Step 63: An Introduction to Taxes

Step 63 of the 100 Steps to Financial Independence: An Introduction to taxes
Step 63: An Introduction to taxes

So you might have thought pensions and insurance sounded boring. Well then taxes sounds probably even more dull to you..Yet in order to manage your money well and plan for a secure financial future, you need to have at least a basic understanding of taxes. And with basic I mean a little more than just, “yeah I know the government takes out some money on whatever I earn”. Eh… right, but that’s not enough to use that information to your advantage.

In this step we will look at a quick overview of the various taxes that you are most likely liable to at the moment or potentially in the future. Every country varies tremendously in terms of which taxes apply, how high they are, whether they have a flat rate or a scale and what the exclusion terms are. This step is therefore only meant to provide an overview of possible taxes around the world: you’ll have to do some work afterwards yourself and find out the rates for your country or state.

Taxes are of course meant to fund the main expenditures of the government, such as national security (police and army), infrastructure (roads and sewage), legal system, health care, education system and also to pay anybody working for the state. Now let’s look at the most common taxes that exist:

Income tax

Income tax is charged on the income of individuals and companies. Many countries use a scaled tax system in which the more you earn the higher the percentage you pay. Income tax can be divided into the following categories:

  • Income tax – charged on regular income
  • Capital gains tax – tax charged on any sales of assets made that resulted in a capital gain. An example of this would of course be selling your house or shares at a profit. Capital gains tax is usually lower  than tax on regular income.
  • Dividend tax – tax charged on any proceeds from dividends.
  • Gift tax – tax charged on any gifts received, such as from parents or grandparents.

Payroll tax

Payroll taxes are paid by both employees and employers on employees’ salaries and generally include contributions to unemployment benefits and other social security charges such as for health care and pensions.

Property tax

Property tax is charged on people’s assets and can include the following:

  • property tax – tax on property such as buildings and land value based on an estimation of the value of the real estate. In the UK this is also known as council tax.
  • wealth tax – taxes on a tax payer’s assets such as on savings and stock portfolio. This is usually based on the person’s net worth and not just their assets, i.e. on the net difference between their assets and their liabilities
  • Inheritance tax – tax paid if you inherit money, property or other assets from a deceased. In some countries there is a distinction between estate tax (on the assets of the deceased) and inheritance tax (on the money going to the heirs).

Excises and VAT

  • VAT are taxes charged on goods based on a Value Added Tax system (VAT). This means that if somebody buys a raw product, they pay VAT on the purchasing price. They then manufacture the raw product into something else and sell it for a higher price than the purchasing price to a wholesale dealer. This dealer pays VAT only over the difference between the price they sold and the price they purchased the product for (i.e. the added value to the original raw product). In essence they get a tax return of the VAT already paid on the initial purchasing price of the raw material. The wholesales dealer then sells the product at a higher price and again only pays VAT over the difference in price. The customer is the one who ultimately can’t get a VAT refund as they are the last in line to pay the VAT and therefore pay the full amount, which is then sometimes also knows as sales tax.
  • Excises – often charged on tobacco, alcohol, petrol, soda and luxury goods, excises are charged on the production and sale of these products. They are considered indirect as the manufacturer is charged but often aims to regain these charges by increasing the price of the product, thereby getting the costumer to pay these taxes. Excises are usually heavier than VAT or sales taxes and can vary more from one year to the next.

Corporate tax

If you own a company you are likely charged corporate tax on any profits you make.

Step 63 – An Introduction to Taxes – in detail:

Okay so taxes are super complicated, I won’t deny this, but you should still know what is going on more or less, so let’s keep it simple and say you are just going to find out which of the above taxes you pay and how much they are.

  • Get your notebook or digital out, do your internet search or check with your accountant or financial advisor write down a list of the following taxes and note down how much each tax rate is:
    • Income tax: how much do you pay in taxes on your income and what are the various percentages for different amounts. Most legislations have a scaled income tax with different tax brackets in which you pay say 10% over the first $10.000 (gross) you earn, 15% over the next $25.000 and so on. Find out your percentage and check it against your pay stubs.
    • Capital gains tax
    • Dividend tax.
    • Gift tax (even if you don’t expect any gifts or aren’t planning on giving anything away anytime soon, it doesn’t hurt to know it).
    • Payroll tax
    • Property tax.
    • Wealth tax: how much is it and is there a minimum you don’t pay anything on.
    • Inheritance tax (again it’s always best to know and be prepared!).
    • VAT and excises.
  • Lastly. do a search for your specific country to find a list of taxes you might be liable to so you know whether anything has been missed out.

Understanding your taxes 100% might be a little too difficult, but you should still know more or less what taxes you are paying. It will help you decide which income stream to develop further, as depending on how much you pay in taxes, one option might be more interesting than other options.

Read more about my 100 steps mission to financial independence or simply decide to take control today and join us on our step-by-step quest on how to make your finances work for you, starting with step 1.

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