The three most common taxes
“What do you mean I owe?” Is a common question I think many accountants who do taxes hear every spring. I get it! The different kinds of taxes can be confusing at best.
In today’s blog, I want to break down the three most common taxes that individuals and small businesses pay: Payroll tax, Income tax, and Sales tax.
First of all, it’s important to point out that payroll taxes and income taxes are two completely different things even though they are both taken out of your paycheck each pay period.
Payroll taxes are taxes imposed on both employers and employees and they are calculated as a percentage of the employee’s salary.
The first payroll tax is Social Security, which is 6.2 percent of the employee’s gross salary. This funds all Social Security benefits. The second payroll tax is Medicare, which is 1.45 percent of the employee’s gross salary. Medicare funds benefits and health insurance for the elderly and disabled.
Here is where most people get confused. I hear this a lot: “But I already paid in all those taxes! How can I still owe?” I get why that’s confusing because both income taxes and payroll taxes come out of your paycheck. They are, however, separate taxes and are based on slightly different amounts.
Your federal and state withholding amounts you see on your pay stubs are actually income taxes and they are based on your taxable income, not your gross salary. They come out of your paycheck because the IRS got smart and realized that the average American wouldn’t save up what they owed in income tax and be able to pay it all in one lump sum April 15.
So, the feds developed a way for the American worker to have it taken out of their paycheck bit-by-bit each pay period. Come tax time, each person either paid too much or not enough into the government. If they paid too much, they get a refund. If they didn’t pay enough in, they owe the remaining sum.
Sales taxes are the third major form of taxation. Sales taxes are charged on various products and services sold by businesses. Businesses don’t get to keep that money! They have to turn around and submit it to the state. Each state has its own rules on what is taxed and what is not. To make things even more interesting, both cities and states can levy a sales tax.
Sales tax has been in the news a lot in recent years because of how it is managed with e-commerce. It used to be that no items purchased on the internet were taxed, thus increasing the appeal of e-commerce. But now, as more and more retailers are choosing online over bricks and mortar locations, the idea of paying sales tax for online purchases has become more common.
A major case, South Dakota vs Wayfair, was a landmark Supreme Court decision that has had a profound effect. The decision was that a state can charge a business sales tax even if that company does not have a physical entity located within the state. The sales tax is for items purchased by people who live in that state. The company qualifies for having to pay sales tax if it has made a certain amount of sales in that state.
Dealing with all the different kinds of taxes can be complicated, especially for a business owner trying to manage their daily operations while keeping their books and filing sales tax and payroll taxes on time. Here is where I can help! Give me a call.