A Simple Guide to Tax Types and How They Work

April 1, 20238 min read
A Simple Guide to Tax Types and How They Work
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Key Takeaways

  • Taxes are collected by federal, state, or local governments in order to fund public services and other government projects.
  • YieldStreet investors will typically want to pay particular attention to earnings taxes, which include taxes on interest, dividends, capital gains, royalties, and rental income.

The Three Basic Tax Types

The three basic types of taxes include taxes on what you earn, taxes on what you buy, and taxes on what you own.

Earned: These taxes are collected on income earned from employment, investments, retirement benefits, or self-employment income like freelance or consulting work. Common taxes that fall under this category include Social Security/Medicare tax, which is often called FICA, or Federal Insurance Contributions Act, income tax that is collected at various federal, state and local levels, unemployment taxes, and more.

Buy Taxes: Buy taxes are associated with purchases and include sales tax, value-added tax (VAT), and excise taxes. Sales Tax is a state-level tax placed on goods or services purchased in a state or locality. Value-added tax (VAT) is a national-level tax on goods and services that is added at each stage of production, where the value added to the good or service is taxed. Excise taxes are levied on luxury items such as cigarettes, alcohol, gasoline, and other items.

Own Taxes: Own taxes are associated with property ownership. These include real estate taxes (property tax). This is a tax imposed on real estate by the local government and is based on the value of a property. Other taxes that fall under this category include inheritance tax which is a tax on the estate of a deceased person, and gift tax which is imposed when one gives away property or money.

Taxes on earned income include:

  • Personal Income taxes: This income tax is based on an individual’s wages and earnings. The taxation rate varies by jurisdiction and different levels of income earners.
  • Corporate Income Taxes: This is an income tax assessed on an entity that is taxed as a C Corporation for tax purposes.
  • Payroll taxes: Payroll taxes are imposed to fund social security and other governmental programs. The tax consists of contributions to social security and Medicare, as well as unemployment insurance.
  • Capital gain taxes: Capital gains tax stems from investments that are capital in nature and are sold in a given year. Capital gains tax may vary based on the time the investment was held. It can either be taxed as short-term or long-term capital gains. See below for the different tax rates assessed for short-term vs. long-term capital gains.

Taxes on what you buy include:

  • Sales Tax: This is a type of consumption tax imposed by the government on goods and services purchased within a jurisdiction. Sales tax is usually collected at the point of sale and can either be imposed on the customer or the retailer.
  • Gross receipts tax: This tax is imposed on the seller of goods and services. It is based on the gross receipts from sales, meaning that it does not take into account any deductions for expenses or losses.
  • Value-added Tax: This type of tax is imposed on goods and services at each stage of production, with the value added to the good or service being taxed. VAT is typically collected from customers, although it can also be passed onto suppliers if certain conditions are met.
  • Excise Tax: Excise taxes can be imposed on certain luxury items, such as cigarettes, alcohol, and gasoline. It is usually collected from the supplier.

Taxes on what you own include:

  • Property taxes: Property taxes are imposed on real estate by the local government. The taxation rate varies depending on the jurisdiction, with some jurisdictions having different brackets for different levels of property owners.
  • Tangible Personal Property taxes (TPP): TPP is a tax on tangible property, such as furniture, appliances, and other items.
  • Estate and Inheritance taxes: Estate tax is usually imposed on the value of the entire estate, while inheritance taxes are imposed on individual heirs. It is imposed on the estate of a deceased person and can also be applied to gifts given away by the deceased.
  • Wealth taxes: This tax is imposed on the net worth of an individual or a business.

What are the Tax Forms?

Tax forms are the documents used to report income and other information related to taxes. Some of the more common tax forms include:

  • 1040: This is used by individual taxpayers to file an annual income tax return with the IRS.
  • 1040-ES: This is used by individual taxpayers to make quarterly estimated tax payments to the IRS.
  • 1099: This form is generally used to report income earned from investments, such as interest, dividends, or capital gains.
  • K-1: This form is used to report each partner’s share of a partnership’s earnings, losses, deductions, and credits.
  • W-2: This form is used to report wages and salaries you have earned in a particular year.
  • W-4: This is the form used to determine an individual’s tax withholding amount for income taxes.
  • W-9: This is the form used to request a taxpayer identification number.

Tax Brackets & Types

In the United States, taxes are generally divided into three categories: Progressive, Regressive, and Flat. Each type of tax has its own set of tax brackets, and each bracket is subject to different rates.

  • Progressive Tax: A progressive tax system is when the rate of taxation increases as your taxable income increases. The goal of a progressive tax system is often to distribute the tax burden more fairly and to ensure that those with higher incomes contribute a larger proportion of their income to support public services and government functions.
  • Regressive Tax: A regressive tax system is when the rate of taxation decreases as your taxable income increases. This system tends to disproportionately favor the wealthy and is seen by many as unfair.
  • Flat Tax: A flat tax system is when everyone pays the same rate of taxation regardless of their income.

Different tax brackets have different tax rates, so it is important to understand the tax brackets when filing your taxes.

Tax brackets include:

  • Marginal Tax Rate: This is the rate of tax paid on each additional dollar earned.
  • Average (Effective) Tax Rate: This is the average (effective) rate of tax paid on all income earned.

Taxes on Investments

Investments come with their own set of taxes, and understanding these taxes is important for investors. Investment income can include interest, dividends, capital gains, royalties, rental income, and more. First, let’s look at how public equity is taxed.

How is public equity taxed?

Publicly traded stocks may be subject to taxes on capital gains and dividend income. Capital gains tax is categorized into long-term and short-term capital gains, which are taxed differently. Long-term capital gains tax rates are typically lower than short-term capital gains tax rates, giving investors an incentive to hold stocks for longer periods of time.

Long term vs short term capital gains tax

Short term capital gains taxes are the taxes paid on profits from a security that has been held for less than one year. These taxes are typically taxed at ordinary income tax rates, which can range from 10% to 37%. Long term capital gains taxes are the taxes paid on profits from selling a security that has been held for usually more than one year.

The Long-term Capital Gains Tax rates for 2023 are as follows:

Filling Status0% Rate15% Rate20% Rate
SingleUp to $44,625$44,626 – $492,300Over $492,300
Head of householdUp to $59,750$59,751 – $523,050Over $523,050
Married filing jointlyUp to $89,250$89,251 – $553,850Over $553,850
Married filing separatelyUp to $44,625$44,626 – $276,900Over $276,900

The Short-term Capital Gains Tax rates for 2023 are as follows:

Filling Status10% Rate12% Rate22% Rate24% Rate 32% Rate35% Rate 37% Rate 
SingleUp to $11,000 $11,000+ to $44,725$44,725+ to $95,375$95,375+ to $182,100 $182,100+ to $231,250$231,250+ to $578,125Over $578,125
Head of HouseholdUp to $15,700$15,700+ to $59,850$59,850+ to $95,350$95,350+ to $182,100 $182,100+ to $231,250 $231,250+ to $578,100Over $578,10
Married filing jointlyUp to $22,000$22,000+ to $89,450$89,450+ to $190,750$190,750+ to $364,200$364,200+ to $462,500 $462,500+ to $693,750 Over $693,750
Married filing separatelyUp to $11,000$11,000+ to $44,725$44,725+ to $95,375$95,375+ to $182,100 $182,100+ to $231,250 $231,250+ to $346,875 Over $346,875

How Are Alternative Investments Taxed?

Alternative investments, such as REITs, private equity, and real estate investments, are taxed differently than public stocks. These types of investments can be subject to different types of taxes depending on the type of investment.

Additionally, some alternative investments may also be subject to taxes from the state or local government. It is important to understand the different tax implications of alternative investments to ensure that you are taking full advantage of any tax benefits available.

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Alternative Investments and Portfolio Diversification

Taxes on alternative investments are useful to understand because alternative investments can be valuable portfolio diversification tools. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Taxes are a part of everyday life, and understanding the different types of taxes is important for all investors. The three main types of taxes are own, buy, and earn. Each type has its own tax implications that need to be taken into account when filing your taxes. Stocks and alternative investments both have their own set of taxes that need to be understood, and failure to understand these taxes can lead to adverse consequences.

All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

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