The tax deadline for 2019 has been extended by 90 days for many but it’s still important to get started on your tax return. Whether you file your own taxes or with a tax professional, understanding the basic terms is important because it may help you:
- Get more familiar with the overall tax filing process
- Talk to your tax preparer to make sure it’s being filed properly
- Save you money on your tax bill
Understanding the basics is a great place to start. Here are 10 tax terms that may help you:
1. Tax Credits
A tax credit is a good thing. It reduces the amount you may owe to Uncle Sam.
Credits were made to reward you for things like buying an energy efficient car (i.e., Plug-in Drive Vehicle credit—$2,500 to $7,500), higher education costs, and child care expenses, to name a few.
These tax credits can reduce your tax liability and may be deemed more valuable than a tax deduction because it directly cuts the amount of taxes you owe, rather than decreasing the amount of taxed income.
2. Adjusted Gross Income (AGI)
Your adjusted gross income (AGI) is crucial to determining your federal income tax bill and takes into account the total amount of income you received in the year. These include:
- Wages
- Interest, dividends and capital gains from investments
- Retirement contributions
- Business expenses
- Moving costs
- Alimony payments
Your AGI will determine how much you owe or will get back in taxes. It also determines your tax bracket, and the amount you can contribute to your tax-deferred retirement accounts.
3. Standard Deductions
Standard deductions are expenses dictated by the IRS that let you subtract your AGI to figure out your taxable income.
The IRS offers tax payers a standard deduction amount, which is a fixed dollar amount that you can deduct from your income. Many taxpayers use this method, which may simplify the process, since it removes the hassle of actualizing specific amounts for each deduction.
4. Itemized Deductions
Itemized deductions are expenses that are deducted from your adjusted gross income in order for you to lower your income amount, as it relates to your taxes. In order to itemize your deductions, you need to file a Form 1040 on your Schedule A.
Itemized deductions may include things such as:
- Medical expenses
- Taxes (state, local, property)
- Charitable contributions
- Unreimbursed employee expenses
- Investment interest
- Miscellaneous deductions such as losses from gambling
5. Dependent(s)
A dependent is a person other than yourself or your spouse that you list on your taxes in order to claim an exemption. In order for someone to qualify as a dependent, he or she must be your qualifying child or relative.
6. Withholding
Withholding is the amount from your paycheck that your employer deducts and sends directly to the government for each pay period. The withholding amount is determined by how many allowances you claim on your W-4.
In a nutshell, allowances directly correlate to how much you may end up owing or receiving (in the form of a refund) during tax time. If you have too many allowances, you may end up owing money.
7. Exemptions
Tax exemptions are amounts that reduce how much of your income is taxed. Typically, you can claim one exemption for yourself and your spouse (if you’re married).
Exemptions relate to the amount of people who rely on your income and is an amount the IRS allows you to deduct. You can also claim one for your dependent. You may not claim your spouse as your dependent.
The IRS sets the amount for exemptions. The total is then deducted from your AGI to lower your income and potentially your tax bill. Your personal exemption amount is in addition to tax deductions. Whether you choose standard or itemized deduction is up to you and your situation.
8. Taxable Income
This is the overall (gross) income that is reduced by adjustments, deductions and exemptions. It’s the final amount of income you use to figure out how much you truly owe in taxes.
9. Capital Gains
Capital gains are earned when the sale price of an asset is larger than the original price and the IRS counts it as a form of income. This is the type of earning that will count toward your gross income.
As an example, if you purchased stock for $2,000 and sold it for $3,500, your capital gains is $1,500. You’ll need to pay taxes on this amount, which is around 15 percent.
Double check your tax bracket to accurately determine the amount of your capital gains.
10. Charitable Contribution
If you’ve made some charitable donations throughout the year, it may count as a type of itemized deduction, as long as it meets the requirements by the IRS. If you donated to a qualifying non-profit organization, charity or private foundation, you can deduct it.
Donations are commonly made in cash, but it can also include things like real estate, clothing, cars, or other assets. It may be helpful to double check the IRS’s Exempt Organizations Select Check tool to find out if your donations qualify for income tax deductions.
File early and talk to a tax professional for advice
While there’s no need to study every single term from the tax code, it helps when you know what the basics mean.
Make sure to ask your tax professional about next year’s taxes and how you can set yourself up for the best way to get a refund or lower your taxes throughout the year.
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