US Tax System: What Are Its Basic Concepts?

The word ‘tax’ has come from a Latin word ‘Taxare’ that means ‘to estimate’. Tax is defined as a charge that is made by the Government on all sorts of income. Taxation is necessary as it provides money for various Government programs. US tax system is progressive and it imposes a charge on taxable income of both individuals and companies.

Meaning of ‘Progressive Tax System’:

US tax system is a progressive one, which means that the Government charges relatively higher percentage from high income people that what it charges from the low income people. In other words, the rate of tax increases with the increase in taxable income.

What ‘Tax Bracket’ means:

‘Tax Bracket’ is a commonly used term in the practice of taxation. It refers to the rate at which an entity is taxed. Tax brackets are set depending on the income level. Individuals with lower income are taxed at relatively low rate in comparison to the individuals with higher income. As a result, if an individual’s taxable income exceeds certain range, then he/she is taxed as per the next tax bracket. According to US tax system, an individual’s total tax is calculated depending on his/her tax bracket.

Purposes of tax collection:

There are primarily 4 purposes of tax collection, which are described in the following lines.

1. Revenue earning: The money, which is collected as tax is actually used for a number of developments (as for example, road developments, building hospitals, schools, etc.). Along with this, the amount is also used for market regulation.

2. Redistribution of wealth: One of the important purposes of tax collection is to transfer the wealth from the rich people to the poorer ones.

3. Repricing of items: Tax collection can also discourage certain practices; tobacco is taxed so as to discourage smoking, which is injurious to health.

4. Representation: One of the reasons behind taxation is to demand accountability from the Government.

The above purposes are commonly referred to as 4 R’s of tax.

Direct and indirect taxation:

There are primarily 2 types of taxation, namely indirect tax and direct tax. The following lines define direct and indirect tax as per the US tax system.

• Direct tax – Direct tax is collected from organizations and people on whom the tax is supposedly imposed. If you’re selling a property, then you’re liable to pay CGT (Capital Gains Tax), which is a type of direct tax.

• Indirect tax – Indirect tax is collected from someone, who is not responsible to pay tax. Indirect tax increases the price of items so that individuals pay more while purchasing those items.

Though you need to pay certain tax, yet you can reduce the amount if you’re able to make an effective planning. However, it is advisable that you work with a CPA (Certified Public Accountant) to do an effective planning right from the beginning of a fiscal year.