For many people, trying to understand basic tax terms can lead to frustration and confusion and that's especially true if you're trying to do your taxes on your own for the first time or if life events have changed your financial situation.
Use the glossary below to get a better understanding of some basic tax terms.
Basic tax terms and definitions
Adjusted gross income
Your adjusted gross income (AGI) is a calculation the Internal Revenue Service (IRS) uses to determine your eligibility for certain deductions and credits. It is your total gross income minus certain adjustments. One common adjustment, for example, is interest on student loan debt.
Audit
An audit is a review of your tax return by the IRS. Some audits are random, however, they are usually triggered by a red flag. If you are audited, the IRS will contact you and ask you to provide specific information to resolve any issues.
Capital gain
A capital gain is profit from the sale of specific assets, including shares of mutual funds, real estate and stock. Depending on how long you've held the asset, it can be taxed at different tax rates.
Capital loss
A capital loss is any loss from the sale of real estate, stocks, bonds and other similar assets. These losses can be used to offset any capital gains you might have for the year up to a certain amount. Any excess losses over that amount can be carried over to the next year to offset capital gains or ordinary income up to the allowable limit.
Deductions
Deductions are amounts subtracted from your gross income to determine your taxable income. These are also referred to as write-offs, as well.
There are two common classes of deductions. The standard deduction is a write-off that is a specific amount based on your filing status. You can choose to forgo the standard deduction and claim itemized deductions, which are certain eligible expenses.
Determining which method to use is a matter that should be discussed with your tax advisor first.
Estimated tax
Many people who own a business including freelancers, consultants and self-employed individuals have income that is not subject to withholding. In this case, they need to make quarterly payments that cover the estimated amount of that year's tax bill.
Exemption
An exemption is a deduction allowed by law to reduce the amount of income that would otherwise be taxed. (Visit IRS.gov to view changes to exemptions due to the 2017 Tax Cuts and Jobs Act.)
Extension
You can request an extension for filing your taxes. Typically, it will move your filing deadline out by six additional months. It's important to note that this extension is for filing your tax return and not for paying taxes owed. You should estimate and pay any owed taxes by your regular deadline to help avoid possible penalties. You must request an extension before the original filing deadline. If you miss a filing deadline and pay your taxes late, you could be subjected to penalties.
Filing status
Your filing status helps the IRS determine your tax rates, as well as your standardized deduction. Some of the options include single, married filing separately and married filing jointly. If you've recently gotten married, for example, determine your best options for how you want to file.
Pre-tax retirement account
Pre-tax retirement accounts are also known as qualified retirement accounts. With these accounts you do not pay any taxes on your contributions until they are withdrawn.
After-tax retirement account
For an after-tax retirement account, you have already paid taxes on your contributions since they were made with after-tax dollars. So you do not pay taxes on any withdrawals as long as the IRS-declared requirements have been met.
Tax bracket
This is the tax rate you will pay for each portion of your income that falls within a certain set range. It's part of a progressive tax system where the more income you have the higher the taxation rate. Depending on your income, any changes to it including taking a part-time job could impact your tax bracket and how much you pay.
Withholding
This is the amount of your wages that are held from each pay check and cover your Social Security and income taxes each year.
Find answers to some common tax questions to help plan your finances throughout the rest of the year..
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