What taxes do you pay and how do they affect your finances?

You pay all sorts of taxes, all year long. But taxes are probably top of mind when April 15 rolls around, or when your property taxes are due.

However, taxes aren’t an immovable force; some change, some are fixed, and many may be in your control.

What types of taxes do you pay, how could they differ each year, and what can you do to control what you pay and free up more for your wallet?

Here are some insights.

Types of taxes you pay: State and federal income

There’s a significant difference in taxes people pay from state-to-state and city-to-city, and how they all fit together is a giant puzzle, says Heather Winston, assistant director of retirement and income solutions at Principal®.

Let’s start with income taxes, both federal and state.

Your federal income taxes help the country pay for everything from national defense to Social Security and health and safety net programs.1 During election time, candidates often talk about their ideas for who to tax more and who to give more tax breaks to. But even a president can’t implement changes to the federal tax code without the buy-in of Congress.

State income taxes primarily pay for big, state-run functions such as education, health care, corrections, and transportation.2 Unlike the federal income tax, the way states tax its residents’ income—if they tax it at all—varies.

“While they’re in session, state legislatures often make changes to tax brackets and rates,” Winston says. Pay attention to any active bills where you live to see if they may impact your taxes.

Once you finish your federal and state tax returns, look at either the total you paid or the refund you received. You can adjust withholdings to take out more (or less) so that you’re not hit with a bill or “lending” the government too much during the year.



Types of taxes you pay: Property

A property tax is simply a tax you pay for something you own—most of the time for your home. There are property taxes of some form in every state, but most of the time they’re levied by the city, county, and even the school district.3 In fact, state property taxes only account for about 1% of state revenue, but about 50% of local revenue, funding services such as public schools, law enforcement, and road improvements.4 “We’re each taxed at different amounts and in various ways,” Winston says.

One way to control taxes is if you’re considering a home upgrade or home purchase. Unlike a mortgage payment, you can never pay off property taxes; they’ll be due every year and may increase from year to year. A larger piece of property or bigger house will typically equal more property taxes. “Try to minimize the taxes you pay unnecessarily, but don’t aim to completely avoid or eradicate all taxes,” Winston says.



Types of taxes you pay: Sales

Much like property taxes, sales taxes originate at both the state and local level: 45 states have a statewide sales tax and 38 allow local sales tax.5 Sales taxes, of course, supply those states and local governments with revenue for all the local things that we depend on—fire departments and public schools, for example.

Of all the taxes you pay, this is the one that offers you the most control. That car you want? You’ll pay sales tax on it. The county one over with a lower sales tax on clothes? It’s great, but you’ll spend extra gas driving there. (If you can, take advantage of no sales tax days if you need to stock up—say, one in August for a bargain on school clothes.)

“There are tradeoffs to be made every single day; some have short-term results, and some have long-term impacts,” Winston says. “Be aware of where you’re saving and where you’re not. Weigh your decisions. Like the old saying goes, ‘Don't step over dimes to pick up pennies.’”

What's next?

1 https://www.usatoday.com/story/money/2019/04/15/what-do-taxes-pay-for-defense-social-security-medicare-and-more/3450446002/

2 https://www.cbpp.org/research/state-budget-and-tax/policy-basics-where-do-our-state-tax-dollars-go#:~:text=But%20states%20also%20fund%20a,projects%2C%20state%20police%2C%20parks%20and

3 https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-property-taxes-work

4 https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-property-taxes-work

5 https://taxfoundation.org/2020-sales-taxes/, https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-sales-taxes-work

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment or tax advice. You should consult with appropriate counsel, financial professionals or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Investment advisory products offered through Principal Advised Services, LLC. Principal Advised Services is a member of the Principal Financial Group®, Des Moines, IA 50392.