 Income tax 2023-2024. Tax types or categories. Get ready and some coffee so you can recognize the quacks while doing income tax preparation 2023-2024. First a word from our sponsor. Actually we're sponsoring ourselves on this one because apparently the merchandisers they don't want to be seen with us but but that's okay whatever because our merchandise is is better than their stupid stuff anyways like our accounting rocks product line if you're not crunching cords using Excel you're doing it wrong a must-have product because the fact as everyone knows of accounting being one of the highest forms of artistic expression means accountants have a requirement the obligation a duty to share the tools necessary to properly channel the creative muse and the muse she rarely speaks more clearly than through the beautiful symmetry of spreadsheets so get the shirt because the creative muse she could use a new pair of shoes if you would like a commercial free experience consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com we now want to take a look at some categories of taxes some types of taxes these types and categories of taxes often coming up when we're listening to discussions about tax law these types and categories of taxes could be useful from a practical data input tax preparation standpoint as well in that they might give us a better understanding of the type of tax we are working on helping us to better understand the data input process and planning process for tax preparation and planning however these are often going to be terms that are useful when discussing different types of taxes in the format of what changes should we make to the tax law what type of tax would be the best for a particular type of situation also note that when we're talking about taxes there's not really anything new under the sun in other words governments have been taxing people for a long time they've gotten quite creative with taxes for a long time the question these days is what kind of tax is being applied in the particular situation and then what kind of little tweak might they be putting on it given the circumstance the particular circumstance that that tax is being applied to also note that when we talk about these blanket terms they are often used in political discussions in a similar way as the terms fair to have a fair tax or a just tax are used as basically very broad statements that don't really say anything that that has enough definition to be meaningful because they're basically just going to stick a label on something with these types of terms and label it as good or bad and then try to leave the discussion from there whereas usually things are much more nuanced than that there's much more complex than that and you have to kind of get into the weeds a little bit to see how the taxes are actually playing out in practice first category we have the flat tax or proportional tax we'll get into more detail about the definitions and how these work shortly let's first just lay them out and list them next we have the progressive tax and then we have the regressive tax now you can imagine just by the names presented here that if you have a political discussion that's happening about the tax code what kind of tax should be be in place what kind of changes should be made to the tax code the terminology of a progressive tax sounds kind of nice so even if you don't know anything about taxes you're probably like a progressive I kind of like the ring of that it sounds positive and then a regressive tax sounds kind of negative and then the flat tax sounds somewhat neutral but normally what will happen is they're going to say that the flat tax is a regressive tax so that's probably the argument that you're going to hear oftentimes when you hear these type of terms in political discussions they're going to be used as a labels to just negatively or positively tag a particular tax in a similar way as saying I want a fair tax system or an unfair tax system if you just label something as unfair that's you know that's it what's I want the fair one not the unfair one but really you have to you have to kind of dig down a little bit deeper to understand what's actually happening to make a fair choice rather than just try to label the things because these are very broad labels so let's go into the first one in more detail a flat or proportional tax now this is the the first kind of thing that you would probably think of when you if you were to try to implement a tax in and of yourself right so if you had a community for example and you're saying we need to have defense in this community which is basically what the federal government was originally designed for we need to have a standing army which is we can't just have a rag tag group a bunch of people that are going to somehow piece them together once we've been attacked right it's too slow so we need to have like an army we need to set something up so that we can have a fire brigade that's going to be set up quickly and so on and so forth well how would you do that well traditionally you would say well I'm going to I'm going to tax people based on their earnings and so you might say 10% for example which is you might recognize as like a charitable contribution in some you know religious areas 10% you would be like a flat type of tax and that means that if you make more money then you will be taxed more because 10% of $1,000 is going to be less than 10% of $100,000 so you can see that it's still a tax that's going to tax more as your as people's income levels rise is the general is the general idea so that's kind of like the baseline tax that you you would first have in mind it's probably the first thing that would come to mind if you were trying to think of a tax system so that you can put together community resources for the greater good which would usually be the for defense right for defense or for like a fire department or police or something like that so then you the one example of that is social security now social security this is not a perfect example and like I say in practice there aren't exactly perfect examples of like flat taxes usually or progressive taxes right they're not it is really more of like is this a more progressive tax or a flatter tax we can talk in terms of how progressive it is and how flat it is so for example with social security we have kind of a flat tax up until a point so for example if you make $40,000 the social security rate we're just like looking at the employee side and not the employer side is 6.2% and that means that the tax would be a 2004 80 for $40,000 if you made $100,000 the tax rate is the same that's what we mean by flat the rate doesn't change the income level did change and therefore the person that makes more money also pays more taxes so that's the general idea now note that we could argue that the social security system isn't exactly flat because it has a cap on it so I'll talk about that shortly but let's just look at what we have here and think about what are the pros and cons of a flat tax system well one of the benefits of a flat tax system is it's easy it's easy to calculate because I all I need to know is how much someone earned and then I multiply the same rate by the amount that they earned if they earned $100,000 I still just multiply by the same rate it's easily made projections to I can I can project how much the tax will be by projecting how much income I'm going to make and I don't have to do some complex calculation in order to get the number when we do payroll taxes that's when we typically have the social security tax calculation and we can typically calculate how much the tax will be as we pay people on a paycheck by paycheck basis and then when we do the informational form the 941 on a quarterly basis as opposed to a yearly basis the form similar to the form 1040 for federal income taxes for payroll taxes we don't have to deal with this oh we had to overpay so that we don't have a penalty or something like that why because we already knew exactly how much to to withhold and pay because it was an easy thing to calculate whereas obviously the income tax system we don't that's why we shoot for basically a refund so the ease is one of the benefits of another benefit of course is that as income levels go up then the people with higher income pay more into the system which is what we would kind of except expect is kind of fair because the higher earners can afford to pay more into the system number one and number two the higher earners are probably the ones that have more to lose in the event if you're talking about the military if a foreign person a foreign country came in and took all the land over here but the person that has higher income might own more of it right so they have more investment in things like military protection or something like that as well and we can see that as the income as people's income goes up they don't like lose incentive to make more money because the next dollar that they make will still be taxed at 6.2 percent so it's not like they're gonna make if they make a hundred and one dollars the next dollar they're gonna make is gonna be taxed at a much higher rate which you would think would disincentivize people to keep on generating revenue which we really want people to do you might say well why do I want people to keep earning money after a hundred thousand they have what they need past that point but the when we're thinking about the economy we're thinking about a pie that's growing so if they're actually getting paid for things that they are producing then they're actually increasing the GDP they're increasing the value of the stuff so we want to incentivize people to work because that increases the the pie it's not just about resources that are being redistributed because that would be like we're just redistributing the oil in the ground without making it into gas or something that's useless to people unless someone refines it into the gas and you know you have to have you have to have incentives for people to basically do that so the pie the pie the GDP pie is actually made up of production it's not just natural resources that are making up of the pie that we can just divvy up so it's not a fixed pie the pie needs to grow if you want to maximize the amount that individuals will get now I want to touch that the social security can be thought of as not a flat tax in the sense that it has a cap on it so if you get if you earn over a certain amount of money you actually stop paying money into the social security system and obviously you might look at that and say well that's crazy because now you're as someone earns more money they should be paying more into the system they shouldn't stop paying into the system if they have over like if they have two hundred thousand dollars they stopped paying into the system they should be they should have an increased tax rate why would that be the case and one of the rationales for this is that we we as a country seem to be like confused about our our social benefit programs the question is is social security a federally funded like retirement program which is more and more what it looks like or is it a safety net when social security was put in place in the 30s it was it seemed like it was thought more as a safety net program in other words people that were not able to save for retirement possibly because they're living longer than expected or had some kind of crisis we want to care for and make sure that we have a net a safety net for them but the social security isn't necessarily designed as everyone's retirement plan right but later later it seems like that it is like the social security program the tax rate has gotten pretty high and this is the employee portion the employer portion is matching that so so so that's you know 12.4 percent and so it seems like the social security is now acting as a federal funded retirement program that everybody should get you're going to pay into it and they structured it like that as well because it looks like a 401k plan where you put money in and the employer matches it so now there's this expectation that that everybody should get money out of it if I paid money into it I should get money out of it now when the money comes out of the social security it's it's it's somewhat tapered in terms of of the benefit of the money that went into it so the later dollars that go into social security you get less of a benefit of the money that comes out of social security so in other words if you thought it was a 401k plan the more money you put into the 401k plan the more you should get out in retirement but with the social security the higher income that you put into the to the to the social security system you're getting less of a benefit with the higher with the more money that you're putting into the system and at some point you don't get any further benefit so and so that's the rationale that that that we should have a cap on it because if you go over a certain threshold on the income you're not getting any benefit for what's supposed to come back to you when we're thinking about social security as basically a retirement program so the bottom line is this is one of the areas that we as Americans really need to basically look at do we want to have a a system that's like a federal retirement program we can't just yank the carpet out of the people that have already paid into it and have promises to it but it's somewhat bankrupt at this point in time the money that's going into it is being taken right out at this point in time to pay the retirements of the current people it's not being put into a savings account or anything like that so that's one of the one of the huge huge debates because it's a huge part of our our spending but let's continue on with our discussion then we have a progressive tax now the obviously the big example of a progressive tax is the the federal income tax system now with a flat tax we saw that as you earn more money you still pay more into the system because you would be paying you know whatever percent 6.2 percent in our case of higher income so if you make a thousand dollars times 6.2 you're going to pay less than ten thousand dollars times the 6.2 percent but we could get more progressive on the taxes and we can say that as your income goes up we're actually going to increase the rate so it's not just that you're going to pay 10 percent on the higher income you're going to pay 12 percent once you go over a certain threshold okay so i'll talk about this in more detail in a second but first let's just think about the pros and cons of that one of the pros is that that now we can say well the people that are getting more of a benefit are paying more into the system now again it used to be the argument was if you're paying for the military rich people should be paying more into the system because they own the property that the military is going to basically be defending right they're using the infrastructure that's being put in place more than normal people but this argument is a little bit more difficult to make when the major when as the spending shifts from military spending to like social welfare programs and stuff like that then then it's it might not be the the wealthy people that are getting the most benefit out of it but still the argument would be that you know obviously as income goes up they have more capacity to pay into you know the system so that's going to be you know one of the benefits of it what are the cons of the system well clearly it's a whole lot more complex to do so it's a lot harder for us this is one of the major reasons that we can't predict how much we should withhold out of our wages because the tax rates will change dramatically if there's a change or difference in how much earnings that we had some people argue well this isn't a problem because you have computers to figure that out it's a simple problem for a computer and that's true when you're a tax preparer because we will rely on the computer to basically do the progressive tax calculation however business people that are trying to invest and look into the future have to make projections like 10 years into the future and the projections get a whole lot more complex when your when your income levels change and then you have to deal with the different changes in the tax brackets and whatnot and then if you get into flow through entities and so on being taxed on the individual level versus the corporate level and then you have different taxes for capital gains tax versus ordinary income it really gets quite complex when you're trying to again make projections into the future also you have the system or the problem of the tax rates drastically possibly changing from period to period as administrations change so that's some of the difficulty with the taxes it could also be somewhat disincentivizing when you earn more money so in other words if if i'm if if i had a flat tax and i and i earn a lot of money i'm still incentivized to increase my production and make more stuff which would be good for gdp because the next dollar i make will still be taxed at the same rate but here then like if i'm if i'm moving from this bracket to this bracket i'm going from 35 percent to 37 percent so so there could be a a disincentive as you make more money to to basically make more money because more of that money is going to go to taxes and the taxes are a disincentive to make money in other words if you imagine that you were in a communist system where they just take all of your money and then they give it to the people that need it the most or they evenly distribute it what would be the incentive in that system for the people that are are making the stuff well the incentive would be to be a deadbeat right you'd want to make as little things as possible and then that's the that would be the incentive right you do as you do as little as possible and then get paid as much as you can which will be the same as your neighbor while doing less work right that's kind of the incentive that's why that's why really high you know socialistic or communist plans typically one reason they do not work right because if you take all the money no one's going to do any work right the the incentive will actually be to not work if you work your sucker right because you're going to get paid the same amount so the so the incentive structure so we want to keep an incentive structure that still doesn't decrease the the the desire to work because again the the the people that are working are making the actual stuff we don't have we have nothing to divvy up between between the people if people aren't making things there's there's no point in divvying up oil that's not refined into gas right there's a it doesn't you know someone's got to do the work before you have something they can actually be distributed okay so let's get a little now it's not as bad as it might look at at first when you're saying well if i make more if i make more money i'm going to get taxed at 24 percent as opposed to 10 percent it's not exactly like that because what happens is you're going to get you're going to get taxed let's look at the single bracket these are going to be the the filing types so single head of household married filing joint married filing separate that also of course adds a huge level of complexity because now we have a whole different set of tax brackets depending on our filing status which as you can imagine will have an impact on people for example deciding if they want to be single head of household which means they have a child a dependent or married filing joint right and so the serious questions could come up is the tax code incentivizing marriage is it incentivizing children is it incentivizing single family households versus two parent households in terms of how it's set up and we'll talk more about that later but right now let's just look at the progressiveness so let's just look at the single area so when it says 10 percent we're talking about 10 percent of zero to 11 000 and it's also a little bit confusing because we're talking about taxable income which is basically the bottom line of like the income statement part of the tax return meaning you have the the gross income minus the deduction which are the above the line deductions and then the standard or itemized deductions and then you have the taxable income which will then be applied the tax rate too so so then if you go over the 11 000 then then it's not like you're going to apply the 12 percent if you made 44 000 you're not going to be taxed entirely at 12 percent you will be taxed up to the 11 000 basically at the 10 percent and then the difference between the 11 000 and the upper threshold that you got to like 40 000 for example would be taxed at the 12 percent if you make over 44 7 25 let's say you make 80 000 then the first 11 000 in theory will be taxed at 10 percent from 11 000 to 44 7 25 at 12 percent from 44 7 25 up to the threshold in the bracket that you are in the marginal tax rate highest tax rate 22 percent in this case up from 44 7 26 up to whatever 80 000 we said was the cap so that's the idea of it so it's not so so if someone says they're in the 22nd tax bracket or something like that doesn't mean that they're paying 22 percent on all of their taxes if that's their marginal tax rate right that means that's the highest taxes which means the next dollar that they earn they are less incentivized to earn it because it'll be taxed at 22 percent then the first dollar they earned because the first dollar was only taxed at you know 10 percent that's going to be you know the general idea so you can see the rationale of this kind of you know it has some sense to it that we're going to try to increase the rates as we go up but you can see it's also quite complex like to try to try to say it's not only that the rates going up but i also have to look at these brackets in terms of single versus head of household and married and if i'm doing planning that becomes that becomes fairly cumbersome to do and to project out in other words as a tax preparer it's not going to be so bad because the tax software will do that for us but if you were to ask an average tax preparer how in the world did you get from an income of 80 thousand dollars to the tax that is owed they probably wouldn't be able to say well the software calculated that right because because it's so and then and if that's the case then the question is well and you have to have some idea we'll talk about this later because if you get into more complex taxes and planning then it becomes it becomes an issue because if they're like well what if i make what if i go from making 80 thousand to 110 thousand or something like that then what's going to be the different how much more should i be withholding how much more money am i going to owe well that becomes kind of difficult to calculate if you don't really understand how these brackets work because because you're not because you would have an average tax meaning the average tax that you made versus your top tax bracket so if you made more money you're going to be you're going to be paying at the top tax bracket so that's your marginal tax rate in economic terms the next dollar that you make that's going to be the impact of the tax on it and then of course if you go up to the next tax bracket then the dollars that go up above that bracket will be taxed another at the next rate up so when you look at tax software you'll typically see two rates an average rate which will be lower than the marginal rate which will be the top rate and if someone earns more money or is going to earn less money in the future then you kind of have to use the marginal tax rate usually rather than the average so we'll get into that later but next taxes are calculated using multiple tax rate rates that increase with tax base next we have the regressive tax now a regressive tax is a tax rate decreases as wage base increases and the the sales tax is sometimes used as an example of basically a regressive type tax now regressive as you can hear from the tone of it you probably hear well that sounds kind of negative on other regressive tax and usually that's how it will be labeled this is the label that people will put on from a political standpoint to try to just trounce the tax policy before it gets it gets off the ground right those that's regressive done it's all it's over right but but again a lot of times it becomes a little bit more complex than just simply labeling something so for example they'll try to label something like the flat tax as a regressive tax but it's not really a regressive tax because we saw that the flat tax does pay more money as you generate more revenue it's just that it doesn't increase as much as the progressive tax which means that you can now start talking about whether a tax is more or less progressive or more or less flat in other words you could see this this thing has one two three four five six seven brackets well what if you added what if you made it have like nine brackets well then you have made it kind of more complex which is kind of like more progressive generally although you can also change the the intervals in all kinds of crazy ways it's infinite how complex it can get into if you start tweaking this table all over the place now oftentimes so the questions will often be well we're in a progressive tax system if you wanted to simplify the tax code which was kind of the trend a few years ago then the idea would be i want to move from all these tax brackets to at least go into fewer tax brackets because that'll make it at least a little bit easier and that you can say that you would be flattening the tax system in that case which would be a form of simplification or making it a less progressive tax and again you can see the terminology on that would be used depending on which side of the debate you would be on so if you if you were lowering the number of brackets and you were in favor of increasing the number of brackets you would argue that it was a less progressive you're making the tax less progressive you might even go and say that you're making the flat regressive which would be a lie really but but you know that doesn't stop these debates right and then or if you if you're in favor of it you might say that you're trying to flatten the tax or possibly you would start out by saying i'm trying to simplify the tax code by flattening it obviously the news generally tries to say that flat tax is equivalent with a regressive tax right because most people and like the media for example are probably going to try to argue for more complex tax system more progressive right always more progress progressive so so regressive as we saw would typically be that would be the the claim that you're making you're just trying to help the rich people right you're making a tax that is falling more heavily on poor people than the rich people you're like the sheriff of knottingham and and uh and so you're horrible right that's basically what the label of the regressive tax kind of means uh in practice what are some examples of where that could happen in practice possibly like a sales tax is the classic example in europe they have a lot of sales a sales or usage tax uh is something often applied in the united states some states apply uh a usage tax instead of an income tax but for the federal government we have an income tax system and anybody that brings up a sales tax system is going to be usually shut down with or they will attempt to shut it down with this kind of regressive tax argument now i'm not arguing for one or the other i'm not sure we could actually politically make the move to a sales tax from a from a federal income tax and i would hate to add a new tax on top of the federal income tax because that would that would just mean it would just grow from there that's all taxes ever do they just the law the law when the tax law first went into place was only supposed to be on very wealthy people because they're the people that could afford it number one and again those are the people that needed to pay for the military because the military was protecting their land right was the general idea so they should be paying for it but now of course the tax is applied to everyone uh uh at this point and the income tax is is is reaching down to more people the sales tax would the same thing would happen they would put a modest sales tax in and then it would grow right so that's how that's how it works i'm not but from a from a theoretical standpoint uh is a sales tax regressive why would it be regressive well the argument is that if you're if you're taxing people when they buy stuff then then that's going to benefit wealthy people because if wealthy people didn't want to pay taxes all they have to do is buy less stuff because they have a lot more disposable income whereas if you're not wealthy you're paying all your money on the necessities which is like food water transportation gas the things that you need the essentials and therefore they have they don't have the capacity to not be spending money on on these things and therefore they're going to pay a higher percentage of their income to taxes than rich people who would be able to if they wanted to not spend money on things and therefore avoid the tax now that makes sense to some degree however you can kind of tweak that pretty easily because like like a lot of states for example some things will not be taxed so if you just didn't tax the staple things then you can kind of you can kind of adjust that pretty quickly meaning if you say okay well what if i do this i do not tax the the food i do not tax the gas and and um and so we don't tax the necessities right and then everything else is going to be taxed well then the argument doesn't then all the people that are paying all their money for the necessities and don't have the capacity to buy things other than the the necessities wouldn't be subject to any tax because they be paying all their money for food and food and gas in theory and the rich people who are let's face it they're more likely to be out there buying stuff it's not like they're they're going to be buying the yachts they're going to be shopping at the fancy restaurants and whatnot and they're going to be the ones that will be subject to the tax in those case when they buy the more the more fancy kind of thing so by doing that i think you can pretty easily tweak a sales tax system so that it's not you know regressive in the sense that is usually argued for or or in the in the news so that's why i say if whenever you look at these kind of categories of taxes the idea would be nothing's new under the sun and taxes it's just what kind of attacks are they applying but there's always tweaks that you can make to it to modify it to whatever you're whatever you're kind of doing here so you could take the sales tax and again kind of modify it so that it doesn't fall more heavily on the on certain individuals now you can also argue an income tax versus a sales tax which is better in terms of does it promote saving or spending and the united states with with an income tax we actually kind of promote spending because when we spend the money then we might get a deduction for it right on the income tax and as you earn the money if you get like the deduction then then you might be paying less taxes with a sales tax type of system you get taxed when you buy things so so unless you're buying you know things that aren't taxable like possibly the food the necessities when you're buying yachts or things like that you are going to get hit with the tax so it's actually promotes a saving a sales tax might be more promoting of a saving kind of system so that's another thing to to that's interesting between the two so those are the general categories