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WHERE ARE YOUR TAX DOLLARS GOING?

By Anita Clinton

In the United States, we pay a variety of different types of taxes:  sales taxes, real estate taxes, federal and state income taxes, capital gains tax, medicare tax, excise tax, social security tax, estate tax, etc.  Most of us pay them, whether we agree with the system or not.  While others attempt to devise plots to evade the system, making them subject to huge fines and even imprisonment.  In this article, we will explore how the tax system was       constructed and how the funds are dispersed.

THE TAX SYSTEM

Federal Income Tax

In the early 1800s, the government levied a small number of taxes (i.e. tax on alcohol, carriages, sugar, tobacco, etc.) to fund expenses.  And as a result of the war in 1812, sales taxes were levied on luxury items to assist with funding the war costs.  The income tax was introduced in 1861 to fund the high cost of the Civil War.  However, when the war ended, the income tax was repealed.  In 1894, Congress enacted the income tax legislation, labeling it as “an act to reduce taxation, to provide revenue for the government, and for other purposes.”  The following year, the Supreme Court ruled the tax to be a “direct tax” which was in violation of the Constitution.  The Constitution specified that Congress could only impose a “direct tax” if it was apportioned or divided equally among the states according to the population.  As a result, the tax was temporarily stifled, but reintroduced with the controversial ratification of the Sixteenth Amendment in 1913:

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

In 1943, the Current Tax Payment Act established the income tax with-holdings and quarterly payments.  Withholdings allowed for consistent/ guaranteed revenue for the government while minimizing opposition from taxpayers.  Ideally, taxpayers were less cognizant of the amount of taxes being paid to the government because the monies were withheld before they even saw them.  Think about it, how many people actually sit down to calculate the amount of dollars they pay IRS annually?  Now what if we had to write a lump sum check at the end of year to cover a $20,000 income tax bill - how many people would willingly adhere without any opposition?  The basis behind the withholdings rest on the belief that if we don't know how much we are paying, we are less likely to make a fuss.  The government packages and presents it as being “convenient” and even agrees to pay us back a small (non-interest bearing) portion of the thousands of dollars we've paid during the year in the form of a “tax refund.” 

Currently, the federal income taxes are imposed on individual payroll checks, income from corporations, and dividends from stocks.  Unlike other countries, our tax is based on citizenship and residency.  Therefore, all U.S. citizens are subject to federal income tax on all income earned or made worldwide.  Taxpayers can apply

tax deductions for mortgage interest, mortgage insurance costs, primary residency, contributions up to $4000 in individual retirement accounts, etc.  In addition there are tax credits like the Earned Income Credit (EIC) which is available to people who earn low-to-moderate incomes.  The amount of taxes a taxpayer pays is based on his/her tax bracket which is determined by income ranges and filing status. 

Using the table above, let’s calculate the tax rate for a “single” taxpayer with a taxable income of $115,000 for

Capital Gains Tax

The federal government is not only interested in monies earned from ways mentioned above, but they are also interested in monies gained as result of investment income or capital gains.  Capital gains normally come into play when an appreciable asset is sold yielding a gain.  The government does, however, make a distinction between the rates on long-term and short-term gains.  A long-term gain is derived from property that has been held more than one year (366+ days).  The rate is generally between 5-15%, depending on the taxpayers income and property type.  A short-term gain is derived from property held for one year or less (0-365 days).  The short-term rate is usually comparable to the taxpayer's income tax level up to 35%.  Below are the current capital gain rates:

Social Security Tax

The Social Security tax which is derived from the Federal Insurance and Contributions Act (FICA) is another tax levied by the federal government that provides the funds necessary to pay Social Security benefits to recipients.  A tax of 12.4% is paid on earned income only  6.2% is paid by the employee and 6.2% is paid by the employer. Self employed people pay the entire 12.4%.  The Social Security tax is only levied on the first $90,000 of the workers annual income.  This tax is not applied to unearned income like interest, dividends, and rental income.

Medicare Tax

The Medicare tax provides funds for the Medicare program which supplies health insurance for eligible recipients.  A tax of 2.9% is paid on earned income only  1.45% paid by the employee and 1.45% paid by the employer.  This tax is not applied to unearned income.

Self-employment Tax

The self-employment tax is the tax levied against taxpayers who work for themselves.  The self-employment tax rate is 15.3% - 12.4% for social security and 2.9% for Medicare.  The 12.4% social security portion is only on the first $97,500 of combined wages, tips & net.  However all the combined wages, tips and net earnings are subject to the 2.9% Medicare tax.  In addition, one-half of the self-employment tax can be de-ducted when figuring the adjusted gross income (only affects income tax).

Unemployment/Training Tax

Another payroll tax of the 1.2% of the first $7000 earned is deducted to cover unemployment insurance.  In addition, there is a tax of .1% of the first $7000 earned to cover retraining of displaced workers.  This tax is only assessed on employers.

Corporate Income Tax

Business owners of “C” Corporation are taxed between 15-39%, based on taxable income.  However, there are a number of loopholes in place that can reduce the corporate tax rate.  In addition, many corporations elect to bypass the corporate income tax by establishing LLC's or “S” Corporations.  These corporate entities allow taxes to be assessed on the shareholders/owners' personal income levels.

Death Tax

The death tax or transfer tax is imposed on wealth transferred amongst families.  There is the gift tax that is assessed on wealth transferred while the transferor is alive; the estate tax which is assessed on wealth transferred after the transferor's death; and the generation-skipping transfer (GST) tax which is assessed on wealth transferred to second or more generation relatives of the transferor.  The gift and estate taxes range from 0  55%, depending on the dollar amount.  There is a credit that can be applied to both gift and estate taxes called the unified credit.  The credit must be subtracted from any gift tax owed and amount used reduces the amount eligible to use in the future.  In addition, the total amount used reduces the credit available for the estate tax.  Gifts that are made to spouse, charity,political organizations, and to pay medical or school tuition bills are usually not taxed.  The GST tax is usually equal to the highest marginal estate and gift bracket applicable at the time of the gift or bequest. That rate is currently 45%.  There is a $2,000,000 exemption from the GST tax, increasing to $3,500,000 in 2009 and unlimited in 2010 (or until new legislation is signed).

Excise Tax

The excise tax is imposed on sale or importation of specific goods like gasoline, liquor, and tobacco products.  The government also accesses an excise tax on activities like highway usage by trucks.

State and Local Government Taxes

In addition to the federal taxes, taxpayers also contribute to state and local government taxes.  In Illinois, there are a number of state and local taxes that taxpayers could be liable for and here we will highlight a couple of the main ones directly from the Illinois Revenue website (www.revenue.state.il.us):

Business Income Tax

The Illinois income tax is imposed on every corporation earning or receiving income in Illinois. The tax is calculated by multiplying net income by a flat rate.  The starting point for the Illinois Corporate Income Tax Return is federal taxable income, which is income minus deductions. Next, the federal taxable income is changed by adding back certain items (e.g., state, municipal, and other interest income excluded from federal taxable income) and subtracting others (e.g., interest income from U.S. Treasury obligations). The result is “base income.”  Corporations pay 4.8% income tax and 2.5% replacement tax.

County Motor Fuel Tax

DuPage, Kane, and McHenry counties have imposed a tax on the retail sale of motor fuel at a rate not exceeding 4 cents per gallon. DuPage and McHenry counties levy the tax at the maximum rate, while Kane County imposes the tax at 2 cents per gallon. 

Electricity Excise Tax

The electricity excise tax is imposed on the privilege of using electricity purchased for use or consumption and not for resale. The tax is also imposed on the privilege of using electricity purchased from a municipal system or electric cooperative on all electricity distributed, supplied, furnished, sold, transmitted, or delivered for use and consumption (not for resale). In addition, non-residential consumers of electricity who elect to register with the department as self-assessing pur-chasers pay the tax directly to the department.  Each month, municipal systems and electric cooperatives collect tax from each purchaser an amount equal to the lesser of 5 percent of gross receipts or $.0032 per kilowatt-hour (kwh) per customer. Delivering suppliers collect the following tax amounts from each purchaser monthly:

            $.0033 per kilowatt-hours (kwhs)                   for the first 2,000 kwhs

            $.00319 per kwh for the next                                                 48,000 kwhs

            $.00303 per kwh for the next                                                 50,000 kwhs

            $.00297 per kwh for the next                                                 400,000 kwhs

            $.00286 per kwh for the next                                                 500,000 kwhs

            $.00270 per kwh for the next 2                                  million kwhs

            $.00254 per kwh for the next 2                                  million kwhs

            $.00233 per kwh for the next 5                                  million kwhs

            $.00207 per kwh for the next 10                                million kwhs

            $.00202 per kwh for all kwhs in                                 excess of 20 million kwhs

Self-assessing purchasers pay 5.1 percent of the purchase price for all electricity distributed, supplied, furnished, sold, transmitted, or delivered to them in a month.  Municipalities may impose a tax on the business of distributing, supplying, furnishing, selling, transmitting, or delivering electricity for use or consumption (and not for resale) within the corporate limits of the municipality. The Department of Revenue does not collect these locally imposed taxes.

Gas Use Tax

The gas use tax is imposed on the purchase of natural gas from outside of Illinois for use or consumption in Illinois. The delivering supplier collects, reports, and pays the Gas Use Tax to the Illinois Department of Revenue (IDOR) unless a customer elects to become a self-assessing purchaser and provides the delivering supplier with a copy of his certificate of registration. If the customer elects to become a self-assessing purchaser, they must report and pay the Gas Use Tax directly to IDOR. Delivering suppliers must collect a tax amount from each customer of 2.4 cents per therm of gas per month.  Self-assessing purchasers must pay a tax amount of 5 percent of the purchase price or 2.4 cents per therm of gas (whichever is less) directly to IDOR.

Municipalities may impose a tax on persons engaged in the business of distributing, supplying, furnishing, or selling natural gas for use or consumption (and not for resale) within the corporate limits of the municipality. The rate cannot exceed 5 percent of gross receipts (8 percent in cities with populations greater than 500,000). The Department of Revenue does not collect these locally imposed taxes.

Individual Income Tax

The Illinois Income Tax is imposed on every individual, corporation, trust, and estate earning or receiving income in Illinois. The tax is calculated by multiplying net income by a flat rate. The Illinois Income Tax is based, to a large extent, on the federal Internal Revenue Code (IRC).  The starting point for the Illinois Individual Income Tax is federal adjusted gross income. Federal adjusted gross income is “income” minus various deductions (not including itemized deductions, the standard deduction, or any exemp-tions). Next, the federal adjusted gross income is changed by adding back certain items ( e.g., federally tax-exempt interest income) and sub-tracting others ( e.g., federally taxed retirement and Social Security income). The result is “base income.”  The base income earned in Illinois or while a resident of Illinois is then reduced by the number of federally claimed exemptions plus any additional exemptions. The amount of each exemption is $2,000.  Additional exemptions are provided for any taxpayer or spouse who was either 65 years of age or older, legally blind, or both ($1,000 each). The total exemption amount is deducted from base income to arrive at “net income.” The tax rate is then applied against net income.  The rate is 3 percent of net income.

Property Tax

Property tax is levied and collected by the local governments which include municipalities, townships, counties, schools, and park districts.  They use the funds to finance the majority of services that they provide to citizens.  The property tax cycle generally extends over a two-year period. A tax year is the year of assessment and reflects the value of real property as of January 1 of that year. The actual tax bills are paid in the year following the tax year. For example, taxes on a 2007 assessment are paid in 2008.  The required assessment level for tax purposes on any parcel of real property in any county, except Cook County, is 33 1/3 percent of the property's fair market value, excluding farmland and farm buildings. Cook County classifies property and assesses classes at different percentages of fair market value. For example, the required assessment level for the residential class is 16 percent of fair market value. The Cook County Assessor's Office has information about other classes. 

Any change in real property assess-ments must be published in a newspaper of general circulation in each county every year. Every four years when all property is reassessed (three years in Cook County), a complete list of assessments must be published for notification purposes. In addition, taxpayers outside Cook County must receive a mailed notice of any changes in their assessment from the previous year, unless the change was due to the application of an equalization factor by an assessor.  Banks, savings and loans, and other mortgage lenders also are required to forward copies of all assessment change notices to affected borrowers.

If a property owner believes the assessment is unfair or inaccurate, there are several administrative remedies available.  If the property is in Cook County, the property owner can file an application for revision with the county assessor or a complaint with the county board of review (formerly the board of appeals). The matter can be pursued further by filing an appeal with the State Property Tax Appeal Board or a tax objection complaint in the circuit court.  If the property is outside Cook County, the property owner can file a complaint with that county's board of review. If the property owner is dissatisfied with the board of review's decision, an appeal may be filed with the State Property Tax Appeal Board or file a tax objection complaint in the circuit court.  A favorable court ruling is unlikely unless the property owner has exhausted all available administrative remedies. 

Real Estate Transfer Tax

The real estate transfer tax is imposed on the privilege of transferring title to real estate or a beneficial interest in real property that is the subject of a land trust in Illinois as represented by documents (deed or trust agreement) filed for recordation. If the property transferred remains subject to an existing mortgage, only the owner's equity (not the amount of the mortgage outstanding) is included in the base for computing the tax, provided that such a statement appears on the face of the deed or trust agreement.  The recorder of deeds or registrar of titles in each county collects the tax through the sale of revenue stamps which counties purchase from the Department of Revenue. The same stamp may also provide evidence of the payment of a county real estate transfer tax.  The state rate is 50 cents for each $500 of value or fraction thereof.

Individual counties may impose a tax of 25 cents per $500 of value on real estate transactions. Home rule municipalities may also impose an additional real estate transfer tax.

Sales and Use Tax

The sales tax is imposed on a seller's receipts from sales of tangible personal property for use or consumption. Tangible personal property does not include real estate, stocks, bonds, or other “paper” assets representing an interest.  If the seller (typically an out-of-state business, such as a catalog company or a retailer making sales on the Internet) does not charge Illinois Sales Tax, the purchaser must pay the tax directly to the department.  The term “sales tax” actually refers to several tax acts. Sales tax is a combination of “occupation” taxes that are imposed on sellers' receipts and “use” taxes that are imposed on amounts paid by purchasers. Sellers owe the occupation tax to the department; they reimburse themselves for this liability by collecting use tax from the buyers. "Sales tax” is the combination of all state, local, mass transit, water commission, home rule occupation and use, non-home rule occupation and use, park district, and county public safety taxes.

The Illinois Sales Tax has three rate structures: one for qualifying food, drugs, and medical appliances; one for items required to be titled or registered (vehicles); and another for all other general merchandise. The fundamental rate for qualifying food, drugs, and medical appliances is 1%, items required to be titled or registered is 6.25%, and other general merchandise is 6.25%. Depending upon the location of the sale, the actual sales tax rate may be higher than the fundamental rate because of home rule, non-home rule, water commission, mass transit, park district, and county public safety sales taxes. Motor fuel distributors must collect “prepaid sales tax” on the motor fuel sold for resale to a retailer who is not an Illinois licensed motor fuel distributor or supplier of diesel and dieselhol. The retailer prepays the sales tax to the motor fuel distributor and then claims a credit for the prepaid tax when the sales tax return is filed. The prepaid sales tax rates are $0.05 per gallon for sales of gasohol and $0.06 per gallon for all other motor fuels.  Units of local government may impose taxes or fees, which the department does not collect.

Tax Increment Financing (TIF)

The Illinois revenue department distributes state sales tax collections to municipalities that have tax increment financing (TIF) districts for either state sales tax, state utility tax, or both that produced an incremental growth in retail sales, or gas and electricity consumption. Funds are prorated to each municipality based on its share of the overall TIF net state increment.

Overall TIF funding is 0.27 percent of net state sales tax revenues. Funds are allocated quarterly to all eligible TIF municipalities. Each TIF district is subject to the following reduction in order to determine the net state sales tax increment (the maximum amount available to each municipality for each TIF district):

o   80 percent of the increment up to and including $100,000

o   60 percent of the increment exceeding $100,000 but not exceeding $500,000

o   40 percent of all amounts exceeding $500,000

For each quarterly distribution, each eligible municipality receives a prorated share of the available distribution amount.

Telecommunications Tax

The tax is imposed on intrastate messages (i.e., those that originate or terminate in Illinois and are billed to a service address in Illinois) as well as interstate messages. The types of telecommunications which are taxable include, but are not limited to, messages or information transmitted through use of local, toll, or wide area telephone services; private line services; channel services; telegraph services; teletypewriter; computer exchange services; cellular mobile telecommunication services; specialized mobile radio; stationary two-way radio; paging services; Digital Subscriber Line (DSL) services; Voice Over Internet Protocol (VOIP) services; and any other form of mobile and portable one-way or two-way communications; and any other transmission of messages or information by electronic or similar means.  The state rate is 7% of gross charges.  The municipal rates vary.  Visit www.revenue.state.il.us/app/trii/ for specific rates.

DISPERSMENT OF TAX DOLLARS

Federal Government Spending

The federal government uses tax dollars to fund expenses. Each year a budget, called the federal funds budget, is created for use of the federal income taxes. The total Federal Fund for the 2008 fiscal year is $2.38 billion.  According to the Office of Management & Budget, federal income tax dollars are divided up as follows (2008 Fiscal Year):

However, according to www.WarResisters.org, this chart is somewhat misleading “because it includes Trust Funds (e.g. Social Security/Medicare) and the expense of past military spending are not distinguished from nonmilitary spending.”  This organization concludes the following chart to be a more accurate representation of the federal income dollar dispersment.  Their figures exclude trust funds that are collected and spent separately from income tax dollars.

Local Government Spending

In Illinois, the funds are recorded from two major sources:  General Funds Expenditures and Lottery Expenditures.  The General Funds Expenditure include those collected from the following:  Individual Income Taxes, Corporate Income Taxes, Sales Taxes, Federal Sources, Gaming Sources, Public Utility Taxes, and Other.  The total amount of funds collected for the 2007 fiscal year is $30.272 billion.  According to the Daniel W. Hynes, Comptroller, the funds are divided as follows:

The Lottery Expenditures include Instant Games, Pick 3, Illinois Lottery, Mega Millions, Pick 4, Little Lotto, Lotto, Pick N Play, and Millionaire Raffle. The total fund of $2.005 billion collected from the Lottery Expenditures are divided as follows:

As you can see, there are various elements to the U.S. Tax System.  In fact, this article has only presented a basic overview of the system.  For more information, the IRS has created several publications, articles, and even training manuals that explain in detail, the various aspects of the Federal System.  This information can be found on the IRS website at www.irs.gov.   Likewise, the state of Illinois has compiled useful information on their website at www.revenue.state.il.us.

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Anita Clinton is the founder and creator of OwnSomethingToday.com,   which encourages people to invest in real estate, stocks, and/or business to create wealth.  For more information, visit www.OwnSomethingToday.com.

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