Net income provides a more accurate account of the financial status. Here’s why.
What is direct tax?
A direct tax is a tax on the property or income of the person who pays it, instead of on goods or services. American taxpayers pay a variety of direct taxes, like income tax, in addition to indirect taxes, like sales tax. Because they’re assessed proportionally to a taxpayer’s income or the value of his property, direct taxes introduce a degree of fairness into the economy when that tax revenue pays for social services.
The U.S. introduced direct taxes in 1913, with the passage of the Sixteenth Amendment to the Constitution. Prior to this amendment, the tax code forbade the imposition of any direct taxes by the federal government.
Unlike indirect taxes, which are paid by an intermediary and then passed onto the taxpayer, direct taxes are the responsibility of the taxpayer. They must be recorded on the individual’s tax return each year.
Some of the most common direct taxes are:
- Income tax: A tax paid to federal and state governments each year.
- Corporate tax: A tax an organization pays on its profit.
- Property tax: A tax based on the value of a taxpayer’s property, usually real estate.
While indirect taxes are assessed at the same rate per transaction regardless of the person, direct taxes are assessed in proportion to the value of what’s being taxed. They’re calculated as a percentage determined by state and federal law.
That makes direct taxes one of the best ways governments distribute social services to lower-income people. The wealthy end up paying a higher proportion of taxes, whether on income they earn or through the ownership of their more valuable property, and lower-income people are sometimes not obligated to pay taxes at all or receive tax payments back in the form of credit.
Invest your tax refund in a savings account. Bankrate can help you choose.
Direct tax example
Each year, people in the U.S. have to pay taxes on the home they own, which are levied by their local government. This is a direct tax called a property tax, and it’s calculated as a small percentage of the value of the home. If they sell the home, the value of the sale is subject to an indirect tax.