Ad valorem tax

What is ad valorem tax?

Ad valorem tax is imposed depending on the monetary value of a property or a transaction. An easy way to remember its definition is to with the Latin phrase “ad valorem,” meaning “according to value.” This tax is levied as a percentage of the assessed value of the property or product, also referred to as the fair market value, defined as the value of the property as objectively determined by the marketplace.

The most common example of ad valorem tax is property tax levied on real estate and personal property. Other examples include sales taxes and value-added taxes (VAT). Ad valorem taxes are an important source of revenue for government entities.

What are the types of ad valorem tax?

There are three types of ad valorem tax. They are property tax, VAT, and sales tax:

• Property tax. These taxes are levied on a taxpayer’s personal and commercial property. Real property or real estate — buildings and land — and personal property — motor vehicles or business equipment — fall under the definition of property.
  
  Ad valorem property taxes are applied to taxpayers in all 50 states and the District of Columbia. States usually levy a tax on personal property but not real property, while local governments — counties, cities, and school districts — typically levy tax on real property. In 2024, state and local governments collected a combined $797 billion in revenue from property taxes, which accounted for 38% of all state or local revenue.

• VAT. Value-added tax is an indirect tax charged on the value added at each stage of the supply chain. In producing a good or service, each business along the production chain receives a tax credit for the VAT tax they’ve paid, with the end consumer ultimately paying the tax. For instance, if a product costs $70 and has a 10% VAT, the consumer pays $77 to the retailer. The retailer keeps $70 and remits $7 to the government.

• Sales tax. This tax is charged as a percentage of the retail cost and is paid at the point of purchase for goods or services. The seller collects the sales tax from the end consumer at the time of sale and forwards the levy to the proper taxing authority.
  
  Sales tax is levied at the national, state, and municipal levels. The sale tax rates vary depending on location. Local sales taxes are collected in 38 states, and statewide taxes are collected in 45 states and the District of Columbia. The five states with the highest average combined state and local sales tax rates are Louisiana (9.56%), Tennessee (9.55%), Arkansas (9.45%), Washington (9.38%), and Alabama (9.29%).
  
  Oregon, Montana, Delaware, and New Hampshire do not have state or local sales tax. Alaska does not have a statewide sales tax, but localities can impose local sales taxes.

What is the difference between ad valorem tax and ad valorem tariff?

While ad valorem tax is based on the monetary value of a property or transaction, an ad valorem tariff is a tax on foreign goods imported from another country, calculated as a fixed percentage of the product's value. For instance, if an imported item is valued at $500 and the tariff rate is 5%, the charge would be $25.

When the government imposes these tariffs, they can lead to higher prices for imported goods in the U.S. market, causing consumers to pay more for those items.

What are ad valorem taxes based on?

Ad valorem taxes are determined by the assessed value of the assets, goods, or services being taxed, meaning the taxpayer pays a specific amount based on that value. For example, property tax is levied on personal property and real estate. The taxation is based on the fair market value of the underlying asset. Ad valorem tax can be charged at the time of a transaction; however, it can also be calculated annually.

How do you calculate ad valorem tax?

Calculating ad valorem tax varies depending on whether it is property tax, VAT, or sales tax:

• Property tax. Property taxes are calculated by multiplying the property's assessed value by the millage rate. The estimated value is the tax assessor's annual determination of the property's fair market value. The millage rate represents the amount of tax per $1,000 of valuation, where one mill equals 1/1,000 of a dollar.
  
  If you know the assessed value of your property and the tax levy rate, you can calculate the amount of tax. For example, if real estate property has an assessed value of $150,000 and the levy rate is $9.41 per thousand dollars of value, the tax amount due is $1,411.50.
  
  There are a few exemptions, which typically include property owned by religious entities, governments, and nonprofit groups. These types of properties are not subject to property tax.
  
  Personal property tax is usually calculated based on the value of the underlying property and charged as a percentage of that value. The types of property taxed and the tax rates will vary depending on location.
  
  For instance, in Washington State, most personal property owned by individuals is exempt. However, personal property tax is due on most property businesses use, including their assets and supplies. Inventory held for sale is excluded. For those who must pay personal property tax in the state, it is generally levied at the same rate as real property, such as buildings or land.

•  VAT tax. Calculating VAT involves a straightforward process. To illustrate, consider the following example with a 10% VAT tax assessed at each stage of the process.
  
  A toy manufacturer buys raw materials for $10, which includes a 10% VAT tax. Once the parts are manufactured, a toy assembler buys them for $12, which carries a $2 VAT tax. The manufacturer receives $12; of that amount, they pay $1 to the government. The manufacturer pays only $1 to the government and keeps the other $1 as a reimbursement for the VAT tax they paid to acquire the raw materials.
  
  This process continues throughout each stage of production or purchase. The tax paid at each phase is calculated by deducting the VAT already paid in the prior stage of production or purchase. The end consumer then pays the entire VAT tax paid by the other businesses in the prior stages.

• Sales tax. This tax is charged as a percentage of the retail cost; the rates vary depending on location. It is levied at the national, state, and municipal levels.
  
  For instance, Illinois imposes a 6.25% state sales tax rate and has an average combined state and local sales tax rate of 8.92%. Meanwhile, Nevada levies a 6.85% state sales tax rate and has an average combined state and local sales tax rate of 8.24%.