What is the Ad Valorem Tax?
Ad Valorem tax simply means a tax charged by state and municipal governments that depends on the assessed value of the asset such as real assetsReal AssetsReal Assets are tangible assets that have an inherent value due to their physical attributes. These assets include metals, commodities, land, and factory, building, and infrastructure assets. or personal property. It comes from a Latin word known as “according to value” and its most common example is property tax in which public tax assessor periodically review the value of a property of real asset and charge the tax based on that value.
Types of Ad Valorem Tax
One of the primary sources for income for State and municipal governments are Ad Valorem taxes. Most common types are:
#1 – Property Tax
Property tax is the taxes levied by state or municipal governments on a commercial or personal property on improvement in the property. Personal property may include a car. Tax authorities usually hire property evaluators to assess the value of a property and then charge tax based on that. For example, if a person has constructed a garage in its property, then though the size of the property has not been changed, the value of property gets increased, and tax authorities will charge tax based on that value.
#2 – Sales Tax
In contrast to property tax, Sales taxSales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%). is charged only at the time of purchase of a property. It is charged as a percentage to the value of a property—sales tax rates varied by country.
#3 – VAT (Value added tax)
The VATVATValue-added tax (VAT) refers to the charges imposed whenever there is an accretion to a product's usefulness or value throughout its supply chain, i.e., from its manufacturing to its final selling point. It is an indirect tax levied on the product consumption. is charged on value added by business or labor. While sales tax is charged on the full value of the property, VAT is charged on value-added or profit by business. The VAT is usually charged on the consumer of the goods. For example, if a consumer is buying some goods, then he/she is paying VAT for the entire production process of those goods.
Examples of Ad Valorem Tax Calculation
Let’s take some examples to understand it better.
A simple example is property tax levied by government authorities. Let’s say you own a house, and for this year, tax authorities have assessed the value of your home to be $100,000. Property tax in your area is 4%.
The calculation for Ad Valorem tax will be –
- Value of House = $100,000
- Property Tax = 4%
- Property Tax = 100,000*4% = $4,000
Hence Property Tax on your house for this year is $4,000.
Ad Valorem Property Tax is applied periodically by state or municipal authorities. Let’s say XYZ school has added 5 more classrooms and constructed a playground in this financial year. When tax authorities evaluate its value for the financial year, because of construction, they increased the value of school from $500,000 to $600,000, though the area of the school remains the same. XYZ school is also eligible for an exemption of $50,000. So the total value of property eligible for Ad Valorem property tax for this financial year would be $550,000. Now tax rate is generally measured in mils. Which is the tax rate multiplied by 1000?
- Tax Rate = Tax Requirement / Tax Base.
- The tax baseTax BaseTax base refers to the total value of the income or assets of an individual or firm which is taxable by the government or the relevant taxing authority. This taxable amount is used to evaluate the tax liability of the individual or company. for that district is $50 million, and the tax requirement is $2 million.
- Tax rate = 2/50 = 0.04 = 40 mils.
The calculation for Ad Valorem tax for XYZ School –
- Assessed Value = $600,000
- Exemption = $50,000
- Taxable Base = $600,000 – $50,000 = $550,000
- Tax Millage rate = 40 mils
- Applicable Tax = 550,000 * 0.04 = $22,000
- Since it is used on the increased value, thus it avoids discrimination against the low-priced items.
- It adjusts as per the spending power of individuals.
- Sometimes it becomes quite challenging to analyze the fair value of assets or property.
- Ad Valorem Property Tax depends on the value-added on the property and the requirement of the tax budget (millage rate) of municipal for that financial year.
- It does not get calculated based on the size of the property.
- It is more progressive than a specific tax because if your house’s value is more, that means you will have to pay more tax than that the less valued house. So wealthier would have to pay more tax since there are chances, they would be spending more on property.
These are one of the primary sources of revenue generation for state and municipal boards. It depends on the assessed value of the property. Some examples of Ad Valorem taxes are Property Tax, Sales Tax on consumer goods, and Value Added Tax on the final product. It is considered more progressive, but it is a bit complicated because sometimes assessing the value of a property can be a tough task.
This article has been a guide to what is Ad Valorem Tax and its meaning. Here we discuss the types of Ad Valorem Tax along with step by step calculation examples, advantages, and limitations. You can learn more about accounting from following articles –