Taxonomy in WordPress is one of those things that everyone use, but they do not know that they are using it. Derived from the biological classification method Linnaean taxonomy, WordPress taxonomies are used as a way to group posts and custom post types together. WordPress has two very popular taxonomies that people use on a regular basis: Categories and Tags.
You also have the option to use custom taxonomies to create custom groups and bring them under one umbrella. For example, you have a custom post type called Books. Even though you can use categories, you may not want to mix the two because they are used differently. You can register a new custom taxonomy called Topics. You can add topic terms like: Adventure, Romance, Non-Fiction, etc. This would allow you and your users to sort your books by each topic. Taxonomies can also be hierarchical meaning that you can have main topics like: Fiction, Non-Fiction, and Children. Then have subtopics under each category for example fiction would have thrillers as a sub-topic.