One of the most difficult things about doing your taxes is learning the lingo. All of those tax forms can be more confusing than some of DJ Khaled’s wild catchphrases. That’s why we’ve put together a list of 10 key tax terms you should know before filing your taxes.
Note: This information is not intended to be tax advice. Consult a tax preparation professional for tax advice.
In This Article
Tax Terminology: Why It Matters
A lot of tax terminology is found in all of the forms you have to fill out before filing your tax return. Although there are books, YouTube videos, and software programs that can help you sort through the madness, a good first step is to prime yourself with the basic terms and definitions so you don’t get stressed out.
The terms below are the most commonly used ones that a lot of people have trouble understanding. If you learn the basic meaning of these words, you’ll be an educated tax filer, and as DJ Khaled would say, “You Smart.”
Withholding is the portion of your paycheck that your employer takes out and sends directly to the government each pay period as partial payment of your income tax. No, this isn’t about your significant other’s emotions. These withheld taxes are deposited in an Internal Revenue Service (IRS) account, and you are credited for the amount when you file your return.
The withholding amount is determined by the number of allowances you claim on your W-4 form. Other withholdings from your paycheck go to Social Security and Medicare.
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.
To ensure your withholdings are correct, be sure to review the breakdown of your paycheck.
Your filing status determines what tax forms you’ll fill out and is an important factor when calculating your taxable income. Whether you’re single and ready to mingle or joined in matrimony, your relationship status determines how you file and if you’re entitled to any tax breaks.
The filing status options are:
- Married Filing Jointly
- Married Filing Separately
- Head of Household
- Qualifying Widower
The IRS offers a handy tool to help you determine your appropriate filing status. Single, married filing jointly, and head of household are the most common statuses. The IRS also makes it easy to choose the correct filing status when you use the IRS e-file, which also happens to be one of the fastest ways to get your refund.
A dependent is a child, relative, or other individual who relies on you, the taxpayer, for financial support. Dependents are claimed as a tax exemption on your federal income tax return. There are rules and qualifications for who is considered a dependent, so make sure you double-check the guidelines before claiming another person as a dependent on your tax forms.
Adjusted Gross Income
Adjusted gross income (AGI) is your total income over the course of 1 year, including wages, tips, interest, dividends, and capital gains, minus certain deductions. To calculate it, you subtract all allowable tax adjustments, like retirement account contributions, moving expenses, student loan interest, and all other adjustments from your gross income. This number is most important because the IRS uses your AGI to calculate if you qualify for other tax credits or deductions, figure out your tax liability, and determine your tax bracket.
A capital gain is one type of earning that counts toward your gross income. It’s money you earn from selling capital assets, such as stocks, bonds, real estate, or other material items where you sell it for more than you originally paid. If you sold an asset resulting in profit this year, you’ll have to pay a capital gains tax, which is 15% for most taxpayers and 20% for those who are in the top bracket. If you’ve earned capital gains this year, you are more and more like DJ Khaled, who would say “We the best!”
Tax deductions are expenses the IRS allows you to subtract from your AGI to arrive at your taxable income. They are items or expenses subtracted from your income to reduce the amount.
When calculating your taxable income, there are 3 different types of deductions:
- Above-the-line deductions. These are immediately subtracted from your gross income. An example would be a contribution to a retirement account.
- Itemized deductions. Itemized deductions include certain medical expenses, charitable contributions, and more. 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.
Standard deduction. If you choose not to itemize, you usually qualify to take a standard deduction. This is mostly for taxpayers who choose not to itemize deductions on their tax return.The amount of the standard deduction is based on your filing status, age, and whether or not you’re claimed as a dependent on someone else’s tax return.
A charitable contribution is a type of itemized deduction you can claim for potential tax breaks. When it comes to charitable giving, acting as your best friend’s wingman unfortunately isn’t going to save you any money at tax time. (As DJ Khaled would say, “Congratulations, you played yourself.”)
However, 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 Tax Exempt Organization Search.
Tax exemptions are specific amounts that reduce how much of your taxable income is actually taxable. Tax exemptions can be claimed for yourself, a spouse, or qualifying dependents. The total of your exemption is subtracted from your AGI before the tax is calculated on your remaining taxable income.
Again, 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. And no, although you and your spouse may think differently, they are never considered your dependent.
Taxable income is calculated by taking your AGI and subtracting your total exemptions and itemized deductions. It determines your tax liability before tax credits. Taxable income includes employment earnings, real estate income, self-employment profits, and any other instance where you make money.
A tax credit is a dollar-for-dollar reduction of the amount you owe. “Anotha one,” as DJ Khaled would say, but really it’s the last tax term you need to know here! After you calculate your tax return, you can use credits to reduce the amount that you owe to the IRS. Tax credits are better than tax deductions because they directly impact the amount of money you have to pay back, rather than reducing the amount of taxed income.
In some cases, if your credit exceeds how much you owe, you get the difference back as a refund. The Earned Income Credit (EIC) is a well-known credit used to decrease taxes for low-income families. The credit amount is determined by your income and number of children.
Other Tax Terms and Definitions
A tax return is a document you fill out and file with the IRS every year reporting your income, expenses, and other important tax information. This is how you receive a refund for the overpayment of taxes throughout the year.
Net of Tax
Net of tax is simply the amount of money leftover after your taxes have been subtracted.
Federal Income Tax
Federal income tax is the money collected by the government and the IRS that’s applied to all earnings made by each citizen in the U.S.
State Income Tax
In addition to federal income tax, most states collect their own income tax on your earnings or income each year.
No Tax Liability
If you have no tax liability in a given year, that’s a good thing! This means you (or your business) don’t owe any money to the federal, state, or local government.
Child Tax Credit
The Child Tax Credit is a financial stimulus payment made to benefit families with children that qualify. For 2021, the IRS is allowing individuals to claim up to $3,600 per child under the age of 6, and $3,000 per child between the ages of 6 and 17 on their tax return. Claiming these credits will reduce the amount you will owe in taxes. The Child Tax Credit was expanded immensely in 2021 amidst the pandemic and will ultimately decrease taxpayers’ tax liability on a dollar-for-dollar basis for their taxes this year.
You may see the term sole proprietor on many of your tax forms. This pertains to a person who owns their own business as they report their income and expenses on a separate form.
Can I file my taxes for free?
The most popular way to file your taxes for free is by using the IRS Free File tool. If your yearly income is below $72,000, you qualify to use this tool to file your federal and state tax return online. If your income is above $72,000, you’re still eligible to utilize this free tool, but there is no state filing included, only federal.
Can I file my taxes online?
When do I need to file my taxes?
The deadline to file your federal taxes is usually April 15 of each year, unless the IRS states otherwise. For example, in 2022 the deadline was adjusted to April 18 because April 16 is a holiday and falls on a Saturday, so IRS and other offices will be closed on Friday, April 15 so the holiday can be observed. The IRS starts accepting income tax returns on January 31 for the previous year.
Knowing some basic tax terminology is the first step toward saving money on your taxes and filing them correctly. When you know the terms and the rules, you’ll be able to avoid making errors on your tax return while maximizing your refund. Be sure to choose direct deposit when you e-file for one of the fastest ways to get your money!