What are the most important terms when it comes to income tax? The tax deadline creeps upon you, and before you know it, you are flooded with terms and conditions you fail to make an iota of sense of. It’s important to know the ins and outs of filing your income taxes to lose money nor your peace of mind either. As a business person or working professional, you must have some unique insights into what you should be aware of when filing your return.
This post will take you through some of the most important and well-known terms so that you won’t have any problems understanding your taxes. If you wish to become your own accountant and learn in-depth about the nuances of tax-paying, the IRS has a website that defines the terms used in income tax law that you can visit for genuine IRS tax information. It is best to learn these as soon as possible to make informed decisions about your taxes and avert any problems with the Internal Revenue Service (IRS) down the line.
A “return” is a document that reports your income to the IRS and explains how much tax you have paid. It’s important to file this every year because if you don’t, or even if you do but don’t pay enough, the IRS will take action against you. This document also establishes your filing status (married/head of household/single), which can affect how much money you’re allowed to claim for deductions and credits on your taxes. For example: If your annual salary was $100,000 in 2012 but only $70,000 in 2013, then there should be no tax form discrepancy because someone with an income of around $100K would be able to report it consistently as it decreased over time.
2. Taxable Income
This is the income that is subject to tax. It can be defined by three areas: gross income, adjusted gross income, and taxable income. Gross income includes items from interest earned on savings accounts or a checking account to an employer’s contribution to health care premiums. Adjusted gross income means gross incomes minus certain deductions such as retirement accounts or student loan interest.
This figure is arrived at by subtracting all the above from gross income. A taxpayer’s tax is calculated on this amount using their applicable tax rate percentage (marginal) based on their taxable income and filing status. The highest marginal rate for 2011 is 35%.
Taxable income is the final number you get after adjustments are taken into account plus any additional taxes owed based on other factors such as whether or not one qualifies for certain exemptions (such as a head of the household status), among other things.
3. Personal exemptions:
A personal exemption allows individuals to exclude $3950 from income. There is a phase-out of the exemption for high-income taxpayers so that individuals earning more than $250,000 and married couples filing jointly with incomes above $300,000 do not end up using these exemptions.
4. Standard deduction:
Each taxpayer receives a standard deduction amount based on their status (either single or married filing jointly) plus an additional amount if they are over age 65 or blind to ensure every individual is treated fairly regardless of whether or not their tax situation fits squarely into the established criteria.
In 2016, the standard deduction was $5,950 for single people and $11,900 for married couples filing jointly. The point of this subtraction is that it spares you from having to list certain deductions you might otherwise incur in arriving at your adjusted gross income, which could be hundreds or thousands of dollars more than what’s listed on your tax return.
5. Itemized deductions:
These include expenses such as charitable donations, certain medical costs, interest paid on a mortgage, and property taxes, among others. In addition, the alternative minimum tax (AMT) applies in cases where itemized deductions exceed income.
6. Alternative minimum tax (AMT)
The AMT is a calculation that ensures people who claim lots of deductions and tax credits are taxed at least a minimum amount. For 2011, the threshold for paying the AMT is $160,800 on joint returns and $80,500 for single filers or married persons filing separately.
7. Capital gains
That’s profits from the sale of assets like stocks or property. If you make money when you sell an asset (the total return was more than your cost), it’s capital gain income. There are two kinds: long-term and short-term. Long-term being anything held longer than one year before sold, while short-term investments were only held for less than 12 months in between purchase date and selling date.
A long-term capital gain is taxed at a lower rate than a short-term one – 15% for those in the 25%-35% ordinary tax brackets and 18.8% for top earners who fall under the 35% bracket.
8. Tax Brackets
There are a number of federal income tax brackets (or categories) into which your taxable income is divided to calculate your tax owed on it. For example, if you assume the standard deduction of $5,950 in 2016 (and you’re single), your taxable income falls under the lowest bracket. This puts the first part of your earnings at 10%, then 15% for the next part, and so forth through the year until reaching 38.6%. The purpose here is to make sure you pay less than that top flat rate of 39.6%.
9. Payroll taxes
When a person works, their employer isn’t required to withhold just federal income tax from their paycheck; rather, they are also required by law (through payroll taxes ) to remit monies for Social Security and Medicare as well [ 20 ]. The amount withheld varies from person to person, but it’s usually around 15% of your total taxable income. Different payroll taxes apply if you’re self-employed, so be sure to look that up before you file!
10. Marginal Tax Rate
The marginal tax rate is the rate of income tax that an individual has to pay on their last dollar of taxable income. It is not necessarily the individual’s overall average tax rate; an average tax rate considers all of one’s total taxable income.
Note that the American Opportunity Tax Credit (before 2006, the Hope credit) can be voided under certain circumstances. For example, the Lifetime Learning Credit is disallowed for those taxpayers claimed as dependent by another taxpayer. One example would be if one’s parents claimed one as a dependent on their income tax return. In addition, this credit will not be deducted if the person or persons who paid for one’s qualified education expenses are also claimed as dependents on another person’s income tax return.