25 Must-Know Tax Terminologies

Mastering Income Tax: 25 Tax Terminologies, Tax Return Guide, and Tax Rate Breakdown

Understanding the terminology on tax forms and online tax preparation programs can be one of the biggest hurdles when it comes to doing your taxes. To assist you, we have put together a list of 25 important tax terms that you should familiarize yourself with before submitting your tax return.

Tax terminologies: Why it matters

When preparing to file your taxes, you will come across specific tax terms in the forms you complete. While resources like books, YouTube videos, and software can assist in navigating these details, it is beneficial to familiarize yourself with basic terms and definitions as a starting point.

We have compiled a list of commonly used and confusing tax terms, along with explanations to help you understand them better. Knowing the meanings of these terms can boost your confidence in filing your taxes.

1. Above-the-line deduction

A deduction above the line enables you to reduce the total taxes you are required to pay. Common examples include the interest on student loans, contributions to a health savings account (HSA), expenses for educators, and tuition fees.

When you file your taxes, make sure to fill out Schedule 1 in order to claim these deductions above the line and include it with your tax return.

2. Adjusted gross income

Adjusted gross income (AGI) is the sum of all your yearly earnings, such as salaries, tips, interest, dividends, and capital gains, after deducting specific expenses. To find your AGI, subtract any eligible tax deductions like contributions to retirement accounts, moving costs, and interest on student loans from your total income. AGI is utilized by the IRS to evaluate qualifications for tax breaks and deductions, calculate tax owed, and determine tax rates.

3. Below-the-line deduction

Itemized deductions, also known as below-the-line deductions, can lower your tax liability. Examples of itemized deductions include mortgage interest, student loan interest, investment interest, charitable donations, and specific medical expenses. These deductions are applied after you have calculated your Adjusted Gross Income (AGI).

4. Capital gains

Capital gains refer to the profit generated from the sale of capital assets such as stocks, bonds, real estate, and other items that are sold for a higher price than what was initially paid. If you make a profit from selling an asset this year, you will be required to pay a capital gains tax of 15% for the majority of taxpayers and 20% for those in the highest tax bracket.

Learn more on how to minimize capital gains through investment tax consideration.

5. Capital losses

Sometimes, you may sell capital assets for less than you paid. If this happens, you have the option to deduct up to $3,000 in losses on your taxes. However, you can only do this if your losses are greater than your gains for the year. Any remaining losses can be carried over to future tax years.

6. Charitable contribution

An individual can claim a tax deduction for charitable contributions made to eligible non-profit organizations, charities or private foundations. These contributions can include cash, real estate, clothing, appreciated securities, and other assets, and may result in an itemized deduction on your tax return. To verify if the organization you donated to is eligible for a tax deduction, use the Tax Exempt Organization Search tool.

7. Child and dependent care credit

If you incur expenses for dependent care while employed (or searching for employment), you are eligible for the child and dependent care credit.

Qualifying dependents include:

– Children under the age of 13
– Adult dependents who are unable to self-care

The IRS caps the credit at a maximum of $3,000 for one dependent or $6,000 for two or more dependents.

Learn more about child and dependent care tax credit and IRS Form 2441.

8. Child tax credit

The child tax credit is a payment designed to provide financial assistance to families with qualifying children. In 2023 taxes (to be filed in 2024), the IRS has reverted back to the original credit limit of $2,000 per child, after temporarily increasing the credit in recent years as part of COVID relief measures.

9. Cost basis

Cost basis is the original purchase price of an asset prior to any increase or decrease in value. For instance, if you buy a stock for $100, the cost basis remains $100 even if the current value changes.

10. Dependent

A dependent is an individual, such as a child or relative, who depends on you for financial support. Claiming dependents allows for tax exemptions on your federal income tax return. It is important to carefully review the criteria and regulations for determining who qualifies as a dependent before filing your taxes.

11. Earned income tax credit

The EITC is a tax credit that is refundable and meant for individuals with low to moderate incomes. To be eligible for the EITC, individuals must earn $59,187 or less. The amount of the EITC varies for each taxpayer and takes into account investment and foreign income.

12. Estimated tax payments

If you work as a freelancer, independent contractor, or business owner, you may be required to make quarterly estimated tax payments.

These payments must be submitted by the following deadlines:

– April 15, 2024: for income earned between January 1 and March 31, 2024
– June 15, 2024: for income earned between April 1 and May 31, 2024
– September 15, 2024: for income earned between June 1 and August 31, 2024
– January 17, 2025: for income earned between September 1 and December 31, 2024

Failing to make these payments on time could lead to penalties.

Find out more about the consequences of filing taxes late.

13. Exemption

Tax exemptions are particular sums that lower the portion of your income that is subject to taxation. These exemptions can be applied for individuals, a partner, or eligible dependents. The sum of your exemption is deducted from your AGI before the calculation of taxes on your remaining income that is taxable.

14. Federal and state income tax

Federal income tax is the tax levied by the federal government on the income of all American individuals. The IRS is responsible for overseeing the national income tax system.

Apart from federal income tax, many states also impose an annual tax on your earnings or income. In certain states, you might also be required to pay taxes to the county, city, and even school district.

15. Filing status

Your chosen filing status dictates which tax forms you will need to complete and plays a crucial role in calculating your taxable income.

The available options for filing status are:

– Single
– Married filing jointly
– Married filing separately
– Head of household
– Qualifying widow or widower with a dependent child

The IRS provides a tool to assist you in determining the appropriate filing status for your situation. Single, married filing jointly, and head of household are the most commonly used statuses.

Choosing the correct filing status is made simple by the IRS e-file system, which is known for being one of the quickest methods to receive your tax refund.

16. Gift tax

If you transfer money or assets to someone without receiving any form of compensation, you could be liable for gift tax, regardless of whether you intended it as a gift.

You are allowed to give up to a certain amount without incurring taxes; for the 2023 tax year, this limit is $17,000.

There are certain situations where gift tax may not apply, such as:

-Paying for educational expenses for someone else
-Covering medical costs for someone else
-Giving gifts to your spouse
-Donating to a political organization

17. Nontaxable income

Some forms of income are not subject to taxation. These may include cash rebates, child support payments, and gifts. Unlike your earnings from employment, you do not have to pay taxes on this type of income.

18. Self-employment income

Self-employment income is earned by independent contractors, freelancers, and sole proprietors. This term refers to any money earned from providing a service to a client.

19. Taxable income

The phrase “taxable income” can encompass two specific definitions:

1) The income earned from employment that is taxable, unlike non-taxable forms of income such as child support payments or bond interest.

2) The portion of income that remains after deductions and exemptions have been subtracted and is subject to taxation.

Learn more here on how to detect and address income record irregularities.

20. Tax bracket

The percentage at which your income is taxed is determined by your tax bracket, which is determined by your filing status and total income, ranging from 10% to 37%.

Learn more about Federal and state income tax brackets.

21. Tax credit

A tax credit is a reduction of the amount you owe by the same dollar amount. Once you have calculated your tax return, you can apply credits to lessen the amount owed to the IRS.

Tax credits are more beneficial than tax deductions as they directly decrease the amount of money you are required to repay rather than lowering the amount of taxable income.

Understand more the difference between tax credit and tax deduction here.

22. Tax deductions

Tax deductions, also known as tax write-offs, are costs that the IRS permits you to deduct from your AGI in order to determine your taxable income. By decreasing your taxable income through deductions, you will owe a lower amount in taxes.

When computing your taxable income, it is important to take into account three distinct categories of deductions.

Deductions taken above the line are subtracted directly from your gross income. For instance, contributing to an IRA or 401(k) would fall under this category.
On the other hand, itemized deductions consist of specific expenses such as medical costs, donations to charity, mortgage interest, and more. Taxpayers must keep a record of these expenses throughout the year and the deduction is usually limited to a certain percentage of their adjusted gross income.
If you decide not to itemize your deductions, you may be eligible for a standard deduction. The amount of the standard deduction is determined by factors such as your filing status, age, and whether you are claimed as a dependent on someone else’s tax return.

Unsure about which deductions you can claim? Familiarize yourself with some of the top tax deductions to make sure you’re taking full advantage.

Learn more on how tax deductions can reduce your taxable income, which can lead to a larger refund or a lower tax bill.

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23. Tax liability

Tax liability is the total amount of taxes that you are required to pay to federal, state, and local governments. As your income increases, your tax liability also increases. Tax credits and deductions can help reduce your tax liability.

Having no tax liability for a particular year is a positive outcome, meaning that you do not owe any taxes to the government. If you have paid more taxes than you owe, you will receive a tax refund.

If you are unsure about how to use your tax refund, consider learning about the most beneficial ways to utilize it.

Learn more here on how you can legally minimize tax liability.

24. Tax return

Completing and submitting a tax return to the IRS each year is necessary to report your earnings, costs, and essential tax details. It is the method through which you may receive a reimbursement for paying more taxes than required during the year. Conversely, if you have not paid enough, your tax return is the way the IRS notifies you of the amount you owe them. If you are late in submitting your tax return, determine if you should request a tax extension.

If ever you’re wondering why your income tax return is so low? This might help.

25. Withholding

A portion of your income is taken by your employer each pay period and sent directly to the government as advance payment of your income tax. This process is known as tax withholding. These funds are held in an IRS account and will be credited to you when you file your tax return.

The amount of tax withheld is determined by the allowances you claim on your W-4 form. Other deductions from your paycheck go towards Social Security and Medicare.

If you claim too many allowances, you may end up owing money at tax time. Failing to pay enough taxes throughout the year could result in penalties when you file your tax return.

Make sure to review your pay stub to confirm that your withholdings are accurate.

Having a good grasp of taxes can help you to get the most out of your return.

Understanding key tax terms is essential for reducing your tax liability and accurately filing your taxes. By familiarizing yourself with common tax definitions and their relevance to your circumstances, you can prevent mistakes on your tax forms and uncover additional deductions to increase your refund. Opt for direct deposit when electronically filing to expedite the receipt of your refund.

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