Tax Glossary: Taxes in Simple Terms
Today, we're focusing on something we know can be a bit daunting for many of our clients – tax terminology. During your tax filing journey with us, you might come across various terms that seem complex. Don't worry; we're here to make these terms as approachable and understandable as your finances should be. Here's a handy glossary to help you navigate the tax filing process with confidence:
Adjusted Gross Income (AGI): This is your total income for the year minus certain adjustments, like retirement contributions. It's the starting point for calculating your taxable income.
Tax Deduction: This is an expense that can be subtracted from your gross income to reduce the amount of income that's taxed. Common deductions include mortgage interest, charitable donations, and certain business expenses.
Tax Credit: Unlike deductions, tax credits directly reduce your tax bill. They're like a dollar-for-dollar discount on what you owe. Examples include the Child Tax Credit and the Earned Income Tax Credit.
Withholding: This refers to the portion of your paycheck that your employer sends directly to the IRS as a pre-payment of your tax liability.
Taxable Income: This is the portion of your income that's subject to taxes after all deductions and exemptions have been applied.
Filing Status: Your filing status determines your tax rates and standard deduction amount. The most common statuses are Single, Married Filing Jointly, and Head of Household.
Standard Deduction: A set amount that reduces your taxable income. It varies based on your filing status and is an alternative to itemizing deductions.
Itemized Deductions: These are specific expenses that taxpayers can use to reduce their taxable income, such as medical expenses, state and local taxes, and mortgage interest.
Capital Gains: This is the profit from selling an asset like stocks or property. Long-term capital gains (on assets held for more than a year) are taxed differently from short-term gains.
Audit: This is when the IRS reviews your financial records to ensure information is reported accurately. While the thought of an audit can be intimidating, remember, they're quite rare and often straightforward.
Extension: If you need more time to prepare your tax return, you can file for an extension, which gives you until October 15th. However, if you owe taxes, you still need to estimate and pay by the original deadline (typically April 15th).
Estimated Tax Payments: These are quarterly tax payments made by people who don't have their taxes withheld automatically, such as self-employed individuals.
Dependent: A person who relies on you financially, such as a child or a relative, which can affect your tax liability and eligibility for certain credits and deductions.
Earned Income: This is income derived from work, such as wages, salaries, tips, and other taxable employee pay. It also includes union strike benefits and long-term disability benefits received prior to minimum retirement age.
Unearned Income: This includes all income that is not earned, such as interest, dividends, capital gains, pensions, rent income, and alimony.
Progressive Tax: A tax system where the rate of taxation increases as the taxable amount increases. Essentially, higher income earners pay a higher percentage of their income in taxes.
W-2 Form: This is the form that an employer sends to employees and the IRS at the end of the year. It reports an employee's annual wages and the amount of taxes withheld from their paycheck.
1099 Form: A series of documents the IRS refers to as "information returns." There are many different 1099 forms that report various types of income you may receive throughout the year other than the salary your employer pays you.
IRA Contributions: Money that you put into an Individual Retirement Account (IRA), which can sometimes be deducted from your gross income.
Self-Employment Tax: The tax covering Social Security and Medicare for individuals who work for themselves. It's similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.
Alternative Minimum Tax (AMT): A supplemental income tax required in addition to baseline income tax for certain individuals, corporations, estates, and trusts that have exemptions or special circumstances allowing for lower standard income tax.
Schedule C: A form used by sole proprietors to report income and expenses from a business or profession.
Tax Bracket: A category based on how much you earn that determines the rate of tax you pay. Higher income usually means a higher tax rate.
Still have questions? At Gallagher we’ll guide you through every step of the process. Whether it’s a simple question or a complex tax situation, we’re here to make your financial journey stress-free and successful.