Direct Tax Definition, History, and Examples

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Direct Tax Definition, History, and Examples

What Is a Direct Tax?

A direct tax is one that is paid directly to the body that levied it by a person or organization. Income tax, real property tax, personal property tax, and asset taxes are all examples of taxes paid directly to the government by an individual taxpayer.

Key Takeaways

  • An person or business pays a direct tax to the body that assessed the tax.
  • Income taxes, property taxes, and asset taxes are examples of direct taxes.
  • There are also indirect taxes, such as sales taxes, when the vendor is taxed but the customer pays.

Understanding a Direct Tax

In the United States, direct taxes are generally based on the ability-to-pay premise. According to this economic theory, individuals with more resources or a higher income should pay a larger tax burden. Some opponents perceive this as a disincentive for people to work hard and achieve more money since the more money a person earns, the more taxes they must pay.

Direct taxes cannot be transferred to another person or business. The person or entity taxed with the tax is accountable for paying it.

A direct tax is the inverse of an indirect tax, in which the tax is imposed on one entity, such as a seller, and paid by another—for example, a sales tax paid by the customer in a retail context. Both types of taxes generate significant cash for governments.

Indirect taxes include excise fees on gasoline, liquor, and cigarettes, as well as a value-added tax (VAT), sometimes known as a consumption tax.

The History of Direct Taxes

The present difference between direct and indirect taxes arose with the adoption of the 16th Amendment to the United States Constitution in 1913. Prior to the 16th Amendment, tax law in the United States required direct taxes to be proportioned directly to a state’s population. A state with 75% of another state’s population, for example, would only be obligated to pay direct taxes equivalent to 75% of the bigger state’s tax bill.

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Due to apportionment restrictions, the federal government was unable to levy numerous direct taxes, such as a personal income tax, as a result of this outmoded language. However, the passage of the 16th Amendment altered the tax structure, allowing for the imposition of several direct and indirect taxes.

Examples of Direct Taxes

Corporation taxes are an example of a direct tax. If a manufacturing firm reports $1 million in sales, $500,000 in cost of goods sold (COGS), and $100,000 in operating expenses, its profits before interest, taxes, depreciation, and amortization (EBITDA) is $400,000. If the corporation had no debt, depreciation, or amortization and a 21% corporate tax rate, the direct tax would be $84,000 ($400,000 x0.21 = $84,000).

A direct tax is also an example of an individual’s federal income tax. If a person earns $100,000 per year and owes the government $20,000 in taxes, then $20,000 is a direct tax.

Other direct taxes that are widespread in the United States include property taxes, which homeowners are obligated to pay. Local governments often collect these, which are based on the assessed value of the property.

Use taxes (such as car licensing and registration fees), inheritance taxes, gift taxes, and so-called sin taxes on booze and cigarettes are examples of direct taxes in the United States and worldwide.

What Are Examples of Direct Taxes?

Direct taxes are those that are paid directly to the entity that imposed them, such as the IRS. Common examples are income, capital gains, and property taxes paid to the government by taxpayers.

What Is the Difference Between Direct Tax and Indirect Tax?

Direct taxes cannot be transferred to another party and must be paid by you. Indirect taxes are the inverse. Whoever is responsible for these taxes might transfer them on to another person or organisation.

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What Are Some Examples of Indirect Taxes?

Sales tax, excise tax, value-added tax (VAT), and goods and services tax are all instances of indirect taxes (GST).Businesses sometimes rely on individual customers to foot the tab and recoup these expenses by charging higher pricing.

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