Folks with a high net worth might be wondering what wealth tax is. Individuals and married couples pay income tax on their paychecks or business profits, but wealth tax is different. It is a tax paid on a taxpayer’s net worth. Net worth is the total value of the taxpayer’s assets minus their liabilities.
Many countries like France, Spain, Norway and Switzerland impose an annual wealth tax on high-net-worth taxpayers. Each has its own definition of wealth, what items are considered assets, and tax rates. The U.S. does not currently impose an annual wealth tax.
Annual wealth taxes are not the only form of wealth tax. Some taxing authorities tax wealth when it is transferred to another taxpayer. For instance, when a high-net-worth taxpayer passes their estate to heirs, the estate may owe taxes. Also, some countries may impose taxes when people gift money or assets above a certain threshold.
The IRS imposes taxes on taxpayers who gift money or assets over a certain amount during their lifetime in the U.S. Beyond that, the IRS imposes taxes on gifts over $15,000 during a calendar year ($16,000 for 2022).
Wealth taxes are very complicated. Generally, the IRS charges taxes on estates over $10.7 million for married couples in 2021 ($12.06 million in 2022). Please contact your tax advisor for more information.
Wealth Tax vs. Income Tax
Readers may be more familiar with income taxes. Every individual and a married couple filing jointly file their taxes every year. The deadline for taxes is typically April 15 each year. Taxpayers pay an amount based on the income they receive from their employer or business. The amount due by taxpayers is based on a marginal tax rate.
The IRS bases marginal tax rates on increasing tiers. Each tier has its own rate. Taxpayers owe taxes on each tier their income surpasses. For individuals, the lowest tier for the 2021 tax year is $9,950. Individual tax filers owe 10% on their first $9,950 of income. The second-tier taxes filers 12% on income between $9,951 and $40,525. Tiers increase in rate and taxable income, different from that of wealth tax. The highest tier taxes individual’s income over $523,600 at 37%.
Say an individual taxpayer had $60,000 in taxable income in 2021.
- The first $9,959 of taxable income is taxed at 10% or $995
- Taxable income between $40,525 and $9,950 (or $39,575) is taxed at 12% or $3,669
- Taxable income between $60,000 and $40,526 (or $19,474) is taxed at 22% or $4,284.28
Taxes owed by the individual filer will be $8,848.28 ($995+$3,669+$4,284.28).
Married couples filing jointly have a different set of tiers. The tax rates are the same, but income levels are double the level of individuals.
Taxpayers can also itemize their tax filing and include deductions from income. Business owners usually deduct business expenses to determine their taxable income more often than individuals or married filers. Taxpayers may also choose to take a standard deduction if itemized deductions do not meet certain thresholds.
If you receive income from an employer, you might get a tax refund when you file your taxes. Employers are required to take taxes out of your paycheck on your behalf. Many times, employers will overestimate the taxes that they take. When this happens, the employee will receive a refund in the amount of overpayment.
Differences Between Wealth Tax and Income Tax
The most apparent difference between wealth tax and income tax is the timing of each. The IRS imposes wealth taxes upon the transfer of money or assets. Transfers may happen when someone passes away or gives a gift. On the other hand, U.S. taxpayers file income taxes each year. However, some countries impose them every year.
In addition, income tax is imposed on the money that filers make during a calendar year. Taxpayers owe wealth tax based on the net worth of the filer.
Wealth Tax Pros and Cons
There are always two sides to every story. The possibility of imposing a wealth tax in the U.S. is no exception.
- Wealthy taxpayers often find loopholes in the tax code to avoid paying income tax. It would increase the amount of taxes paid by wealth taxpayers.
- It could be used to relieve the tax burden of low and middle-class taxpayers.
- Wealthy taxpayers also pay income tax. Some of that income increases the wealthy taxpayer’s net worth. If the net worth is also taxed, the taxpayer would be taxed multiple times on the same money.
- Taxpayers subject to wealth tax could flee to another country to avoid it.