What are Direct Taxes?
Direct taxes are one type of taxes an individual pays that are paid straight or directly to the government, such as income tax, poll tax, land tax, and personal property tax. Such direct taxes are computed based on the ability of the taxpayer to pay, which means that the higher his capability of paying is, the higher his taxes are.
For example, in the case of income taxation, an individual who earns more pays higher taxes. It is computed as a percentage of the total income. Additionally, direct taxes are the responsibility of the individual and should be fulfilled by no one else but him.
Example of Direct Taxes
As mentioned above, one good example of direct taxes is a person’s income tax. Usually, income tax is filed annually although deductions from one’s salary can be done on a monthly basis. If, for example, an individual incurs tax amounting to $30,000 a year for his annual salary of $120,000, the $30,000 is his direct tax.
Types of Direct Taxes
1. Income tax
It is based on one’s income. A certain percentage is taken from a worker’s salary, depending on how much he earns. The good thing is that the government is also keen on listing credits and deductions that help lower one’s tax liabilities.
2. Transfer taxes
The most common form of transfer taxes is the estate tax. Such tax is levied on the taxable portion of the property of a deceased individual, including trusts and financial accounts. A gift tax is also another form wherein a certain amount is collected from people who are transferring properties to another individual.
3. Entitlement tax
Such type of direct tax is the reason why people enjoy social programs like Medicare, Medicaid, and Social Security. The entitlement tax is collected through payroll deductions and is collectively grouped as Federal Insurance Contributions Act.
4. Property tax
Property tax is charged on properties like land and buildings and is used for maintaining public services like the police and fire departments, schools, and libraries, as well as roads.
5. Capital gains tax
Such type of tax is charged when an individual sells assets such as stocks, real estate, or business. The tax is computed by determining the difference between the acquisition amount and the selling amount.
Advantages of Direct Taxes
Though it is strictly implemented on every individual who does not qualify for an exemption, there are actually numerous advantages of paying taxes directly. They include:
1. Promotes equality
Since direct taxes are based on the ability of a person to pay, it promotes equality among payers and citizens. Every person is charged a different amount, depending on how much they make.
2. Promotes certainty
The good thing about direct taxes is that they are determined and made final before they are even paid. In the case of income tax, the annual tax is the same for every year, for as long as the salary does not change.
3. Promotes elasticity
Taxes are the earnings of the government, and when they fluctuate, the earnings also change. It can go higher or lower.
4. Saves time and money
The government does not need to spend on the collection of taxes because they are already taken right at the source of the income. Some companies use automatic payroll deduction systems, which help save time and money.
Direct Taxes vs. Indirect Taxes
There are basically two types of taxes – direct and indirect taxes. The following are the differences between the two:
- Direct taxes refer to taxes that are filed and paid by an individual directly to the government. Indirect taxes, on the other hand, are taxes that can be transferred on to another entity. Therefore, the burden of paying it can be put on another person’s shoulders.
- Direct taxes can be evaded in the absence of proper collection administration. Indirect taxes cannot be escaped from because these are charged automatically on goods and services.
- Direct taxes can help address inflation while indirect taxes can lead to inflation.
- Direct taxes lessen the savings of earners, but indirect taxes encourage the opposite because it makes products and services more expensive and unaffordable.
- Direct taxes are imposed only on people that belong to various income brackets. Indirect taxes, on the other, can be felt by everyone who buys goods and avails services.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: