Ad valorem is a Latin phrase, and the literal ad valorem meaning is ‘according to value’. Yes, it is indeed a complicated phrase, but not so difficult to understand. Now that we know the literal ad valorem meaning, let’s start with its most vital characteristics. The most critical feature of ad valorem tax is that it is directly proportional to the value of the underlying asset, unlike specific taxes, wherein the tax amount remains consistent, irrespective of the value of the underlying asset. The real estate sector has to pay the ad valorem tax, and they have to pay it on an annual basis.
What is an Ad Valorem Tax?
Let us look at the simplified and easy-to-understand ad valorem meaning. The ad valorem tax is simply based on the assessed item value, such as any form of personal property or real estate. The most common examples of this ad valorem tax are property taxes levied on real estate. However, ad valorem meaning can also extend to a number of other tax applications, for example, the import duty tax on goods coming in from abroad.
In court proceedings involving ad valorem tax, the court usually appoints a tax assessor for the purpose of determining the value of an asset. In order to understand ad valorem meaning, one can use the fair market value of an underlying asset since ad valorem tax represents a percentage of the same.
A majority of ad valorem tax laws specify the amount limit or the upper percentage of tax a state, country or other relevant administrative division can charge and make allowance for increments in population, inflation etc.
How Ad Valorem Tax Works?
Ad valorem taxes, such as property taxes, are levied by the municipality. However, they can also be levied by the other local government entities. For example, the special taxing districts otherwise known as ‘special purpose districts’.
Property owners can be subject to ad valorem taxes levied by more than one entity. The authorities calculate and levy ad valorem tax on an annual basis. But they can levy transactional tax at any point of the transaction.
Ad valorem taxes can be levied on both commercial property as well as personal property. One way to calculate this tax is by multiplying the estimated property value by the applicable tax rate. Let’s have a look at the table below to understand the formula to calculate ad valorem tax.
| Asset Value | Applicable Ad Valorem Tax Rate | Tax Applicable |
| 10,000 | 4% | 1000*4/100= 40 |
How Ad Valorem Taxes are Levied?
When determining the value of any asset in the form of property, the concerned authorities will choose assessors to examine the taxable property. As per the assessment, they will then determine its value and settle on an applicable tax rate for further tax calculation. Unlike transactional taxes, ad valorem taxes are levied on an annual basis. Even though people are not required to pay this tax frequently, it can be charged by more than one authority. For instance, One person might have to pay these ad valorem taxes several times as charged by the municipality and county for a real estate asset.
Also Know: What is Income Tax?
Ad Valorem Tax Example
Let us define ad valorem tax and understand its meanings. The government unit may require an individual or business to own an asset or do business within a jurisdiction to pay the ad valorem tax. The most common examples of ad valorem taxes can be:
Property Tax
Property tax is an example of ad valorem tax that an owner of residential, commercial or real estate property pays on the value of their owned property. The term property refers to either a personal form of property or land and even the improvements in the land (man-made improvisations). The tax authorities can hire evaluators to determine the property’s value on a regular basis prior to arriving at the final tax assessment value.
Sales Tax
The government charges sales tax at the point of purchase of certain goods and services. This tax includes the price of a product or adds it at the point of sale. Tax authorities charge sales tax in the form of a percentage. The product seller has the authority to collect this tax at the time of purchase from the final customer and then forward the levies to the relevant tax authority. Resale products are not part of sales tax. This holds true as long as the purchaser produces a certificate of resale along with a statement that the goods are for resale.
Value Added Tax (VAT)
VAT or ‘Value Added Tax’ is a type of goods and services tax (GST). It is charged on a particular value-added upon a business’s services and goods it purchases from a market. VAT and sales tax differ because the latter is on the net value of services and goods. It is an indirect tax, which means a varying party bears the cost of the tax. For example, when a customer purchases a cup of coffee, the consumer is paying VAT for the complete production process, starting from the cultivation of coffee, purchase of coffee beans, the processing and ultimately the final product, since coffee only becomes more valuable at each stage.
Also Read: What is Direct Tax?
The Functionality of Ad Valorem
All ad valorem taxes are levied on the basis of the determined value of the concerned property. In the most common application of the ad valorem taxes, including municipal property taxes, real estate of property owners undergoes periodic assessment by the public tax assessor to determine the current value.
Ad valorem tax is based on the ownership of real assets and can be viewed as a contrast to category of transactional taxes such as sales taxes.
How to Determine the Value of Your Taxes?
Tax assessments are done for the purpose of determining ad valorem taxes. Assessors calculate these taxes on 1st of January of every year. Ad valorem tax meaning is representative of a percentage of the assessed value of a property. This is commonly known as a property’s fair market value.
The fair market value is an estimated price of a property, assuming a transaction between the seller and a buyer. Both of whom have reasonable knowledge of the pertinent facts relating to a property.
Conclusion
Ad valorem is a tax based on the assessed value of a service, product or property. The most common examples of ad valorem tax include property tax on real estate, sales tax on consumer-based goods and VAT on the value added . Ad valorem taxes, as per ad valorem tax definition, is a primary source of revenue for governments.
Ad Valorem Tax FAQs
The simple ad valorem meaning is ‘according to value’. It is most commonly applied to a tax imposed on the value of a property.
Ad valorem tax as per ad valorem meaning and specific tax differ as ad valorem places a proportionately greater tax on the expensive goods.
Ad valorem is an indirect tax charged as a percentage of the price of a service or a good.
A major advantage of ad valorem tax is that tax revenue to the government can rise automatically with the economy’s growth.
Yes. Ad valorem tax is both determined and collected on an annual basis. Transaction or sales tax, on the other hand, is only levied when a transaction is made.
Ad valorem tax is levied on real estate assets, consumer goods, and value added to the final product or service.
The formula to calculate Ad Valorem tax is: Property value*Applicable tax rate/100
An ad valorem is a type of taxation levied on the basis of the value of an asset. Income Tax is a type of ad valorem tax since it also increases as the income slab increases.
Also read about TCS Tax, Pension on Investment Simplified.
