Use our tax terms and definitions guide to look up common tax and accounting terms that you may be unfamiliar with. Of course, we’re always happy to explain any of these terms when you meet with us. We hope these tax definitions are helpful to you as you navigate through your tax documents.
Tax Terms and Definitions
A – C
Above the Line Deduction
An above the line deduction is an item subtracted from gross income in order to calculate adjusted gross income on the IRS form 1040. IRS form 1040 is used by individual U.S. taxpayers to calculate and file yearly taxes. Above the line deductions include items such as health savings account deduction, educator expenses, deductible self-employment taxes, and some contributions to retirement accounts. They also include student loan interest, tuition and fees, and others. Above the line deductions are separate from the itemized deductions provided on the form 1040 schedule A. They are also different from the standard deduction, as a standard deduction can be claimed on line 40 of the IRS form 1040.
Actual-Expense Method
The actual-expense method prorates home expenses based on the portion of the home that qualifies as a home office. This is generally based on square footage. The non-business portions of home mortgage interest and real property taxes continue to be deductible on Schedule A if you itemize deductions. Aside from prorated expenses, 100% of directly related costs, such as painting and repair expenses specific to the office, can be deducted. Unlike the simplified method, the business-use part of the home is not limited to 300 square feet.
AGI
AGI, or adjusted gross income, is all of the income you receive over the course of the year. This includes wages, interest, dividends and capital gains, minus things such as contributions to a qualified IRA, some business expenses, moving costs and alimony payments. Knowing your AGI is the first step in when determining your federal income tax bill. Many tax benefits and allowances, such as credits, certain adjustments, and some deductions are limited by the amount of a taxpayer’s AGI.
AMT
AMT, or alternative minimum tax, is a baseline limit on the percentage of taxes that a filer must pay to the government, no matter how many deductions or credits the filer may claim. Under the tax law, a number of tax benefits can significantly reduce a taxpayer’s regular tax amount. The alternative minimum tax (AMT) applies to taxpayers who earn above certain thresholds by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.
ARM Mortgage
An ARM mortgage, also known as adjustable-rate mortgage, is a home loan with an interest rate that changes periodically. With an ARM, the initial interest rate is fixed for a period of time. After that the interest rate applied on the outstanding balance resets at different rates. These rates can change yearly or even on monthly intervals.
Basis
The basis is the starting value (or capital investment) in property that is used to calculate gains or losses for tax purposes. The basis is also used to determine the amount of depreciation that can be claimed for property used in the rental activity. In addition, you can use your basis to figure out amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property. In most situations, the basis of an asset is its cost to you.
Tax Terms and Definitions
C – I
Compensation
Includes the following:
- Wages, tips, bonuses, professional fees, commissions;
- Alimony received (but only if taxable);
- Net income from self-employment (reduced by the sole proprietor’s own contribution to a Keogh retirement plan and the above-the-line deduction allowed for part of self-employment tax); and
- Non-taxable combat pay.
Compensation does not include rents, interest, dividends, nontaxable alimony, pensions, deferred compensation, or disability payments.
Credits
Tax breaks that directly reduce your tax obligation.
Deductions
Tax breaks that reduce the amount of income you’re taxed on.
Dependent
A dependent is a person, other than the taxpayer or spouse, who entitles the taxpayer to claim a dependency exemption. Generally a dependent is a qualified individual whose living expenses you provide at least half of the year. There are tax benefits a taxpayer can claim for having a dependent.
Earned Income Tax Credit (EITC)
The Earned Income Tax Credit, EITC or EIC, is a benefit for working people with low to moderate income. You must meet certain requirements and file a tax return to qualify. Even if you do not owe any tax, or aren’t required to file. EITC reduces the amount of tax you owe and may give you a refund.
FBAR
FBAR refers to Form 114, Report of Foreign Bank and Financial Accounts.
FHFA
Federal Housing Finance Agency. www.fhfa.gov
FICA
FICA is a U.S. federal payroll tax. It stands for the Federal Insurance Contributions Act enacted in 1935 that mandates a payroll tax on the paycheck of employees and is deducted from each paycheck. Employers must also make matching contributions. The money collected is used to fund both the Social Security and Medicare programs.
Filing Status
Generally, if you are married at the end of the tax year, you have three possible filing status options: married filing jointly, married filing separately, or, if you qualify, head of household. If you were unmarried at the end of the year, you would file as single, unless you qualify for the more beneficial head of household status. A special status applies for some widows and widowers.
Income source
Wages from a job, interest earned, Social Security benefits, and so on.
IPO
IPO is short for Initial Public Offering. It refers to the process of offering shares of a private corporation, to the public in a new stock issuance. This process allows a company to raise capital from public investors.
Inflation Adjustments
Inflation adjustments include the standard deductions, tax rates, and amounts that can be contributed to retirement plans. Virtually all amounts claimed as deductions and credits are annually adjusted for cost-of-living changes from year to year, as required by the tax code. Thus, when determining inflation amounts, be careful to determine the year-specific amount.
Head of household
This is the most complicated filing status to qualify for. Head of Household is frequently overlooked, and often incorrectly claimed. Generally, the taxpayer must be unmarried AND:
- pay more than one half of the cost of maintaining his or her home, a household that was the principal place of abode for more than one half of the year of a qualifying child or certain dependent relatives, or
- pay more than half the cost of maintaining a separate household that was the main home for a dependent parent for the entire year.
A married taxpayer may be considered unmarried for the purpose of qualifying for head of household status if the spouses were separated for at least the last six months of the year. This is provided that the taxpayer wanting to qualify for the head of household status maintained a home for a dependent child for over half the year.
IRA
An Individual Retirement Account (IRA) is an account set up at a bank that allows you to save money for retirement with tax-free growth or on a tax-deferred basis. There are 3 main types of IRAs – each with their own advantages:
- Traditional IRA – You make contributions that may be able to be deducted on your tax return. Earnings can potentially grow tax-deferred until you withdraw them in retirement. Many retirees find themselves making substantially less money, therefore they are in a lower tax bracket than they were in pre-retirement. In this way, tax-deferral means the money may be taxed at a lower rate.
- Roth IRA – You make contributions with money you’ve already paid taxes on, and your money may potentially grow tax-free. When you retire, you can enjoy tax-free withdrawals, provided that certain conditions are met.
- Rollover IRA – You contribute money “rolled over” from a qualified retirement plan into this traditional IRA. Rollovers involve moving eligible assets from an employer-sponsored plan, such as a 401(k) or 403(b), into an IRA.
Itemized Deductions
An itemized deduction is an expense that can be reduced from your adjusted gross income that helps you reach a smaller income amount for calculating your tax bill. Itemized deductions include charitable contributions, medical expenses, state, local and property taxes, mortgage interest, casualty or theft losses, and other miscellaneous deductions like gambling losses. Some itemized deductions are required to meet IRS limits before they can be claimed. When you itemize on your taxes, you must file Form 1040 and explain in detail your tax deductions on Schedule A.
Tax Terms and Definitions
I-N
Marginal Tax Rate (Tax Bracket)
Not all of your income is taxed at the same rate. The amount equal to your standard or itemized deductions is not taxed at all. The next increment is taxed at 10%, then 12%, 22%, etc., until you reach the maximum tax rate, which is currently 37%. When you hear people discussing tax brackets, they are referring to the marginal tax rate. Knowing your marginal rate is important because any increase or decrease in your taxable income will affect your tax at the marginal rate. For example, suppose your marginal rate is 24% and you are able to reduce your income $1,000 by contributing to a deductible retirement plan. You would save $240 in federal tax ($1,000 x 24%). Your marginal tax bracket depends upon your filing status and taxable income. You can find your marginal tax rate for 2021 by using the table below.
Mortgage
A mortgage is a loan from a lender used to buy a home, land or other real estate. The borrower agrees to pay the lender over time, typically in a series of regular payments that are divided into principal and interest. The property serves as collateral to secure the loan. Mortgage types vary based on the needs of the borrower, such as conventional and fixed-rate loans. It is also an agreement between the borrower buying the home and a lender that gives the lender the right to take the property if the borrower fails to repay the money borrowed, plus interest.
Modified AGI (MAGI)
Modified AGI is AGI adjusted by tax-exempt and tax-excludable income. MAGI is a significant term when income thresholds apply to limit various deductions, adjustments, and credits.
Tax Terms and Definitions
N-S
Non-Refundable Tax Credit
Some tax credits are non-refundable. That means they will directly reduce the tax you owe. While they can reduce your tax to zero, they cannot result in a refund.
Penalty
A punishment imposed for breaking a law, rule, or contract. The IRS charges a penalty for various reasons, including if you don’t file your tax return on time, pay any tax you own on time and in the right way, prepare an accurate return, or provide accurate information on your return.
Private Letter Rulings
Private letter rulings are when the IRS responds in writing to a taxpayer’s request about something. These letters contain guidance for complex situations. A private ruling is applicable only to the specific tax situation. Private letter rulings can not be cited as precedence by other taxpayers. Nor does a private ruling commit the IRS to taking a similar position with regard to other taxpayers. However, a ruling does provide a look into the IRS’ position on the matter in question. A private ruling can sometimes lead to a broader revenue ruling that would apply to all taxpayers. Taxpayers must pay a fee when submitting their request for a private ruling.
Qualified Child
A qualified child is one who meets the following tests:
- Has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences;
- Is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual;
- Is younger than the taxpayer;
- Did not provide over half of his or her own support for the tax year;
- Is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age); and
- Is not married; (or if married, either did not file a joint return or filed jointly only as a claim for refund).
Qualified Opportunity Zone Fund
A Qualified Opportunity Zone Fund is any investment vehicle, organized as a partnership or corporation for investing in qualified opportunity zone property (other than another qualified opportunity fund). Also a QOZ must hold at least 90 percent of its assets in qualified opportunity zone property.
Refinance
Refinance, or “refi” for short, refers to the actions of revising and replacing the terms of an existing credit agreement, most often as it relates to a loan or mortgage. When an individual chooses to refinance a credit obligation, they often seek to make favorable changes to their interest rate, payment schedule, and/or other terms outlined in their contract. If the refinance is approved, the borrower gets a new contract. The new contract replaces the original contract.
RMD
A required minimum distribution (RMD) is the minimum amount of money that must be withdrawn from your account each year from your traditional IRA, SEP IRA, or employer-sponsored retirement plan by owners when you reach a specific age.
Roth IRA
A Roth IRA is a special individual retirement account (IRA) where you pay taxes on money going into your account, and then all future withdrawals are tax-free. (There are specific rules about the length of time you’ve owned the account and your age at the time you’d like to withdraw money.). People choose ROTH IRA’s because they offer tax-free growth and tax-free withdrawals in retirement. However, you can’t contribute to a Roth IRA if you make too much money.
Safe Harbor
Current year safe harbor: If you pay estimated taxes of at least 90% of your final bill for 2020 and you made payments on time, no penalties will apply. The safest option to completely avoid an underpayment penalty is to shoot for “100 percent of your previous year’s taxes.”
Schedule A
The Schedule A is an income tax form that taxpayers use to report their itemized deductions. It is an optional form for taxpayers who want to itemize deductions rather than take the standard deduction that may help reduce federal tax liability. Taxpayers can use whichever option will give them greater tax savings.
SEP
Simplified Employee Pension (SEP)
Simplified Method
The simplified method allows for a deduction equal to $5 per square foot of the home used for business, up to a maximum of 300 square feet, resulting in a maximum simplified deduction of $1,500. You may elect to take the simplified method or the actual expense method (also referred to as the regular method) on an annual basis. Thus, you may freely switch between the two methods each year.
Standard Deduction
A deduction decreases your taxable income. This is a fixed dollar amount that you can subtract from your income. The standard deduction amount is based on your filing status and age. Standard deduction amounts change each year due to inflation. Many taxpayers use the standard deduction method when calculating taxes because that eliminates the need to itemize actual deductions like charitable contributions, medical expenses, and state and local taxes.
Step-up in Basis
The step-up in basis is a provision in tax law that applies to the taxation of capital gains at death. It adjusts the value (basis, or “cost basis,”) of an asset to reflect the asset’s value at the time that the owner passes away, instead of the value when it was originally purchased. Increasing the basis often reduces the capital gains tax owed by the recipient, limiting the tax burden on heirs.
Tax Terms and Definitions
T-Z
Tax Credit
A tax credit is a dollar for dollar reduction in your actual tax bill. Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed. Some credits are non-refundable. That means they will directly reduce the tax you owe. While they can reduce your tax to zero, they cannot result in a refund.
However, other credits are refundable. This means you will receive money back in the form of a tax refund. Some of the most common refundable tax credits are following:
- Child Tax Credit
- Dependent Credit
- Earned Income Tax Credit
- American Opportunity Tax Credit (partially refundable)
- Lifetime Learning Credit
- Advanced Premium Tax Credit
- Savers Credit
- Adoption Credit
- Residential Energy-Efficient Property Credit
Tax Deductions
A tax deduction is a term for an expense that lowers your tax liability by lowering taxable income. Generally, the lower your income, the lower your tax bill.
Tax Exemption
An exemption is the amount the IRS lets you subtract from your income to show all the individuals who rely on your income. You can claim yourself, your spouse and your dependents as tax exemptions. The IRS allows a specific, set amount of money for each exemption. Like deductions, the total tax exemption is subtracted from your AGI to determine your final earnings amount. This amount is what you use to figure out your tax bill.
Taxable Income
Taxable income is your total (aka gross) income minus all allowable adjustments, deductions and exemptions. This income determines what you owe on your taxes.
Unearned Income
Unearned income includes investment income such as taxable interest, dividends (including capital gain distributions), and capital gains. Also, unearned income includes rents, royalties, pension income, survivor benefits, the taxable part of Social Security benefits, taxable scholarship and fellowship grants not reported on Form W-2, and other income types.
Unemployed
A person without a paid job but available to work. The term unemployment refers to a situation when a person who is actively searching for employment is unable to find work.
W-2
A W-2 tax form displays key information about income that you’ve earned from your employer, the amount of taxes withheld from your paycheck, any benefits provided and other information for the year. This form is used to file your federal and state taxes.
Withholding
The amount your employer withheld from your paychecks over the course of the year. Our “pay-as-you-go” tax system in the United States requires that you make payments of your tax liability evenly throughout the year. If you don’t, it’s possible that you could owe an underpayment penalty. Some taxpayers meet the “pay-as-you-go” requirements by making quarterly estimated payments. However, when your income is primarily from wages, you usually meet the requirements through wage withholding and rely on your employer’s payroll department to take out the right amount of tax, based on the withholding allowances shown on the Form W-4 that you filed with your employer. You are required to deposit by payroll withholding or estimated tax payments to avoid potential underpayment penalties. This amount changes annually.
