During the 4th of July weekend we talk a lot about freedom—and hotdogs—but we don’t usually talk about a major way we all continue to invest in that freedom: taxes. And don’t worry, I won’t personally charge you any taxes to read this!
So, what do we know about taxes? Politicians love to talk about them. They fund the government’s spending—sometimes spending we agree with, sometimes spending we don’t. And, of course, taxes are baked right into the story of America. Remember the Boston Tea Party? When colonists famously threw tea into the Boston Harbor and decided they’d rather start a revolution and build a global superpower than pay what they considered unfair taxes to the British crown.
Fast-forward 250 years, and we’re still debating what’s fair, what’s too high, and how taxes should be structured. But whether you love them or hate them, they keep our roads paved, our firework shows funded, and… you’re required to pay them. So, let’s talk about them.
Taxes: State vs Federal
One of the first things to understand is that not all taxes come from the same place. In the U.S., you have federal and state taxes. Federal taxes are collected by the Internal Revenue Service (IRS) and go toward national programs—think defense, Social Security, Medicare, and other government operations. State taxes, on the other hand, fund local needs such as public schools, transportation projects, and emergency services. While federal taxes come for us all with the same rulebook, state taxes vary depending on which state you live in.
Types of Taxes: The Greatest Hits
Taxes come in more flavors than Dr. Pepper or Mountain Dew these days… okay well maybe not more than Mtn Dew but you get my point. Here are a few of the main types:
- Income Taxes: The most familiar, these are taxes on the money you earn. Both the federal government and most states levy income taxes.
- Sales Taxes: Added to your purchases. Some states allow counties or cities to add an additional sales tax.
- Estate Taxes: Often referred to as the “death tax,” this applies to the transfer of wealth after someone passes away (though some estates are too small to owe it).
- Property Taxes: Based on the value of your home or land, used largely to fund local services.
- Luxury Taxes: Extra taxes on items considered non-essential or indulgent, such as expensive cars, yachts, or certain jewelry.
Tax Brackets: How Do They Work?
Now let’s talk about tax brackets, because they confuse nearly everyone at some point. In the U.S., we have a progressive tax system. That means, the more you earn, the higher percentage you pay—at least on the portion of income that falls within each bracket.
For example, if you’re in the 24% bracket, that does NOT mean all your income is taxed at 24%. Think of tax backets as buckets, once you’ve made over the limit for the 10% tax bracket, your income pours into the next bracket. Everything in the 10% bucket is taxed at 10% and everything in the 12% bucket is taxed at 12% and so on until you pour out your last dollar. So, if you are $1 over the 12% tax bracket—meaning you put $1 into the 22% bucket—that single dollar is going to be taxed at 22% while everything else you made is taxed at 12% and 10%.
This means Taylor Swift and you both pay $1,160 on the first $11,600 you make in a year! Stars… they’re just like us!
This system is designed to ensure those with higher incomes contribute a larger share to the country’s budget. Whether you consider that patriotic, frustrating, or a bit of both, it’s the framework that funds our nation.
I get it, taxes are about as fun to talk about as they are to pay. That being said, they don’t appear to be going anywhere so understanding how they work is a critical part of financial planning. We’ll dive more into the different types of taxes later but for now, go finish those leftover hotdogs!
Best,
Chandler