How Tax Expenses Work
When an individual or commercial entity owes a money to a governing agency, that amount is considered a tax expense. The amount of a tax expense is determined by the tax rate, which is typically a percentage of the amount being taxed. The government imposes multiple types of taxes, creating tax expenses related to earned income, investments, and gross sales revenue. Consider this common example of a tax expense for individuals: direct income taxes. Say it’s April and you’re using tax preparation software to calculate how much you owe in income taxes. You discover that you owe $1,000 to the federal government and $800 to your state. In total, you are required to pay a tax expense of $1,800.
Federal Income Tax as a Tax Expense
Arguably, the most common tax expense for most Americans is income tax. The federal government imposes taxes on the income you earn, which includes salaries, wages, tips, and commissions. Income taxes also apply to unearned income, such as interest or dividends paid on stocks and bonds. Americans face tax expenses because the government needs to raise funds to provide public goods and services for the benefit of the country. Taxes are commonly used to fund social and medical benefits, such as Social Security, Medicare and Medicaid, public transportation, and public education. Taxes are also used for military and defense programs, veterans’ benefits, and foreign aid. Your federal tax expenses are affected by how much you make and your filing status. The U.S. enforces a progressive tax system, in which portions of your income are taxed at different rates. For example, for a taxpayer filing their 2022 tax returns as an individual, income up to $10,275 is taxed at 10% and income from $10,276 to $41,775 is taxed at 12%. Married individuals filing a joint return will have their income up to $20,550 taxed at 10%. Taxpayers often want to minimize their tax expenses, reducing the amount they owe to the government. Filers can use various tax credits to lower their tax expenses, as well as some tax deductions. The Child and Dependent Care Credit, for example, can help eligible individuals offset some of the costs of babysitting or daycare. Another example is the Lifetime Learning Credit, which offers a credit for eligible students seeking post-secondary education. Businesses can minimize their tax expenses by taking advantage of business tax deductions. For example, companies are eligible to deduct business expenses that are both “ordinary and necessary,” per the IRS. Deductions can include the mileage for business use on your vehicle, employee salaries, rent, interest on commercial loans, and business insurance.
Other Types of Tax Expenses
Income taxes are just the start of the tax expenses you might face as an individual. Other tax expenses you might encounter include:
Capital gains taxesSales taxesExcise taxesProperty taxesEstate taxes
Several types of tax expenses are unique to businesses with employees:
Medicare taxesFederal unemployment (FUTA) taxesFederal income taxesGross receipts taxes
What Tax Expenses Mean for You
Just as you should be careful to pay tax you owe, you should be wary about overpaying your taxes. Receiving a generous refund check after filing your tax return can feel nice, but you’re paying more than your required tax expenses throughout the year. That means the government is taking more money than necessary out of your paycheck. In effect you’re giving the government a loan, without earning any interest in return.
