This information is not intended to be tax advice. Consult a tax preparation professional for tax advice.
One of the most difficult things about doing your taxes is learning the lingo. All those tax forms can be harder to translate than DJ Khaled’s wild catch phrases. That’s why we’ve put together this list of ten key tax terms you should know.
No, this isn’t about your significant other’s emotions. Withholding is the portion of your paycheck that your employer sends directly to the government each pay period as partial payment of your income tax. The withholding amount is determined by the number of allowances you claim on your W-4.
If you claim too many allowances, you may owe money at tax time, and if you significantly underpay your taxes during the year, you may get hit with a penalty when you file your tax return.
Read more about withholding via GoBankingRates: How to Correctly Fill Out Your W-4 for a Bigger Paycheck
2. Filing Status.
Whether you’re single and ready to mingle or joined in matrimony, your relationship status determines how you file and what, if any, tax breaks you’re entitled to such as the amount of your standard deduction.
The most common filing status options are “Single,” “Married Filing Jointly” and “Head of Household,” and the IRS offers a handy cheat sheet to help you determine the appropriate filing status for you. They also make it easy to choose the correct filing status when you use IRS e-file, which also happens to be one of the fastest ways to get your refund.
3. Gross Income.
From maggot farmers to chimney sweepers, there are plenty of disgusting jobs out there that we’ll never want to do. Fortunately, that has nothing to do with gross income.
Gross Income is your total income before accounting for deductions and taxes. Sources of gross income include salary, wages, tips, capital gains, interests, and dividends.
4. Capital Gains.
A capital gain is one type of earning that counts toward your gross income. You earn capital gains when the sale price of an asset is higher than the initial purchase price and as noted above, it’s considered a form of income. Say you purchased a vintage car for $3,000, spent $2,000 restoring it, and sold it for $6,000. You made a grand of profit, i.e. capital gains, on that sale – nice job! Before you go spending all that profit, be aware you’ll have to pay taxes on it. The same principle applies if you buy stock for $5,000 and sell it for $6,000.
Deductions are items or expenses subtracted from your income to reduce the amount of income that is subject to being taxed. Whether or not a tax-deductible expense ultimately reduces the income tax you owe depends on several factors. The biggest differentiator in tax deductions is whether a taxpayer decides to take the standard deduction or to itemize their deductions.
An itemized deduction requires taxpayers to keep track of each possible tax-reducing expense throughout the year and is usually limited to a certain percentage of one’s adjusted gross income.
If you’re someone who frequently spends significant amounts on medical care, donations, or other deductible expenses you may be better off itemizing. However, tax law may set certain thresholds in spending that must be exceeded before deductions can be made.
Taxpayers who choose not to itemize deductions on their tax return can take a standard deduction. The amount of the deduction is based on your filing status, age, and whether or not you’re claimed as a dependent on someone else’s tax return.
6. Charitable Contribution.
A charitable contribution is a type of itemized deduction. When it comes to charitable giving, unfortunately acting as your best friend’s wingman isn’t going to save you any money at tax time.
Charitable contributions can earn you an itemized tax deduction when you donate to a qualifying non-profit organization, charity, or private foundation. These gifts are commonly made in the form of cash, but can also include real estate, clothing, appreciated securities or other assets.
To determine if the organization that you have contributed to qualifies for income tax deduction purposes, refer to the IRS’s Exempt Organizations Select Check tool.
7. Adjusted Gross Income.
Adjusted Gross Income or AGI, is all the personal income you receive over the course of the year, minus certain types of deductions noted above. These include such things as retirement plan contributions, some unreimbursed business expenses, moving costs, and alimony payments.
Tax exemptions are specific amounts that reduce how much of your taxable income is taxable. For Tax Year 2015, each tax exemption is worth $4,000.
Generally, you can claim one exemption for yourself and one for your spouse assuming you’re married. You can also claim one exemption for each dependent. Be aware, while you may think differently, your spouse is never considered your dependent.
9. Taxable Income.
Taxable income is calculated by taking your adjusted gross income and subtracting your total exemptions and itemized deductions. It determines your tax liability before tax credits.
10. Tax Credit.
Happiness is a tax credit!
A tax credit is a dollar-for-dollar reduction of the amount you owe. For example, you may be eligible for the Plug-in Drive Vehicle credit, between $2,500 & $7,500, if you purchased a car that draws energy from a battery with at least 4 kilowatt hours, was purchased in or after 2010, and began driving it in the year in which you’re claiming the credit.
These credits are designed to reward behaviors that the government deems important.
Knowing your basic tax terminology is the first step toward saving money on your taxes. When you know the terms and the rules, you’ll be able to avoid overpaying on your taxes while maximizing your refund. Be sure to choose direct deposit when you e-file for one of the fastest ways to get your refund.