Owe Money to the IRS? Here are 20 Terms to Know

Share on facebook
Share on google
Share on twitter
Share on linkedin

One of the reasons many people struggle with taxes is because the IRS effectively has its own language. You can access IRS instructions and forms with ease, but if you can’t decipher the vocabulary, you will face trouble and frustration – almost as if you’ve been parachuted into a surprise college Latin final. To simplify, review these 20 key terms, and you’ll be “speaking IRS” in no time.

1040. The 1040 is the official income tax return distributed and printed by the Internal Revenue Service. There are three versions designed for increasingly complex returns – 1040-EZ, the 1040A and the full-fledged 1040. Use the simplest form that covers the benefits to which you are entitled.

Adjusted gross income. Also known as AGI, adjusted gross income is all of the income you receive throughout the year, including wages, capital gains, dividends and interest minus things such as alimony payments, moving costs, some business expenses and contributions to a qualified IRA. Your AGI is the first step to calculating your federal income taxes.

Amended return. Filed on Form 1040X, an amended return is a revised tax return, completed to correct an error on a return filed during the prior three years. Depending on the mistake you correct, an amended return may result in getting a refund or owing extra tax.

Audit. An audit is a review of your tax return by the IRS. You will be asked to prove that you have correctly reported your deductions and income. Approximately 1% of all returns are audited, and most are done by mail and involve specific problems – not the entire return.

Basis. The basis of an asset is its value. It is used for computing loss or gain when the asset is sold. For example, if you bought stock in a business two years ago and sold it this year, you’ll need to determine the basis, or the amount you initially paid, to determine your loss or gain on the sale for tax purposes.

Capital gains. Capital gains are profits that result from disposing of real estate, bonds, stocks or other types of capital assets. If you received a profit after selling an asset, you’ll need to pay capital gains tax – 15% for most taxpayers and 20% for those in the top tax bracket.

Defined benefit plan. This type of retirement plan, also known as a traditional pension plan, promises a participant a specific monthly benefit when he or she retires. The benefit is determined by factors like the participant’s age, salary and the number of years he or she worked for the company.

Defined contribution plan. This type of retirement plan is more common than the defined benefit plan and includes contributions from the employer and/or the employee. Common types of defined contribution plans include profit-sharing plans, employee stock ownership plans, 403(b) plans and 401(k) plans.

Dependent. A dependent is someone other than yourself or your spouse for whom you can claim an exemption. In order to count him or her as a dependent, he or she must be a qualifying child or relative.

Exempt from withholding. This phrase means you are not required to have federal income tax withheld from your paycheck. You must meet certain dependency, tax liability and income criteria to be exempt from withholding, and it does not make you exempt from Social Security tax and other kinds of tax withholding.

Exemption. An exemption is the amount a taxpayer can claim for herself or himself, eligible dependents and spouse. The total amount of your exemption is subtracted from your AGI before tax is calculated on your remaining taxable income.

Filing status. Your filing status determines the tax rates that apply to your income and the size of your standard deduction. For tax purposes, you are considered single, married filing separately, married filing jointly, head of household or qualifying widower or widow.

Itemized deduction. An itemized deduction is an expense allowed for casualty and theft losses, dental and medical expenses, charitable contributions, investment interest and home mortgage interest, taxes and miscellaneous deductions such as gambling losses. When figuring taxable income, subtract itemized deductions from your AGI. If you choose the standard deduction, you cannot claim itemized deductions.

Progressive taxation. In a progressive taxation system, as income levels increase, higher tax rates are applied. The U.S. tax system is based on progressive taxation with brackets beginning at 10% and increasing to 39.6% for taxpayers with the highest income.

Standard deduction. Taxpayers can subtract a fixed dollar amount from their income. This standard deduction is determined by the taxpayer’s filing status and is available to all filers. For tax year 2016, the standard deduction is $9,300 for heads of households, $6,300 for singles and married persons filing separate returns and $12,600 for married couples filing jointly.

Taxable income. Taxable income is your gross, or overall, income after it is reduced by any allowable exemptions, deductions and adjustments. In other words, it is the final amount of income you use to calculate your tax liability.

Tax credit. A tax credit reduces your tax liability. The IRS allows credits for qualifying children, higher education costs, child-care expenses and earned income of low-income taxpayers.

Tax deduction. A tax deduction is a reduction of income that can be taxed and is commonly a result of expenses. The difference between credits, deductions and exemptions is that deductions and exemptions both decrease your taxable income, whereas credits decrease tax.

Voluntary compliance. Voluntary compliance describes the philosophy on which we base our tax system. U.S. taxpayers will voluntarily comply with the country’s tax laws and honestly report their income and other tax items.

Withholding. Withholding, also known as the pay-as-you-earn taxation, enables taxes to be withheld from wages or income as you earn it – before you receive your paycheck. These taxes are deposited into an IRS account, and you receive a credit for this amount when you file your return. Some taxes may also be withheld from other types of income such as interest and dividends.

Got questions about your IRS tax debt? The team at Highland Tax Group, Inc. is here to help. Call us at 720-398-6088 or email us to speak with an Enrolled Agent immediately.