74000 pages. That’s how long the US Tax code is. Sure, these terms can be confusing and put you in a fix which could lead to mistakes that can cost you dearly. Decoding key tax terminologies can help you when it comes to planning your taxes, filing returns and knowing your refunds.
For those of you still struggling to understand the different tax terminologies, here’s a quick primer to get you up to speed.
Adjusted Gross Income or AGI is the sum total of income that you receive throughout the year including wages, capital gains, interest, dividends, commissions minus allowable tax expenses like retirement account contributions, moving expenses, student loan interest, alimony, etc. AGI is the first step in calculating your final federal income tax.
The alternative minimum tax is the percentage of taxes that a filer must pay to the government, no matter how many deductions or credits the filer may claim. AMT ensures that certain taxpayers pay their fair share or at least the minimum.
Let’s say you discovered a mistake after filing your tax return. You can correct this by submitting an amended return to the IRS using the 1040X form within 3 years of the original filing or 2 years of paying your taxes.
The credit offers relief to individuals and spouses who pay for the care of a qualifying child or a disabled dependent while they work or look for work.
An individual retirement account (IRA) is a tax-advantaged account that individuals use to save and invest for retirement.
Itemizing lets you cut your taxable income by leveraging any of the hundreds of available tax deductions you qualify for. The higher the deductions, the lesser you’ll pay in taxes. These deductions need to be listed separately in Form 1040. Mortgage interest, 401(K) contributions, medical expenses, IRA contributions are a few commonly used deductions.
A joint return is for taxpayers who have elected the status of “married filing jointly,” thus combining their income, credits, deductions and any other benefits for tax purposes.
A taxing system where higher the income, higher the taxes meaning high tax rates are applied as your income increases. US tax brackets progress from 10% to 39.6% for the wealthiest income groups.
This is a fixed dollar amount that taxpayers can subtract from their income. The standard deduction is often the easiest route to take because there is no need to make a calculation or itemize deductions. The amount is already set subject to factors like age, filing status etc. The deduction amount may vary every year depending on inflation.
Tax credits work just like credit notes that you receive from a store. Credits are way more beneficial than tax deductions as they reduce your tax liability by the said amount.
Subtracting the amount of tax deduction from your income will lower your taxable income, thereby reducing your tax liability. The lower your taxable income, the lower your tax bill or the higher your tax refunds.
A tax exemption is a set amount that reduces your taxable income, which helps you lower your tax liability. This is a right of the tax abiding citizens to exclude certain amounts of income or activities from taxation.
Taxable Income refers to the sum total of all your incomes minus deductions, exemptions and credits. This is the final amount on which your taxes will be calculated.
Voluntary compliance is the philosophy on which the US taxation system is based - taxpayers will voluntarily comply with tax laws, are transparent about their income and pay their taxes honestly.
Withholding AKA pay as you earn taxation refers to taxes being taken out of your wages or income before you receive your paycheck.
Form 1040 is used by U.S. taxpayers to file an annual income tax return.
A 401(k) is a retirement savings plan sponsored by an employer. It lets employees save and invest a piece of their paycheck before taxes are taken out and perhaps matched by the employer.
A grasp of these terms will make your tax filing experience much easier and comfortable.
Don’t wait until the last minute - April 15th to jam the jargon. Being aware of the basics can put you ahead of the curve this filing season, and hold an unwavering view of the taxation process. Make sure to file your taxes the right way for better savings and a better outcome.