Definition of direct tax


What is a direct tax?

A direct tax is a tax that a person or organization pays directly to the entity that imposed it. A taxpayer, for example, pays direct taxes to the government for a variety of purposes, including income tax, property tax, personal property tax, or tax on assets.

Key points to remember

  • A direct tax is paid by an individual or organization to the entity that collected the tax.
  • Direct taxes include income taxes, property taxes and taxes on assets.
  • There are also indirect taxes, such as sales taxes, in which a tax is levied on the seller but paid by the buyer.

Understanding a direct tax

In the United States, direct taxes are largely based on the ability to pay principle. This economic principle states that those who have more resources or earn a higher income should bear a higher tax burden. Some critics see this as a deterrent for individuals to work hard and make more money, because the more a person earns, the more taxes they pay.

Direct taxes cannot be transferred to another person or entity. The person or organization on which the tax is levied is responsible for paying it.

A direct tax is the opposite of an indirect tax, in which the tax is levied on one entity, such as a seller, and paid by another, such as a sales tax paid by the buyer in a context of retail. Both types of taxes are important sources of revenue for governments.

Examples of indirect taxes include excise taxes on fuel, alcohol and cigarettes as well as a value added tax (VAT), also known as consumption tax.

The history of direct taxes

The modern distinction between direct and indirect taxes arose with the ratification of the 16th Amendment to the United States Constitution in 1913. Prior to the 16th Amendment, the tax law in the United States was written so that direct taxes had to be directly attributed to the population. A state with a population 75% of the size of another state, for example, would only be required to pay direct taxes equal to 75% of the larger state’s tax bill.

This archaic verbiage created a situation in which the federal government could not impose many direct taxes, such as a personal income tax, due to apportionment requirements. However, the advent of the 16th Amendment changed the tax code and allowed the collection of many direct and indirect taxes.

Examples of direct taxes

Corporate tax is a good example of direct tax. If, for example, a manufacturing company reports $ 1 million in revenue, $ 500,000 in cost of goods sold (COGS), and $ 100,000 in operating costs, its earnings before interest, taxes, depreciation, and amortization (EBITDA) would be $ 400,000. If the business has no debt, depreciation, or amortization and has a corporate tax rate of 21%, its direct tax would be $ 84,000 ($ 400,000 x 0.21 = $ 84,000 ).

Another example of direct tax is the federal personal income tax. If a person earns $ 100,000 a year, for example, and owes the government $ 20,000 in taxes, that $ 20,000 would be a direct tax.

Other types of direct taxes

There are a number of other common direct taxes in the United States, such as property taxes that homeowners must pay. These are usually collected by local governments and based on the estimated value of the property. Other types of direct taxes in the United States and elsewhere include use taxes (such as vehicle registration and registration fees), property taxes, gift taxes, and so-called taxes. peach.

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