Preparing for Taxes
Preparing for Taxes Glossaries
401(k) plan: An employer-sponsored retirement savings plan where employees contribute part of their salary to a tax-deferred investment account. Funds put in the plan are not taxed until withdrawn in retirement. Employers often match part or all of the employee's deposits. Penalties usually apply to any withdrawals before age 55, but most plans do allow employees to borrow limited amounts tax- and penalty-free from their accounts.
Acquisition indebtedness: A technical term used for home mortgage debt, on which the interest is deductible. To qualify, debt must be used to buy, build or improve a principal residence or second home and must be secured by the property. Interest paid on up to $1 million of acquisition indebtedness is deductible if deductions are itemized.
Active participation: The level of involvement real estate owners must meet to qualify to deduct up to $25,000 of passive losses from rental real estate.
Additional child tax credit: Taxpayers may qualify for this credit if the standard child credit eliminates tax liability. This additional credit can cause a refund from the IRS even if the taxpayer does not owe tax.
Adjusted basis: Starting point for determining whether a gain or loss is enjoyed when property or an asset is sold. (Sometimes referred to as cost basis or tax basis.) The basis can change over time; when an investor buys rental property, the basis is the initial amount paid, plus the cost of permanent improvements. Basis can also be reduced by depreciation.
Adjusted Gross Income (AGI): Income from all taxable sources, minus adjustments. Adjusted Gross Income is the amount from which deductions (standard deduction or itemized deductions) and personal and dependent exemptions are deducted to determine taxable income. Adjustments include deductible contributions to Individual Retirement Accounts (IRA), SIMPLE and Keogh plans, contributions to Health Savings Accounts (HSA), job-related moving expenses, etc.
Alimony: Qualifying payments to an ex-spouse deducted as adjustments to income. The recipient of alimony must include payments as taxable income.
Alternative Minimum Tax (AMT): Special tax designed primarily to prevent the use of loopholes or otherwise legal tax breaks.
Amended return: A revised tax return filed using Form 1040X to correct an error on a return filed during the previous three years. Depending on the mistake made, an amended return could result in owing more tax or receiving a refund.
Audit: Review of a tax return by the IRS. The filer of the return is required to prove income and deductions made.
Capital gain: The profit from the sale of property like stocks, mutual-fund shares and real estate. Gains from the sale of assets owned for twelve months or less are considered short-term capital gains and are taxed at the filer's normal income bracket. Profits made on assets owned more than twelve months are considered long-term capital gains and are taxed at a different rate.
Capital loss: The loss from the sale of assets like stocks, bonds, mutual funds and real estate. Losses can offset capital gains and then a portion can offset normal income.
Casualty loss: Damage that results from a sudden or unusual event.
Charitable contribution: A gift of cash or other assets to a qualified charity where a tax deduction is allowed.
Child credit: Credit for each child under age seventeen claimed as a dependent on a tax return return.
Child and dependent care credit: Credit that offsets some of the cost of paying for care for a child under the age of thirteen while parent is working.
Child support: Payments made under a divorce or separation agreement to help provide for the support of a child. Payments are not deductible by the person who pays them and are not considered taxable income to the person who receives the money.
Deductions: Amounts or expenses a taxpayer subtracts from gross income to calculate taxable income. Taxpayers can claim a standard deduction or report itemized deductions.
Dependent: A person supported by the taxpayer eligible to be claimed as a dependent on a tax return. Dependents can be children, spouses, the elderly, and people who are legally disabled.
Depreciation: A deduction reflecting the gradual loss of value of real property as it grows older or otherwise loses value.
Earned income: Compensation, like wages, salary, tips, and commission, received from providing personal services.
Elderly or disabled credit: Credit for lower income taxpayers 65 and older.
Estate tax: Federal tax on decedent's taxable estate. Limits, rates, and exclusions can change from year to year.
Estimated tax: Quarterly payments of an estimated amount required for expected tax liability. Estimated tax is typically paid made by taxpayers who are not subject to withholding or who enjoy significant returns on investments.
Exemptions: Self, spouse, and dependent "credit" for filers. Exemptions reduce total taxable income.
FICA: Federal Insurance Contribution Act (FICA) tax that pays for Social Security and Medicare.
Filing status: Filing status determines the amount of standard deduction and tax rate. Filers can be considered single, married filing jointly, married filing separately, head of household, or qualifying widow or widower.
Gift tax: Tax on gifts that exceed IRS guidelines. Money can be given, without tax consequences, to another person as long as the amount does not exceed annual or total limits. When gift tax is owed, the person making the gift owes the tax, not the person receiving the gift.
Gross income: All income from taxable sources, before subtracting any adjustments, deductions or exemptions.
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, generally, for themselves and a qualifying person, for more than half the tax year.
Health Savings Account (HSA): A HSA allows people under age 65 to make tax-deductible contributions to a special account tied to a high-deductible health insurance policy. Earnings inside the HSA are tax-deferred (just like in an IRA). Money from the HSA can be used tax and penalty free to pay insurance policy deductibles, co-payments, and any other qualifying expenses.
Home equity loan: Debt secured by a principal residence or second home that is not used to buy, build or substantially improve a property (although it can be). Under certain circumstances, interest paid can be tax deductible.
Investment interest: Interest paid on loans used for investment purposes.
Like-kind exchange: Tax-free exchange of similar assets, like one real estate property for another. Any tax on profits from the first property is deferred until the exchanged property is sold.
Lump-sum distribution: Payment within one year of the full amount of an interest in a pension or profit-sharing plan, instead of receiving payments on a recurring basis.
Marital deduction: A tax law allowing any amount of property to shift in ownership from one spouse to the other without paying gift or estate tax.
Mortgage interest: Deductible interest paid on home mortgage or home equity loans.
Non-cash contribution: The full fair-market value of an asset donated to charity.
Points: Money paid in connection with a home mortgage. A point equals 1% of the amount of the mortgage. Points are tax deductible.
Premature distribution: Withdrawal from retirement plans subject to a 10% penalty if the taxpayer is under age 55 (or if the withdrawal is from an IRA, if the taxpayer is under the age of 59 ½).
Real estate taxes: Tax paid on the value of real property. Real estate taxes are tax deductible.
Rollover: Transferring funds, tax free, from one retirement account to another. Money must be deposited in the new retirement account within sixty days.
Roth IRA: Retirement account where contributions are not tax deductible but all withdrawals are tax-free after the age of 59 ½.
SEP: Simplified Employee Pension is a retirement plan most used by self-employed taxpayers. Contributions to the plan are tax deductible.
SIMPLE: Savings Incentive Match Plan for Employees plan offered by companies with less than 100 employees. The employer generally must match employee contributions up to 3% or contribute 2% of pay for each employee, whether or not the employee contributes.
Standard deduction: Deduction from taxable income based on filing status. Deduction can be based on single, joint, and head of household. The standard deduction is used when the taxpayer chooses not to itemize deductions.
Taxable income: Income that is taxable, like wages, interest and dividends.
Tax bracket: Rate at which income is taxed; generally speaking, the rate increases as income increases.
Vested benefits: Benefits in a company retirement plan that the employee retains even if he or she quits or retires.
Withholding: The amount deducted from a paycheck to pay income and Social Security taxes. The amount withheld is based on income and deductions claimed on the employee's W-4 form.