What Are the Main Things That Get Taxed?

Taxation is the process by which governments compel the payment of a mandatory financial contribution from individuals and businesses to fund public services. In the United States, different authorities tax various aspects of economic life, from what a person earns to what they own or purchase. This revenue funds everything from national defense and infrastructure at the federal level to schools and police departments at the local level. Each tax type is governed by its own rules, rates, and regulations.

Taxes on Income and Earnings

The most widely applicable form of taxation is on income. Federal and most state governments levy an income tax on the annual earnings of individuals, corporations, and other legal entities. U.S. citizens and residents are taxed on their worldwide income. The calculation begins with gross income, from which taxpayers subtract allowable deductions to determine their taxable income. The U.S. employs a progressive tax system, where tax rates increase as income rises.

Wages, Salaries, Bonuses, and Tips

For most individuals, the primary taxable income source is compensation from employment, including wages, salaries, bonuses, and commissions. The amount reported to the IRS is the gross pay before any deductions. Tips are also taxable income. If an employee receives more than $20 in tips in a calendar month, they must report the total to their employer using IRS Form 4070.

Self-Employment Income

Income earned by independent contractors, freelancers, and small business owners is subject to self-employment tax. This tax is calculated on net earnings after business expenses. Self-employed individuals must pay their own income and self-employment taxes, which cover Social Security and Medicare. These are paid in quarterly estimated tax payments using Form 1040-ES.

Investment Income

Earnings from investments are another category of taxable income. This includes interest from bank accounts and dividends from stocks, with qualified dividends taxed at lower rates. Capital gains, the profits from selling an asset like stocks or real estate, are also taxable. Short-term gains from assets held one year or less are taxed at ordinary rates, while long-term gains are taxed at lower, preferential rates.

Retirement Plan Distributions

Withdrawals from most retirement accounts are taxable income. Distributions from traditional IRAs and 401(k)s are taxed at ordinary income rates because contributions were often made pre-tax. Withdrawals before age 59½ may incur an additional 10% early withdrawal penalty. Account holders must begin taking required minimum distributions (RMDs) after age 73.

Government Benefits

Certain government benefits are subject to federal income tax. A portion of Social Security benefits may be taxable if a recipient’s “combined income” exceeds set thresholds. Unemployment compensation is fully taxable income. Recipients receive Form 1099-G showing the total compensation to report on their tax return.

Miscellaneous Income

The tax code also captures other income. Gambling winnings from lotteries or casinos are fully taxable, and payers may issue a Form W-2G for large amounts. Other examples include prizes, royalties, and certain forgiven debts. A forgiven debt is considered taxable income and is often reported on Form 1099-C.

Payroll Taxes (FICA)

Separate from income tax, payroll taxes fund Social Security and Medicare through the Federal Insurance Contributions Act (FICA). These are deducted from an employee’s wages. The Social Security tax is 6.2% for both the employee and employer on wages up to an annual limit. The Medicare tax is 1.45% for both, with no wage limit. Self-employed individuals pay both portions via self-employment tax.

Taxes on Property

Governments also levy taxes based on the ownership of property. These taxes are a primary source of revenue for local governments, such as counties, cities, and school districts, and are distinct from taxes on income the property might generate. The amount of tax is based on the property’s value, determined through an assessment. The two main categories are real property and personal property.

Real Property Tax

The most common property tax is on real property, including land and permanent structures like houses. This tax funds local services like schools and law enforcement and is paid annually or semi-annually. The tax owed is calculated by multiplying the property’s assessed value by the local tax rate. Property owners can appeal their assessment.

Personal Property Tax

A less common tax is levied on movable assets, or personal property. Its application varies by locality. For individuals, this can include vehicles and boats; for businesses, it can include machinery and equipment. Owners report their property to a local assessor, who determines the value and calculates the tax.

Taxes on Goods and Services

Consumption taxes are another source of government revenue, levied on the purchase of goods and services. These taxes are paid by the consumer at the point of sale and collected by the business, which then remits the tax to the government. The rates and rules are primarily set at the state and local levels. The main types are sales tax, use tax, and excise tax.

Sales Tax

Sales tax is imposed by state and local governments on the retail sale of most goods and some services. Calculated as a percentage of the sales price, it is added to the final cost at purchase. The seller collects the tax and remits it to the state. Rates vary by location, and many states exempt necessities like groceries.

Use Tax

Use tax is the counterpart to sales tax, applying to items bought from a seller who does not collect sales tax for the buyer’s state, such as an out-of-state online retailer. The buyer is legally responsible for reporting and paying the use tax. This is often done through a line on the annual state income tax return to ensure purchases are taxed at the same rate as local ones.

Excise Tax

Excise taxes are levied on specific goods or services, rather than being a general tax. Imposed by federal and state governments, these taxes are often included in the product’s price. Common examples include gasoline, alcohol, and tobacco products. The revenue is often earmarked for related purposes, like using gasoline taxes to fund highway maintenance.

Taxes on Wealth Transfers

The final category of taxation involves the transfer of wealth from one individual to another, either during a person’s lifetime or at their death. The federal government imposes taxes on large estates and gifts, while some states have their own estate or inheritance taxes. Due to very high exemption amounts, these taxes affect only a small fraction of the population and serve to limit the concentration of wealth across generations.

Federal Estate Tax

The federal estate tax is a tax on the transfer of property to heirs after death. It is calculated on the decedent’s taxable estate, which is the gross value of assets minus certain deductions. A large exemption amount means most estates owe no tax. For 2025, the exemption is $13.99 million per individual, and only estates valued above this are taxed.

Federal Gift Tax

The federal gift tax applies to property transfers made while the giver is alive, preventing avoidance of the estate tax. The gift and estate taxes share a unified lifetime exemption. For ordinary gift-giving, there is an annual exclusion. For 2025, an individual can give up to $19,000 to any number of people without tax implications or needing to file Form 709.

State-Level Taxes

Some states impose their own wealth transfer taxes. An estate tax is paid by the deceased’s estate and state-level exemptions are much lower than the federal one. A smaller number of states levy an inheritance tax, which is paid by the heir. The inheritance tax rate depends on the heir’s relationship to the decedent, with close relatives paying less or being exempt.