What are Taxes?

Robinhood Learn
Democratize finance for all. Our writers’ work has appeared in The Wall Street Journal, Forbes, the Chicago Tribune, Quartz, the San Francisco Chronicle, and more.

Taxes are mandatory fees charged by the government, which help fund vital services. They can be charged to individuals or businesses.

🤔 Understanding taxes

Federal, state, and local governments impose taxes on their residents and businesses to provide services, operate public works, or create infrastructure for the community. There are lots of different types of taxes, including income, property, and sales taxes. Some, like income taxes, go into the state and local government’s budget to fund a wide variety of programs and services. Others, such as the Social Security tax, go toward one particular purpose.

Governments at all levels may collect taxes. The federal government primarily funds programs using income and payroll taxes. Local governments, on the other hand, rely more heavily on property and sales taxes (and fees). The United States has a progressive income tax system, meaning that typically, the more you earn, the greater the percentage of your income you pay in taxes.

In this article, you’ll learn about taxes - what they are, why they’re important, and the different types that help keep our society functioning.


If you’ve ever had a job, you’ve likely had to pay income tax. Every time you get your paycheck, you’ll probably see that your employer has withheld money to pay your federal income taxes. In most states, employers withhold state income taxes, too. Income tax makes up the largest source of revenue for the federal government and many state governments. It helps pay for services and infrastructure that we all use and enjoy.

Can you come up with three things that everybody relies on? Here are some examples: the roads we drive on, public education, and the court system.


Paying taxes is like snack duty for a youth soccer team...

Part of being on a soccer team is snack duty. When it’s your week, you have to bring snack for everyone to enjoy — for example, orange slices. Everyone is relying on you to bring the oranges and they benefit the entire team. If you forget (or neglect) to bring a snack, you might not be allowed to play—and you might even have to double up on future snack duties to make up for it. Similarly, when you pay your taxes, your contribution is for the benefit of the entire society. Your taxes help pay for social services and infrastructure that’s available to everybody, like roads, other public works, and education.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.
Sign up for Robinhood
Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

Tell me more…

What are the different types of taxes?

Most people pay several different types of taxes. Let’s talk about some of the most common types.

Income tax

Income taxes are what we pay as a percentage of our incomes. The amount of money that we make determines what percentage of our income we have to pay.

The Internal Revenue Service (IRS) collects income taxes on a pay-as-you-earn basis, meaning you have to pay taxes on your income throughout the year. As a result, your employer typically withholds money from your paycheck to pay the government.

After the year ends, we have to file a tax return with the IRS. On this tax return, we tell the government how much we earned throughout the year and how much we’ve already paid in taxes. In the end, we either get a refund from the government for overpaying our taxes (this means we get some money back), or we receive a tax bill and we have to pay what we still owe.

Here are the income tax rates for an individual taxpayer in 2020 (taxes that are due spring 2021):

Taxable Income BetweenTax Due
$0 - $9,87510% of taxable income
$9,876 - $40,125$987.50 + 12% of the amount over $9,875
$40,126 - $85,525$4,617.50 + 22% of the amount over $40,125
$85,526 - $163,300$14,605.50 + 24% of the amount over $85,525
$163,301 - $207,350$33,271.50 + 32% of the amount over $163,300
$207,351 - $518,400$47,367.50 + 35% of the amount over $207, 350
Over $518,400$156,235 + 37% of the amount over $518,400

Did you know? Income taxes represent the largest source of revenue for the federal government. About half of federal tax revenue comes from individual income taxes.

Most states also have a state income tax, but as of 2012, seven states don't: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. If you live in one of these states, you’ll still have to pay federal income taxes.

Corporate tax

Corporate taxes are like income taxes, but for businesses. Companies pay a percentage of their profit for the year in taxes.

Unlike individuals who pay a tax rate based on their income level, most corporations are subject to a flat income tax of 21%, as of 2021. Corporate income taxes make up just a small share of the federal government’s annual revenue.

Property tax

If you own a home or any other type of property, you likely have to pay property taxes. State and local governments levy property taxes to pay for government expenditures. School districts also sometimes levy property taxes to help fund educational and infrastructure expenses in the school district.

The amount you’ll pay in property taxes will vary widely depending on where you live. You usually pay property taxes as a percentage of the value of your home. Both the cost of housing and the property tax rate in your area will impact your property tax bill.

Capital gains tax

You’ll pay capital gains taxes when you sell an asset and the sale results in a profit for you.

Capital gains taxes apply to other things beyond physical assets–the same thing happens when selling stock: if you sell it for more than its purchase price, you’ll owe capital gains tax.

The percentage you pay in capital gains depends on your individual income, not on the value of the asset. As of 2021, the rate you’ll pay in capital gains taxes will either be 0, 15, or 20 percent, depending on your income. In some cases, usually when the asset is held for less than a year, you'll be taxed at your income tax rate (rather than the capital gains tax rate).

For an individual, these rates are as follows for 2020 (taxes due spring 2021) and 2021 (taxes due spring 2022):

Capital gains tax rate2020 Taxable income2021 Taxable income
10%$0 to $9,875$0 to $9,950
15%$9,876 to $40,125$9,951 to $40,525
22%$40,126 to $85,825$40,526 to $86,375
24%$85,826 to $163,300$86,376 to $164,926
32%$163,301 to $207,350$164,925 to $209,425
35%$207,351 to $518,400$209,426 to $523,600
37%$518,401 and up$523,601 and up

Sales tax

When you buy goods and services, you’ll often pay sales taxes on your purchase. Sales tax applies at the time you make the purchase. The seller collects the taxes and then sends those dollars to the appropriate government body. The amount you pay in sales tax is a percentage of your total purchase amount.

The federal government does not collect sales taxes. Instead, state and local governments collect these taxes. In some places, you’ll pay sales taxes to both levels of government, while individuals in other locations will pay sales taxes to just one level of government.

FICA tax

In addition to withholding income taxes from your paycheck, your employer also withholds Federal Insurance Contributions Act (FICA) taxes. FICA taxes are payroll taxes that pay for Social Security and Medicare, both of which are vital government programs to help senior citizens. Payroll taxes make up more than 25% of the federal government’s annual revenue.

As of 2021, the FICA tax is 7.65% of income. Your employer also pays 7.65% of your income in FICA taxes. Self-employed individuals pay both the employee and employer portion of the FICA tax — This is often referred to as self-employment taxes.

Why do we pay taxes?

Taxes help pay for things we all have access to, such as roadways, law enforcement, and public education. Taxes also help to pay for programs to help our nation’s most vulnerable. These programs include the Social Security program, which provides income to older individuals, and Medicaid, which provides health insurance coverage to low-income families.

The longer you fail to pay your tax bill, the more you’ll pay in penalties. The penalty is 4.5% per month for failing to file and 0.5% per month for failing to pay. Since the penalties accrue monthly and interest compounds daily, the amount will add up quickly.

In extreme cases, the punishment won’t just be a financial one. If you use illegal means (such as misrepresenting your income to the IRS) to avoid paying taxes, you might be guilty of tax fraud. The penalty for tax fraud can be as high as five years in prison and up to $250,000 in fines.

What are taxes used for?

Your tax dollars pay for vital infrastructure, programs, and services that the federal, state, and local governments provide. On the federal level, just a few programs make up the vast majority of spending. Based on 2020 budget data, those programs are:

  • Social Security provides monthly income for seniors and costs taxpayers more than $1,100B annually. The program is funded by a dedicated payroll tax (aka the Social Security tax).
  • Medicare is a federal program that provides seniors health insurance coverage. The program costs more than $900B annually and, like Social Security, has a dedicated payroll tax.
  • Medicaid provides health insurance coverage to low-income individuals and families, and costs about $450B annually.
  • Defense spending costs more than $690B annually.

Other federal government spending includes transportation, education, health, housing, unemployment insurance, and veterans benefits. The federal government also spent $576B in 2020 on interest.

In total, federal government spending represents more than 20% of the nation’s gross domestic product (GDP), which is the total value of goods and services that a country produces.

We also pay taxes to our state governments, which are responsible for delivering many essential government programs. One of the primary jobs of state governments is providing public education. As a result, K-12 education represents about 26% of state spending.

Another significant expenditure for state governments is funding Medicaid. The program is jointly funded by the federal government and state governments and administered by the state governments. It makes up about 17% of state government spending.

Other major state expenditures include higher education, transportation, corrections, and public assistance to families in need. Ultimately the spending numbers vary widely from one state to another, as each state has different needs and priorities.

How do income taxes work?

In the United States, we have a progressive income tax system. The percent you pay in income taxes increases as your income level does. There are seven tax brackets with seven different tax rates. Individuals pay a particular rate on the portion of income that falls within a given bracket.

Here are the federal tax brackets in the US for 2020 (the taxes that are due spring 2021):

Tax RateSingleMarried, filing jointlyHead of Household
10%$0 to $9,875$0 to $19,750$0 to $14,100
12%$9,876 to $40,125$19,751 to $80,250$14,101 to $53,700
22%$40,126 to $85,525$80,251 to $171,050$53,701 to $85,500
24%$85,526 to $163,300$171,051 to $326,600$85,501 to $163,300
32%$163,301 to $207,350$326,601 to $414,700$163,301 to $207,350
35%$207,351 to $518,400$414,701 to $622,050$207,351 to $518,400
37%$518,401 or more$622,051 or more$518,401 or more

Here are the federal tax brackets in the US for 2021 (the taxes that are due spring 2022):

Tax RateSingleMarried, filing jointlyHead of Household
10%$0 to $9,950$0 to $19,900$0 to $14,100
12%$9,951 to $40,525$19,901 to $81,050$14,101 to $54,200
22%$40,526 to $86,375$81,051 to $172,750$54,201 to $86,350
24%$86,376 to $164,925$172,751 to $329,850$86,351 to $163,300
32%$164,926 to $209,425$329,851 to $418,850$163,301 to $209,400
35%$209,426 to $523,600$418,851 to $628,300$209,401 to $523,600
37%$523,601 or more$628,301 or more$523,601 or more

Suppose that an individual had $250,000 of taxable income in the tax year 2020. They would pay income taxes in six of the seven tax brackets. But each percentage would only apply to a portion of their income. For example, the 35% tax rate would apply only to the portion of their taxable income that was greater than $207,351.

How do state and local taxes work?

Remember that it’s not just the federal government that levies taxes — State and local governments do as well. The makeup of state and local tax revenue looks very different than that of the federal government.

States rely heavily on sales taxes, individual income taxes, and fees for their tax revenue. Fees that state governments collect include university tuition, payments to public hospitals, and tolls on highways or bridges.

States also rely on intergovernmental transfers, meaning the money they receive from other state or local governments. Most state intergovernmental transfers come from the federal government to pay for welfare programs such as Medicaid.

Like state governments, local governments get a lot of their money from other levels of government. Most of their transfers come from the state government, while a smaller portion comes from the federal government.

Local governments also collect taxes directly. They rely most heavily on property taxes, sales taxes, and fees such as water, sewer, and parking charges.


Robinhood does not provide tax advice. Please consult with a tax professional regarding your personal circumstances.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.


Related Articles

You May Also Like

The 3-minute newsletter with fresh takes on the financial news you need to start your day.
The 3-minute newsletter with fresh takes on the financial news you need to start your day.

© 2021 Robinhood. All rights reserved.

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC provides brokerage services. Robinhood Securities, LLC, provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. Robinhood U.K. Ltd (RHUK) provides brokerage services in the United Kingdom. All are subsidiaries of Robinhood Markets, Inc. ('Robinhood').