The tax filing deadline is just around the corner, and that means it is time to start preparing your personal tax return if you haven’t already. To get you started, we explain some of the top tax terms you need to know to be more informed this tax season.
When it comes to taxes, it can seem like you are reading a different language. Learning the lingo can be one of the toughest parts when it comes to filing your taxes correctly and walking away from the experience feeling good. That’s why we’ve compiled the top 10 tax terms you need to know to complete your taxes with confidence.
1. Form 1040
This is the federal income tax return form you’ll use to file your taxes. The form calculates your total taxable income and determines how much you’ll get refunded or how much you’ll owe the federal government. The Internal Revenue Service (IRS) has two versions of Form 1040‡, and the one you fill out depends on your personal situation. Here’s the breakdown:
- 1040: The standard tax return form; this is what most people file. All reportable activity is included on this form.
- 1040-SR: A version of the standard 1040 designed specifically for filers who are 65 or older.
2. Adjusted gross income
Your adjusted gross income (AGI) is the amount of money you’ve made throughout the year. Your gross income includes your salary, wages, tips, capital gains, eligible alimony payments, retirement distributions, eligible Social Security benefits, rental income, unemployment compensation, interest and dividends. Once you’ve calculated this initial figure, you need to subtract any adjustments, such as traditional individual retirement account (IRA) contributions, health savings account (HSA) contributions, student loan interest, educator expenses, or any eligible alimony payments to get your adjusted gross income. Your AGI determines the deductions and credits you are eligible to take.
3. Taxable income
Taxable income is the amount of your income, after deductions, that is subject to income tax. It can consist of both earned and unearned income and is generally less than your gross income. You calculate this by taking your AGI, which is your total income, and subtracting your standard or itemized deductions and qualified business income deduction, if applicable. This final figure is used to determine what you owe in taxes.
4. Filing status
Your filing status indicates which tax rates apply to your income and the size of your standard deduction. Filing status is closely linked to marital status, and it’s important because marital status and dependents determine a person’s tax bracket. The IRS offers an interactive tool‡ to help you determine your filing status. There are five different filing statuses:
- Single
- Married filing jointly
- Married filing separately
- Head of household
- Qualifying surviving spouse
5. Tax deductions
A deduction is an expense or other amount the IRS allows you to use to reduce the amount of income that is taxed. The rule of thumb is the lower your income, the lower your tax bill will be. Common deductions include traditional IRA contributions, eligible alimony payments and any student loan or mortgage interest you paid. The IRS lists new deductions for the current filing season‡.
6. Itemized deduction
To take an itemized deduction, you must keep track of each tax-reducing expense you incur throughout the year. Medical expenses; other taxes such as state, local and property tax; mortgage interest; charitable contributions; casualty and theft losses; and miscellaneous losses, such as a significant gambling loss, can count as itemized deductions. Each subtracted itemized deduction from your AGI further lowers your taxable income. However, most of the time, you must exceed the standard deduction and meet IRS limits to claim itemized deductions. These deductions are also sometimes limited to a percentage of your AGI.
7. Standard deduction
If you choose not to itemize deductions on your tax return, then you will opt to take a standard deduction. This is a fixed dollar amount, adjusted annually, and is subtracted from your AGI, which reduces the tax amount you’ll owe. ‡. The amount of the deduction can vary depending on your filing status, age and whether you are claimed on someone else’s tax return.
8. Tax credit
Tax credits lower the amount of money you owe to the federal government. Credits are a dollar-for-dollar reduction and directly reduce the amount of tax that you owe, rather than reducing taxable income. Certain tax credits, including the earned income tax credit, are refundable if the amount of the credit exceeds the amount of tax due. For example, if you claim the earned income tax credit for $1,000 and owe $400 to the IRS, you’ll receive a $600 refund. Activities that may qualify for tax credits include incurring child and dependent care expenses, paying for higher education, and qualifying as low-income. Note that the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) have specific income and eligibility limits that change annually. Claiming all your eligible credits can help boost your refund.
9. Tax scams
Thousands of people have lost millions of dollars and their personal information to tax scams. Scammers use a variety of tools to contact you, including mail, phone or email. Individuals impersonating IRS officials will ask for personal or financial information and these scams continue year-round. The IRS does not initiate contact with taxpayers by email, text message or social media. If you are unsure of whether a communication you receive is actually from the IRS, you can report it by sending it to phishing@irs.gov‡.
10. Voluntary compliance
Voluntary compliance means everyone is required to pay their taxes by preparing and filing honest and accurate returns. If you make over a certain amount, you must file a tax return. If you don’t file, the penalty is 5% of your unpaid taxes each month that your return is late, with the penalty capped at 25% of your total unpaid tax. The IRS failure to pay penalty is 0.5% of your unpaid taxes for each month that the taxes remain unpaid after the due date. It’s important to be informed so you aren’t penalized.
A certified public accountant (CPA) can guide you through each step, helping you meet deadlines smoothly and submit everything without stress. If you find yourself needing an extension, the IRS may grant you a six-month extension to file your taxes as long as you complete Form 4868‡, which you can do for free or a low cost. To obtain the extension, you must estimate your tax liability on Form 4868 and pay any amount due by the original deadline.
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This article is provided for informational purposes only and is not intended to be a substitute for professional legal or tax guidance.
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