Presented by TaxAct
As Tax Day draws closer, many of us are already dreading it. Why? Because it often seems like you need to be an accountant to understand all that clunky vocabulary. Luckily, the folks at TaxAct make your financial future a breeze. In fact, TaxAct is confident your simple federal return won’t take longer than 10 minutes. And the quicker you file, the sooner you get that sweet, sweet refund.
Still, it doesn’t hurt to brush up on these tax terms for your own personal growth. Call it a rite of passage into serious adulthood. TaxAct’s tools will empower you to take control of your taxes, but knowing what all that tax jargon actually means will only take you further. Here are the most important tax terms you should know before 30.
Taxable income
The amount of income that’s used to calculate how much tax you owe the state and Federal government each year is called your taxable income. It’s also referred to as “gross income” or “adjusted gross income.” That includes (among other things) wages, bonuses, salaries, tips, and investment income.
Earned income
This is the amount of taxable income you earned from either working for someone or running your own business. It includes taxable employee pay, union strike benefits, and long-term disability benefits.
Unearned income
Income that comes from investments or other sources not related to your work is classified as unearned income. Examples include interest from savings accounts, alimony, interest from bonds, and stock dividends. It’s also commonly referred to as a “passive source of income.”
Earned Income Tax Credit
Generally referred to by its acronyms, EITC or EIC, the Earned Income Tax Credit is a tax benefit for working people on the lower end of the economic scale. If you meet certain requirements, this credit reduces the tax you owe and may add to your refund.
Dependent
A dependent is a person who relies on you for the majority of their financial and personal wellbeing. This generally includes your children, but the tax code allows certain qualifying relatives to be claimed as dependents too. Each dependent must meet specific requirements. Claiming a dependent grants you certain tax benefits on your return.
Deduction
A tax deduction is an expense that reduces your taxable income. It’s subtracted from your gross income, which is used to ultimately determine your tax liability. Tax deductions fall into two categories: standard deduction or itemized deduction.
Standard deduction
The standard deduction is a pre-determined portion of income that’s based on your filing status. For example, if you file as single, you can claim a $12,000 standard deduction on your 2018 tax return. If you plan to file your return as married, the standard deduction increases to $24,000. You can only claim the standard deduction if you do not itemize your deductions.
Itemized deduction
If your total qualifying expenses in a year equal more than the standard deduction for your filing status, you can choose to itemize your deductions. Itemized deductions allow taxpayers to deduct more from their taxable income than the standard deduction. However, there are specific guidelines around what type of expenses qualify as itemized deductions. A short list includes mortgage interest, charitable gifts, and medical expenses.
Credit
A tax credit reduces your tax liability. That means if you qualify to claim the credit, you can subtract the value of the credit directly from your tax bill. The value of tax credits vary and not everyone qualifies for each one. Additionally, some credits are nonrefundable while others are refundable.
Nonrefundable tax credits are used to reduce your tax liability to $0. Once the tax bill reaches that point, you can no longer use any remaining portion of the credit. Refundable credits work slightly different. Once your tax bill hits $0, you can receive any remaining portion of the credit as a tax refund.
Form 1040
U.S. Individual Income Tax Return is the standard IRS form individuals use to file their tax return. The form is used to report information like your taxable income, the number of dependents and various deductions to, ultimately, determine if you owe taxes or are owed a refund.
Form W-2
Traditional employees receive Form W-2, a wage and tax statement, from their employer. The form reports annual wages along with the taxes withheld from your paycheck. If you are not self-employed, you should expect to receive this form for any part-time or full-time work.
Tax rate
A tax rate is a percentage at which your income is taxed. It’s based on your total taxable income and the percentage increases as your taxable income increases.
Tax bracket
A tax bracket is a range of incomes that are assigned to the same tax rate. In the U.S. tax system, lower incomes fall into tax brackets with lower rates, while higher incomes fall into brackets with higher rates.
Audit
The IRS examines your financial statements and tax return during a tax audit. The intent is to make sure the tax records are accurate. Not every tax return is audited.
Filing status
Your filing status is based on your marital status or family situation. It determines your filing requirements and the standard deduction value for which you qualify. The type of filing statuses includes Single, Married Filing Jointly, Head of Household, Widower, and Married Filing Separately.
Withholding
A tax withholding is an amount your employer withholds from your paycheck to cover your tax liability throughout the year. They pay that money directly to the government. You can change how much is withheld from your pay by completing Form W-4, Employee’s Withholding Allowance Certificate. If you are self-employed, you likely do not have any taxes withheld from your paycheck and are expected to pay your share of taxes on your own.
Capital gain
The rise in the value of an investment or real estate property is considered a capital gain. You can have a short-term or long-term capital gain depending on how long you owned the asset before you sold it.
Capital loss
A capital loss is the opposite of a capital gain. If you experience a loss in value of a capital asset, like an investment or real estate property, that’s called a capital loss. It is the difference between the purchase price and the price at which you sold the asset.
Tax liability
The total amount of tax debt you owe throughout the year is your tax liability. You are required to pay that amount to the government.
Tax refund
A tax refund is perhaps the most exciting tax term. It’s a refund on the taxes you paid in a given year to the government. If you pay more than your tax liability, you’ll receive the extra money back as a refund. It is typically money you already earned and not extra income. Sometimes, you can receive extra money as a refund if you qualify for a nonrefundable tax credit.
This little primer will arm you with the knowledge to navigate your taxes this year. If you’re still scared of filing your return, let TaxAct guide you. It’s free for simple returns and as low as $14.95 for more complicated tax situations. Plus, TaxAct offers all of its customers a $100k Accuracy Guarantee.
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