedia: Taxes


Indirect Tax

What is an 'Indirect Tax'

An indirect tax is a tax that is paid to the government by one entity in the supply chain, but it is passed on to the consumer as part of the price of a good or service. The consumer is ultimately paying the tax by paying more for the product. An indirect tax is shifted from one taxpayer to another.
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BREAKING DOWN 'Indirect Tax'
Import duties, fuel, liquor and cigarette taxes are all considered examples of indirect taxes.

Indirect taxes are defined by contrasting them with direct taxes. In the case of direct taxes, the person immediately paying the tax is the person that the government is seeking to tax. Income tax is the clearest example of a direct tax, since the person earning the income is the one immediately paying the tax. Admission fees to a national park is another clear example of direct taxation.
Examples of Indirect Taxes

The most common example if an indirect tax is import duties. The duty is paid by the importer of a good at the time it enters the country. If the importer goes on to resell the good to a consumer, the cost of the duty in effect is hidden in the price that the consumer pays. The consumer is likely to be unaware of this, but he will nonetheless be indirectly paying the import duty.

Essentially, any taxes or fees imposed by the government at the manufacturing or production level is an indirect tax. In recent years, many countries have imposed fees on carbon emissions to manufacturers. These are indirect taxes, since their costs are passed along to consumers.

Sales taxes can be direct or indirect. If they are imposed only on the final supply to a consumer, they are direct. If they are imposed as value-added taxes along the production process, then they are indirect.
Regressive Nature of Indirect Taxes

Indirect taxes are essentially fees that are levied equally upon taxpayers, no matter their income. As such, they are regressive taxes. For example, the import duty on a television imported from Japan will be the same amount, no matter what the income of the consumer purchasing the television is.

There are also concerns that indirect taxes can be used to further a particular government policy by taxing certain industries and not others. For this reason, some economists argue that indirect taxes lead to an inefficient marketplace and alter market prices from their equilibrium price.
Direct Tax
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Direct Tax
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What is a 'Direct Tax '

A direct tax is paid directly by an individual or organization to an imposing entity. A taxpayer, for example, pays direct taxes to the government for different purposes, including real property tax, personal property tax, income tax or taxes on assets. Direct taxes are different from indirect taxes, where the tax is levied on one entity, such as a seller, and paid by another, such as a sales tax paid by the buyer in a retail setting.
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BREAKING DOWN 'Direct Tax '
Direct taxes are based on the ability-to-pay principle. This principle is an economic term that states that those who have more resources or earn higher income should pay more taxes. The ability to pay taxes is a way to redistribute the wealth of a nation. Direct taxes cannot be passed onto a different person or entity; the individual or organization upon which the tax is levied is responsible for the fulfillment of the full tax payment.

However, this sometimes acts as a negative. Direct taxes, especially in a tax bracket system, can become a disincentive to work hard and earn more money, because the more money a person earns, the more taxes he pays.
The History of Direct Taxes

The modern distinction between direct taxes and indirect taxes came about with the passing of the 16th Amendment in 1913. Prior to the 16th Amendment, tax law in the United States was written so that any direct taxes were required to be directly apportioned to the population. For example, a state with 75% of the population in relation to another state would only be required to pay direct taxes equal to 75% of the larger state.

This antiquated verbiage made it so many direct taxes, such as personal income tax, could not be imposed by the federal government due to apportionment requirements. However, the passing of the 16th Amendment changed the tax code and allowed for the levying of numerous direct and indirect taxes.
An Example of Direct Taxes

Corporate taxes are a good example of direct taxes. If, for example a manufacturing company operates with $1 million in revenue, $500,00 in cost of goods sold (COGS) and $100,000 in total operating costs, its earnings before interest, taxes, depreciation, and amortization (EBITDA) would be $400,000. If the company had no debt, depreciation or amortization, and had a corporate tax rate of 35%, its direct tax would be $140,000, derived as: ($400,000 * 0.35) = $140,000.

Additionally, a person's income tax is an example of a direct tax. If a person makes $100,000 in a year and owes $40,000 in taxes, the $40,000 would be a direct tax.
Next Up Taxes

    Direct Tax
    Taxes
    Effective Tax Rate
    Indirect Tax
    Tax Rate
    Tax Base
    Hidden Taxes
    Income Tax Payable
    IRS Publication 514
    Net Of Tax

Taxes
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Taxes are generally an involuntary fee levied on individuals or corporations that is enforced by a government entity, whether local, regional or national in order to finance government activities. In economics, taxes fall on whomever pays the burden of the tax, whether this is the entity being taxed, like a business, or the end consumers of the business's goods.
BREAKING DOWN 'Taxes'

Taxes are levied by states upon their citizens and corporations to fund public works and services. Payment of taxes at rates levied by the state is compulsory, and tax evasion, the deliberate failure to pay one's full tax liabilities, is punishable by law. Most governments utilize an agency or department to collect taxes; in the United States, this function is performed by the Internal Revenue Service.

There are several very common types of taxes:

    Income Tax (a percentage of individual or corporate earnings filed to the federal government)
    Sales Tax (taxes levied on certain goods and services)
    Property Tax (based on the value of land and property assets)
    Tariff (taxes on imported goods imposed in the aim of strengthening internal businesses). 

However, tax systems vary widely among nations, and it is important for individuals and corporations to carefully study a new locale's tax laws before earning income or doing business there. 

Like many developed nations, the United States has a progressive tax system by which a higher percentage of tax revenues are collected from high-income individuals or corporations rather than from low-income individual earners. Taxes are imposed at federal, state and local levels. Generally speaking, the federal government levies income, corporate and payroll taxes, the state levies sales taxes, and municipalities or other local governments levy property taxes. Tax revenues are used for public services and the operation of the government, as well as the Social Security and Medicare programs. As baby boomer populations have aged, Social Security and Medicare have claimed increasingly high proportions of the total federal expenditure of tax revenue. Throughout United States history, tax policy has been a consistent source of political debate.

Capital gains taxes are of particular relevance for investors. Levied and enforced at the federal level, these are taxes on income that results from the sale of assets in which the sale price was higher than the purchasing price. These are taxed at both short-term and long-term rates. Short-term capital gains (on assets sold less than a year after they were acquired) are taxed at the owner's normal income rate, but long-term gains on assets held for more than a year are taxed at a lower rate, on the rationale that lower taxes will encourage high levels of capital investment.


Effective Tax Rate
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The effective tax rate is the average rate at which an individual or corporation is taxed. The effective tax rate for individuals is the average rate at which their earned income is taxed, and the effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed.
BREAKING DOWN 'Effective Tax Rate'

An individual's effective tax rate is calculated by dividing total tax expense from line 63 of his 1040 Form by his taxable income from line 43 of that form. For corporations, the effective tax rate is computed by dividing total tax expenses by the firm's earnings before taxes.
Which Taxes Are Included in Effective Tax Rates?

In many cases, effective tax rate only refers to income taxes incurred by taxpayers and does not include sales tax or other types of taxes. However, in other cases, analysts include excise taxes as well payroll taxes. This can be especially useful when trying to compare the effective tax rate of two or more individuals, as income tax is only a portion of the total tax paid by most taxpayers. To calculate effective tax with these inclusions, add together all of the tax under consideration and divide it by the individual's income.
Effective Tax Rate Versus Marginal Tax Rate

The marginal tax rate refers to the tax bracket into which a business's or individual's income falls. The effective tax rate is typically a more accurate representation of tax liability than an individual or business's marginal tax rate. For example, two companies with income in the same upper marginal tax bracket may end up with difference effective tax rates depending on the amount of their earnings that fall into each tax bracket.

For example, imagine a tax system where earnings under $100,000 are taxed at 10%, earnings between $100,000 and $300,000 are taxed at 15%, and earnings over $300,000 are taxed at 25%. Two businesses both fall into the upper tax bracket. However, one earned $500,000, while the other only earned $360,000. Both businesses pay 10% or $10,000 on their first $100,000 of earnings, and they both pay 15% or $30,000 on their earnings between $100,000 and $300,000. Both companies also pay 25% on their earnings over the $300,000 threshold, but that equates to $50,000 for one company and only $15,000 for the second company. With a total tax liability of $90,000, the company with $500,000 in revenue pays an 18% effective tax rate, while the company with $360,000 in income pays a total income tax bill of $55,000, making its effective tax rate only 15.2%.
Indirect Tax
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An indirect tax is a tax that is paid to the government by one entity in the supply chain, but it is passed on to the consumer as part of the price of a good or service. The consumer is ultimately paying the tax by paying more for the product. An indirect tax is shifted from one taxpayer to another.
BREAKING DOWN 'Indirect Tax'
Import duties, fuel, liquor and cigarette taxes are all considered examples of indirect taxes.

Indirect taxes are defined by contrasting them with direct taxes. In the case of direct taxes, the person immediately paying the tax is the person that the government is seeking to tax. Income tax is the clearest example of a direct tax, since the person earning the income is the one immediately paying the tax. Admission fees to a national park is another clear example of direct taxation.
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