Tax Terms Database
Ability to pay:
A concept of tax fairness stating that people with different amounts of wealth or different amounts of income should pay tax at different rates. Wealth includes assets such as houses, cars, stocks, bonds, and savings accounts. Income includes wages, interest, and dividends, and other payments.
Accelerated depreciation is any method of depreciation used for accounting or income tax purposes that allows greater depreciation expenses in the early years of an asset.
A material change to the recorded initial cost of an asset or security after it has already been owned.
Adjusted gross income (AGI):
Gross income reduced by certain amounts, such as a deductible IRA contribution or student loan interest.
This credit effectively refunds part of what one pays to adopt a qualifying child. An eligible child is generally under the age of 18 or is physically or mentally incapable of caring for him or herself. The right to the credit phases out as AGI rises.
A revised tax return, filed on Form 1040-X, to correct an error on a return filed during the previous three years. An amended return can result in owing extra tax or receiving a refund, depending on the mistake you correct.
An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.
This is a review of your tax return by the IRS, during which you are asked to prove that you have correctly reported your income and deductions. Most audits are done by mail and involve specific issues, not the entire return.
Burden of proof:
The responsibility of the taxpayer to prove that their tax return is accurate, rather than the IRS having to provide convincing evidence that it is inaccurate.
Although Congress has shifted the burden of proof to the IRS in certain tax disputes, it is best to hold onto your records. The change will have no effect on most taxpayers. The burden shifts only if a case gets to court—which happens very rarely—and then, only if the taxpayer has complied with all record-keeping requirements and has cooperated with IRS requests for information. In almost all cases, the burden of proof remains with the taxpayer.
The cost of permanent improvement to a property. Such expenses, for example, adding central air conditioning or an addition to your home, increase the property’s adjusted tax basis.
The profit from the sale of property such as stocks, mutual-fund shares, and real estate. Gains from the sale of assets owned for 12 months or less are known as “short-term capital gains” and are taxed in one’s top tax bracket, just like their salary.
For most assets owned more than 12 months, profits are considered “long-term capital gains” and are taxed at 0, 15, or 20 percent. Taxpayers who otherwise fall in the 10 percent or 15 percent bracket get an even better deal. Their rate on long-term gains is 0% percent.
However, there are a few other exceptions where capital gains may be taxed at rates greater than 20%:
- The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
- Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
- The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.
The loss from the sale of assets such as stocks, bonds, mutual funds, and real estate. These losses are first used to offset capital gains and then up to $3,000 of excess losses can be deducted against other income, such as your salary.
Long- and short-term losses (distinguished by whether the property was held for more than one year or not) are first used to offset gains of a similar nature. Any excess first offsets the other kind of gain, then other types of income.
A gift of cash or property to a qualified charity for which a tax deduction is allowed. You must have either a receipt or a bank record to back up any donation of cash, regardless of the amount.
Write-offs that one can subtract from their gross income to calculate their taxable income. All taxpayers may claim a standard deduction, which is determined by the IRS.
If your qualifying expenses exceed your standard deduction, you may claim the higher amount by itemizing your deductions. While no records are needed to prove your right to the standard deduction, you must maintain records of qualifying expenditures if you choose to itemize.
For higher income taxpayers, the amount of their otherwise allowable itemized deductions will be reduced when adjusted gross income (AGI) exceeds a threshold amount. The reduction and threshold amounts can vary each year. Read this article here for more.
Amount that taxpayers can claim for a “qualifying child” or “qualifying relative”. Each exemption reduces the income subject to tax. The exemption amount is a set amount that changes from year to year. One exemption is allowed for each qualifying child or qualifying relative claimed as a dependent.
A qualifying child or qualifying relative, other than the taxpayer or spouse, who entitles the taxpayer to claim a dependency exemption.
A deduction to reflect the gradual loss of value of business property as it wears out. The law assigns a tax life to various types of property, and your basis in such property is deducted over that period. See also Accelerated depreciation.
Includes wages, salaries, tips, includible in gross income, and net earnings from self-employment earnings.
Earned income credit
If your adjusted gross income is below a certain amount, you may be able to claim this credit, which might balance out your income tax bill and even result in a refund of any leftover credit. The exact credit amount depends on your income level, as well as the number of qualifying children you have.
Interest on college loans can be deducted as an adjustment to income, so you get a benefit even if you claim the standard deduction rather than through itemizing deductions on your return.
To qualify for the write off, the debt must be incurred to pay higher education expenses for you, your spouse or your dependent. Up to $2,500 of such interest can be deducted, but this tax-saver—like so many others—is phased out at higher income levels.
This deduction is allowed for kindergarten through 12th grade teachers for expenses on classroom supplies. This is an “adjustment to income,” which means you can take this benefit even if you claim the standard deduction rather than itemizing.
Residential Energy Efficient Property Credit: This tax credit helps taxpayers pay for qualified residential alternative energy equipment, such as solar water heaters or solar electricity equipment. The credit is 26 percent of the cost of qualified property through from 2020 through 2022, and the credit drops to 22 percent for 2023, when it ends.
Currently, there is no cap on the amount of credit available. Generally, you can include labor costs when figuring the credit and you can carry forward any unused portions of this credit. Qualifying equipment must have been installed on or in connection with your home located in the United States.
If you have income that’s not subject to withholding, such as investments or self-employment income, you may have to make quarterly payments of the estimated amount needed to cover your expected tax liability for the year.
Excess Social Security tax withheld
If you hold more than one job during the year—either at the same time or successively—too much Social Security could be withheld from your pay. This is because each employer is required to withhold the tax, but no taxpayer must pay the full tax on more than the annual limits. If wages from two jobs pushes you over the limit, too much tax will be withheld. You will get a credit for the excess withholdings when you file your tax return for the year.
Also known as the Section 179 deduction, expensing lets you treat a certain amount of the expenditures that normally would be depreciated over several years as current business expenses to be deducted immediately.
Federal income tax
The federal government levies a tax on personal income. The federal income tax provides for national programs such as defense, foreign affairs, law enforcement, and interest on the national debt.
Federal Insurance Contributions Act (FICA) Tax
This tax provides benefits for retired workers and their dependents as well as for disabled workers and their dependents. Also known as the Social Security tax.
This determines the rate at which income is taxed. The five filing statuses are: single, married filing a joint return, married filing a separate return, head of household, and qualifying widow(er) with dependent child.
Money, goods, services, and property a person receives that must be reported on a tax return. Includes unemployment compensation and certain scholarships. It does not include welfare benefits and nontaxable Social Security benefits.
Head of household
A filing status with lower tax rates for unmarried or some married persons considered unmarried (for purposes of this filing status) who pay more than half the cost of maintaining a home, normally, for themselves and a qualifying person, for more than half the tax year.
The period of time you own an asset for purposes of determining whether the profit or loss on its sale is a short- or long-term capital gain or loss.
Sales of assets owned one year or less produce short-term results. The sale of assets owned more than one year produces long-term results. The holding period begins on the day after you purchase an asset and ends on the day you sell it.
Taxes on income, both earned (salaries, wages, tips, commissions) and unearned (interest, dividends). Income taxes can be levied on both individuals (personal income taxes) and businesses (business and corporate income taxes).
This is someone who performs services for others. The recipients of these services do not control the means or methods that the independent contractor uses to accomplish their work. The recipients do control the results of the work; they decide whether the work is acceptable. Independent contractors are self-employed.
The simultaneous increase of consumer prices and decrease in the value of money and credit.
Tax rules designed to protect married taxpayers who file joint returns from being held responsible for taxes due to errors made by their spouses—such as failing to report income or claiming unsubstantiated deductions.
Basically, if you can prove that you didn’t know and didn’t have reason to know about the error that resulted in the underpayment of tax on the joint return, you can be relieved of responsibility for that underpayment. You have two years from the time the IRS begins trying to collect the underpayment to petition for innocent spouse relief.
Interest paid on loans used for investment purposes, such as to buy stock on margin. You can deduct this interest on Schedule A if you itemize, up to the amount of investment income (not including capital gains or dividends that qualify for the 0, 15, or 20 percent rates) you report.
This is a retirement plan for the self-employed. As much as 25 percent of your net earnings from self-employment income (up to $61,000 for 2022) can be deposited in a defined contribution Keogh. Contributions are tax deductible. There is no tax on the earnings until the money is withdrawn, and there are restrictions on tapping the account before age 59 ½.
The distribution or payment, within a single tax year, of a plan participant’s entire balance from an employer’s qualified pension, profit-sharing, or stock bonus plans. All the participant’s accounts under the employer’s qualified pension, profit-sharing, or stock bonus plans must be distributed to be considered a lump-sum distribution.
Marginal tax rate
This is the tax rate you pay on any additional dollar of income. In the United States, the federal marginal tax rate for individuals increases as income rises.
The tax law provision that generally allows any amount of property to go from one spouse to the other—via lifetime gifts or bequests—free of federal gift or estate taxes.
Used to provide medical benefits for certain individuals when they reach age 65. Workers, retired workers, and the spouses of workers and retired workers are eligible to receive Medicare benefits upon reaching age 65.
When the amount of a credit is greater than the tax owed, taxpayers can only reduce their tax to zero; they cannot receive a “refund” for any excess nonrefundable credit. Read this article here for more.
Basically, this is interest that doesn’t qualify as mortgage, business, student loan or investment interest. Included is interest that one pays on credit cards, car loans, life insurance loans, and any other personal borrowing not secured by your home. Personal interest cannot be deducted.
Withdrawals from a company retirement plan that are subject to a 10 percent penalty (in most cases) if you’re under age 55 in the year you leave the job or from a traditional IRA if you’re under the age of 59 ½.
Taxes on property, especially real estate, but also can be on boats, automobiles (often paid along with license fees), recreational vehicles, and business inventories.
An employee benefit plan—such as a pension or profit-sharing plan that meets the IRS requirements designed to protect employees’ interests.
Money owed to taxpayers when their total tax payments are greater than the total tax owed. Refunds are received from the government.
When the amount of a credit is greater than the tax owed, taxpayers can receive a “refund” for some of the unused credit.
The tax-free transfer of funds from one individual retirement account (IRA) to another or from a company plan to an IRA. If you take possession of the funds, the money must be deposited in the new IRA within 60 days. Beware that when the rollover method is used to move money from a company plan to an IRA, 20 percent of the amount will be withheld for the IRS, even though the rollover is tax-free if the money is in the IRA within 60 days. To avoid this automatic withholding, use the direct transfer method to move money from a company plan to an IRA. See Direct transfer.
Employers are now allowed to add a Roth option to 401(k) plans to allow employees to invest after-tax money with the promise of tax-free withdrawals in retirement. With the regular 401(k), you invest pre-tax money but must pay tax on all withdrawals in retirement. If your firm offers a matching contribution, it must go into the traditional 401(k), and you will be taxed on distributions from that part of the plan. The same dollar limits apply to Roth 401(k)s as to regular plans. The maximum employee contribution for 2021 is $19,500. Plus, you can make an extra $6,500 “catch-up” contribution if you are age 50 or older. You can choose to divert part of your pay to each kind of 401(k) account, but your combined contributions can’t exceed the preceding limits.
The back-loaded IRA is named after a main supporter—the late Senator William Roth of Delaware. It’s called back-loaded because the tax benefits come at the end of the line. Contributions are not deductible, but all withdrawals are tax-free, as long as they come after you reach age 59 ½ and at least five years after January 1st of the year in which you opened up your first Roth account.
Named after the subchapter of the tax law that authorizes it, an S corporation generally pays no tax because profits and losses are passed on and taxed to the corporation’s shareholders.
Compensation received by an employee for services performed. A salary is a fixed sum paid for a specific period of time worked, such as weekly or monthly.
A tax on retail products based on a set percentage of retail cost.
The Self Employment Contributions Act tax pays for Social Security and Medicare for self-employed individuals. For 2022, the self-employment tax rate is 15.3 percent on the first $147,000 of self-employment income and 2.9 percent on all amounts over this amount.
Generally, to contribute to a traditional or Roth IRA, you must have earned income. But a working spouse can contribute up to $6,000 of his or her own earned income to an IRA for a nonworking spouse in 2022. The limit is $7,000 if the account owner is age 50 or older by the end of the year.
A no-questions-asked write-off that reduces your taxable income, the amount of which varies depending on filing status. Taxpayers aged 65 and older or are blind get larger standard deductions. Unlike taxpayers who itemize deductions, you do not need records to prove you deserve this deduction. Even if you somehow made it through the year without incurring any deductible expenses, you may still claim the full standard deduction. About two-thirds of all taxpayers use the standard deduction rather than itemize. Special rules can reduce the standard deduction for children who are claimed as dependents on their parents’ returns, however.
Standard deduction for a dependent
If you can claim a child as your dependent on your tax return, the child may not claim a personal exemption on his or her own tax return.
Standard mileage rate
The deductible amount you can claim for each mile you use your car for business, charitable, job-related relocation, or medical purposes without having to keep track of the actual cost. You can also deduct the actual cost of parking and tolls when driving for any of these purposes.
Student loan interest deduction
You can deduct a portion of the interest you pay on student loans used to pay for college or other post high school education expenses for yourself, your spouse, or your dependents. This tax break is phased out as income rises. You can claim this write-off whether you itemize deductions or not.
This can mean different things. It can refer to income that is taxable (such as wages, interest, and dividends) rather than tax-exempt (such as the interest on municipal bonds). On tax returns, “taxable income” is your income after subtracting all adjustments, deductions, and exemptions—that is, the amount on which your tax bill is computed.
Each tax bracket encompasses a certain amount of income to be taxed at a set rate. The rates for 2021and 2022 run from 10 percent to 37 percent.
A dollar-for-dollar reduction in the tax. Can be deducted directly from taxes owed.
A reduction in the amount of taxes taken by the government.
An amount (often a personal or business expense) that reduces income subject to tax.
A failure to pay or a deliberate underpayment of taxes.
Interest paid on bonds issued by states or municipalities that is tax-free for federal income tax purposes. You must report this income on your return, it is not taxed. Note that some interest that is exempt from the regular tax is taxed by the Alternative Minimum Tax.
All sorts of income can end up being tax-free in some circumstances, including: Auto rebates; child-support payments; damages in lawsuits for physical injury; disability payments; dividends on a life insurance policy; gifts; inheritances; life insurance proceeds; qualified Roth IRA and Roth 401(k) withdrawals; scholarships and fellowship grants; Social Security benefits (between 15 percent and 100 percent are tax-free); veterans benefits; and workers’ compensation, among many others.
Tax liability (or total tax bill)
The amount of tax that must be paid. Taxpayers pay their federal income tax liability through withholding, estimated tax payments, and payments made with the tax forms they file with the government.
A tax rate is the percentage at which an individual or corporation is taxed. The United States (both the federal government and many of the states) uses a progressive tax rate system, in which the percentage of tax charged increases as the amount of the person’s or entity’s taxable income increases. A progressive tax rate results in a higher dollar amount collected from taxpayers with greater incomes.
Income from investments, such as interest, dividends, and capital gains. See Earned income.
The penalty is the IRS’s not-so-subtle reminder that taxes are due as income is earned, not just on the tax deadline of the following year. Basically, it works like interest on a loan, with the penalty rate applied to the amount of estimated tax due, but unpaid by each of four payment dates during the year. The penalty rate is set by the IRS and can change each quarter. There are several exceptions to the penalty. See Estimated tax.
Withholding (“pay-as-you-earn” taxation)
Money, for example, that employers withhold from employees’ paychecks. This money is deposited for the government. This withheld money will be credited against the employees’ tax liability when they file their returns. Employers withhold money for federal income taxes, Social Security taxes and state and local income taxes in some states and localities.
An employer-sponsored retirement savings plan through which employees divert part of their salary to a tax-deferred investment account. Salary put in the plan is not taxed until it is later withdrawn, presumably in retirement. Employers often match a percentage of or all the employee’s deposits. Penalties usually apply to withdrawals before age 55, although most plans allow employees to borrow limited amounts tax- and penalty-free from their accounts. See also Roth 401(k).