Understanding Ad Valorem Taxes

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Every tax professional encounters ad valorem taxes at some point in their career. Many will work with this type of tax every day. In fact, in the U.S. and many other countries, ad valorem taxes represent the most significant source of government revenue.

What are ad valorem taxes, and how do they impact the work of tax professionals?

Creating an ad valorem tax definition

In Latin, ad valorem means ‘according to the value.’ Essentially, an ad valorem tax is based on the value of a property or transaction, regardless of its size, weight, or quantity. Typically, this tax is a percentage of an assessed value of the property or transaction being taxed.

Generally, this percentage is calculated by the determined market value ― the dollar amount a buyer would be willing to pay and the amount a seller would be willing to accept. In the U.S., this figure is often an annual determination, especially in the case of property transactions. However, not all ad valorem taxes are levied annually.

So, what are the most common types of ad valorem taxes, and how are they levied?

Examples of ad valorem taxes

In the U.S., property and sales taxes are the most common forms of ad valorem taxes. In foreign jurisdictions, tax professionals may encounter value added taxes as well. Let’s examine each one in detail:

Property tax

A property tax may be levied on real and personal property, including land, structures, private roads, and vehicles. It may be applied to improvements to property as well, such as adding a second bathroom to an existing house. In the U.S., property taxes fund local services such as schools and fire departments.

Property taxes are based on an assessment by a local authority. Typically, an assessment is conducted using one of three methods:

Income: In this case, an assessor would determine how much income the property could create if it were rented out, minus common expenses such as insurance and maintenance. This form of assessment most often applies to commercial property.
Cost: This method assesses the current value of the property by determining how much it would cost to reproduce the building from scratch. The assessor will take material prices into account, as well as labor costs. To this value, the assessor will add the value of the land and subtract depreciation.
Sales: Perhaps the most common method, this compares a property to similar properties in the area that have recently sold. The assessor will use that value as a baseline, and then factor in any particularities about the property that could raise or lower its value, such as a recent remodel.

Sales tax

Unlike property taxes, which are levied once a year, sales taxes are charged at point of purchase and are the responsibility of the buyer. The sales tax is typically charged as a percentage of the value of the purchased item. This rate varies by jurisdiction, and five states do not levy sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon.

Value added tax

VAT is a tax on goods and services that is levied throughout the supply chain, rather than at point of sale. However, in practice, the consumer still pays the tax ― they’re simply paying for the value added at each stage of production. One of the purposes of a VAT system is to incentivize collection of taxes at every stage of the supply chain. Across the globe, VAT rates range from 10% to 25%.

Understanding the professional implications of ad valorem taxes

Considering their ubiquity in the U.S. tax system, both professionals who work in the corporate world and those who work with individual taxpayers will likely encounter ad valorem taxes with great frequency. As noted above, sales and property taxes are two common forms of ad valorem taxes. In 2018, federal, state, and local governments collected over $1.4 trillion in ad valorem taxes.

Tax preparers and specialists may need to work with evaluators who can accurately determine the market value of assets. Taxes will vary by jurisdiction, so it’s important that preparers get accurate, local evaluations to best help their clients develop ideal strategies for managing their tax situations.

Additionally, tax professionals who work with international transactions may encounter VAT leveraged across a supply chain. These professionals will have to develop a deep understanding of how international taxes impact individuals and companies. This can seem very complicated on the surface, which is why an online master’s in taxation program breaks down key topics to address specific challenges comprehensively.

Developing a practical understanding of ad valorem taxes

As one of the most common types of taxes, ad valorem taxes are a frequent theme in the Online Master’s in Taxation program from the D’Amore-McKim School of Business at Northeastern University. In this program, students looking to take the next step in their careers can delve deeper into federal, state, and local tax issues. Whether students want to work in the public sector or a corporate environment, these courses can provide useful insights into common ad valorem taxes:

Federal Tax Issues and Analysis: This course emphasizes property transactions, including the tax treatment of basis calculations. Lessons also focus on how the tax structure impacts individual taxpayers.
Estate and Gift Taxation: Ad valorem taxes play a crucial role in the transfer of property and wealth from one generation to the next. This course explores the planning opportunities applicable to wealth transfer taxes.
State and Local Taxation: This elective course covers the most common types of taxes imposed by state and local governments, many of which fall within the ad valorem category.
Planning for Estate Tax Issues: Emphasizing several vehicles for estate planning, this advanced course covers the principles of estate taxation and related issues such as life insurance policies and associated annuities.

As one of the primary forms of government revenue, ad valorem taxes account for a significant portion of the work many tax professionals will encounter on a daily basis. The 100% online Master’s in Taxation program from the D’Amore-McKim School of Business at Northeastern University can help you take your career to the next level by strengthening your understanding of tax fundamentals and expanding your knowledge of complex tax compliance challenges.