10 Income Tax Definitions You Should Know before Filing Your Taxes
When tax season rolls around many people dread the task, even if they’re getting a refund. Filing your taxes can be confusing and the terms and acronyms are a big part of the problem. Our list of 10 common tax terms is designed help you conquer the confusion and cut through the jargon. It might even help you navigate your own tax forms this year.
Gross income. Your gross income is the total sum of everything you earn in the year. While your wages probably come to mind first, your gross income can actually include income sources from other areas as well. Some other places where you might receive income could include tips, capital gains, dividends, rent, pension or alimony. The gross amount refers to how much you earn, not how much you had in take home pay. It’s sometimes called pre-tax income.
Taxable income. Your taxable income is the amount you make in the year that your tax payment is based upon. It starts with your gross income and then subtracts all adjustments, deductions and exemptions you’re allowed to take. You don’t pay taxes on your gross income, your taxes are determined by your taxable income.
Adjusted gross income (AGI). This is the money you make over the course of a year (your gross income) minus specific deductions that are often called above-the-line deductions.
Above-the-line deductions. These deductions are outlined in Internal Revenue Code Section 62 and can be pretty complicated, but some of the more common above-the-line deductions include: moving expenses when moving for a job, teachers subtracting the cost of classroom supplies, student loan interest and tuition payments, contributions to qualifying retirement accounts and alimony payments.
Tax bracket. The United States has set its taxation schedule into brackets, or divisions. Each bracket has a range of incomes (low to high) and a set tax rate for incomes that fall within the established range. When you try to determine which bracket your income falls in, it’s key that you use your taxable income, not your gross income or your AGI.
Tax deductions. Tax deductions are subtracted from your gross pay, which then lower your AGI and your taxable income. This means that a deduction will probably lower how much you owe in taxes. There are different types of tax deductions, each with their own qualifications and/or limitations.
Standard deduction. Each person is allowed a standard deduction, which is then subtracted from your income and will lower your taxes due. The standard deduction is divided into categories, but once you find your category you know exactly what that deduction will be — so this requires no math!
Itemized deduction. While you’re entitled to a standard deduction, you may choose not to use it and to itemize your expenses instead. There is a large list of allowable items and limits on how much you can deduct, but some popular itemized categories include medical payments, premiums for medical insurance, charitable contributions, property taxes and more. Most people only choose to itemize if they will get a greater tax deduction by itemizing than they would with their standard deduction.
Tax credits. One important distinction is a tax deduction reduces your taxable income, which may reduce the total amount you owe in taxes. A tax credit is a dollar-for-dollar reduction in how much you owe. So a tax credit of $100 means you owe $100 less than you did prior to the credit.
Tax credits are less common than deductions and each one is different, so there are qualification guidelines. Some credits include buying a first home, adopting a child, child care expenses, home office expenses and a variety of business tax credits. One of the most popular credits is the Earned Income Credit (EIC), which is designed to give a tax break to lower- and middle-income families.
Tax Exemption. An exemption is a type of deduction that reduces the amount of your taxable income. Up until 2018 each person can claim themselves as an exemption, unless someone else (usually a parent) can claim them. This personal exemption will not apply after the 2017 tax season.
Other exemptions are made for dependents and those will remain in the 2018-2025 period. A dependent is typically a child, but it can also be other relatives who rely on the taxpayer for support. A good example of a dependent that is not a child is an elderly parent who needs to live with the taxpayer for health and personal care reasons. But even in that situation, there will be some qualifying criteria.
This list of income tax definitions should get you on your way, or at least clear up some of the confusion. If you have further questions about tax terms, the Internal Revenue Service (IRS) tax glossary is full of terms and definitions you may encounter this tax season.
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