Here is a glossary of terms (a work in progress) with simplified definitions:
AMT: Stands for “alternative minimum tax.” AMT is an alternative tax calculation that affects higher-income individuals. The AMT calculation takes away personal exemptions and many itemized deductions in arriving at taxable income for AMT purposes.
Asset: This term can have several meanings in the tax world. For businesses, an asset is something the business purchases that has a useful life of one year or more (equipment, for example). For individuals, things such as houses, stocks and other such items are considered assets.
Bonus Depreciation: A special, accelerated depreciation deduction available for purchases of brand-new assets. Bonus depreciation allows immediate expensing of a certain portion of the purchase price asset, with the remaining cost being depreciated. The bonus depreciation amount is set by Congress and varies from 100% (in other words, immediate expensing in full) to some lesser percentage (oftentimes 50%). (See also, asset, depreciation, Section 179.)
Capital gain/capital loss: Gain or loss from the sale of an asset (see also). Long-term capital gains may be subject to special, preferential tax rates. Capital losses are limited to $3,000/year.
Capital loss limit: Tax law places a limit on how much a taxpayer can deduct in capital losses each year. That limit is $3,000/year. Unused losses in one year can be carried forward to be used in future years.
C-Corporation: By default, any incorporated business entity is taxed as a C-Corporation. A corporation can elect to be taxed as an S-Corporation. A C-Corporation is a separate taxpaying entity. The results of C-Corporation operations stay within the corporation, and the corporation itself pays taxes on corporate net income.
Child tax credit: A $1,000 per child tax credit available for parents who have kids under the age of 17. The credit is non-refundable, but part of it may be refundable, depending on a person’s income for the year.
Community Property: Most states follow “common law,” but 9 states in the United States follow “community property” laws. When married couples in community property states file separate tax returns, they must employ community property rules. Those rules require splitting most of items of income and some deductions 50/50 between both spouses. The 9 states that follow community property laws are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Defense of Marriage Act (often abbreviated as DOMA): A federal law, declared unconstitutional by the U.S. Supreme Court in June 2013, passed in 1996 that said, for all federal purposes, that marriage is defined as “one man, one woman.” Because of DOMA, the federal government did not recognize any same-sex marriage, civil unions or domestic partnerships. Law was struck down on June 26, 2013.
Depreciation: For tax purposes, depreciation is a deduction taken by businesses on the purchase of assets. Rather than taking a deduction in full in the year of purchase, the deduction is spread over time. The IRS determines the length of time. For example, a computer is depreciated over 5 years because that’s the length of time for depreciating computers set out by the IRS. This concept differs from the accounting principle of depreciation under Generally Accepted Accounting Principles. Under GAAP, an asset is depreciated over its estimated useful life. But in the tax world, the IRS assigns the depreciation period and it may not always align with the estimated useful life of the asset. (See also, Asset, Bonus Depreciation and Section 179.)
Earned Income Credit (EIC) - A tax credit available to taxpayers between the ages of 25 and 65 whose income is below certain levels. The income level varies depending on how many children the taxpayer has. The credit is designed to be an incentive for lower-income people to work, and essentially refunds FICA taxes that are withheld from the taxpayer’s wages. The EIC is fully refundable, meaning the taxpayer receives a refund from the EIC even if their tax liability is $0.
Employer Identification Number (EIN) - A 9-digit number assigned by the IRS to businesses. All business entities other than sole proprietors must have EINs. Sole proprietors may need an EIN in certain circumstances.
Enrolled Agent: Federally licensed tax practitioners. In the tax world, Enrolled Agents have equal rights and privileges as attorneys and CPAs. Read more about Enrolled Agents here.
FICA - Stands for “Federal Insurance Contributions Act.” FICA taxes fund Medicare and Social Security and are generally paid for through withholdings from paychecks (if an employee) or through paying self-employment tax (for people who are self-employed).
Filing status - There are 5 filing statuses one can choose from when filing a federal income tax return: single, head of household, married filing jointly, married filing separately, and qualified widow(er). Each status comes with its own standard deduction, tax bracket, and (s0metimes) special rules or restrictions on certain deductions and credits.
529 Plan: A savings plan that lets a taxpayer save for their children’s college expenses. Money put into a 529 plan does NOT result in a federal tax deduction, but withdrawals (including earnings) are tax-free if used for college expenses. Many states, such as Iowa, allow for a deduction on the state tax return for money put into a 529 plan. For more information about Iowa 529 plans, visit the College Savings Iowa website.
FSA: Stands for “flexible spending account,” sometimes called a “cafeteria plan.” FSA’s allow a taxpayer to set money aside to pay for things such as medical expenses or daycare. Money put into an FSA is tax-deductible, and withdrawals are tax-free if used for qualified expenses.
Gift tax: A federal tax assessed against the givers of gifts above a certain amount. For 2013, that amount is $14,000. If a person gives gifts to any one person that total more than $14,000 for the year, that person may need to file a gift tax return and potentially pay gift tax.
Head of Household: A filing status on a tax return that provides a tax bracket that is halfway between that of a single person and that of a married person. A person can qualify for head of household if they are single and have a qualifying dependent living with them.
Health Reimbursement Arrangement: Abbreviated “HRA” and sometimes called a “Section 105 Plan.” This is an arrangement where an employer agrees to reimburse employees for medical expenses. These are especially useful for sole proprietors who are in a position to hire their spouse as an employee.
HSA: Stands for “health savings account.” An HSA allows you to save money, tax-advantaged, for medical expenses. Contributions to an HSA reduce your taxable income, and withdrawals from an HSA are tax-free if used for medical expenses. To qualify, you must meet certain requirements, such as being enrolled in a high-deductible health care plan. See IRS Publication 969 for more information.
Individual Retirement Account (IRA): a retirement account that is not part of an employer-provided retirement plan. Anyone can set up and make deposits into an IRA. Those deposits may or may not be deductible, depending on the taxpayer’s income.
Listed Property: For tax purposes, “listed property” means depreciable property (see “Depreciation”) that has elements of personal use. Examples include vehicles and computers. The IRS generally requires stricter documentation of usage of property that is considered “listed” property.
LLC: Stands for “Limited Liability Company.” LLCs are entities formed under state law. As with corporations, LLCs give liability protection but LLCs are usually simpler to form and administer. One-person LLCs are taxed as sole proprietorships by default and multi-member LLCs are taxed as partnerships by default, but an LLC can elect to be taxed as an S-Corporation or a C-Corporation.
MACRS: Stands for “Modified Accelerated Cost Recovery System.” MACRS is the default method of depreciation for tax purposes.
Married Filing Jointly: a filing status on tax returns for taxpayers who are married at the end of the year.
Medical Dependent: A person can be a dependent for purposes of medical expenses and health insurance coverage, without you actually claiming them as a dependent on your tax return. The test for someone to be your medical dependent is: did they live with you all year and did you provide more than half of their support? If so, they might be your medical dependent.
Net Operating Loss: When your business losses exceed your income, you have a net operating loss. The loss can be carried back to prior years and/or forward to future years to offset income in those years. The exact rules vary depending on your circumstances.
Non-refundable credit: A tax credit that reduces your taxable income to $0 but cannot generate a refund in and of itself.
Passive Activity Losses: A passive activity is an investment activity in which a taxpayer doesn’t “actively participate.” In overly simplified terms, this means the taxpayer doesn’t work in the business day-to-day. There are limits on the amount of losses a taxpayer can deduct from passive activities.
Pass-through Entity: Sometimes called “flow-through” entities. This term refers to business entities that do not pay income taxes themselves. Instead, results of business operations “pass through” to the owners, who report their share of the operations on their personal tax return. Examples include partnerships and S-corporations.
Qualified Plan: Generally refers to a 401(k) retirement plan offered by an employer. If a plan is “qualified,” deposits into the plan by employees reduce the employees’ taxable income, and deposits into the plan by employers reduce the employers’ taxable income.
Qualified Widow(er): A filing status on a tax return for a person whose spouse has died and the surviving spouse is still raising kids. In the year of the spouse’s death, the couple will file as married filing jointly. The surviving spouse can use Qualified Widow(er) as a filing status for the next two tax years after that. This filing status provides the same tax brackets and standard deduction as married filing jointly.
Refundable Child Tax Credit: The Child Tax Credit is generally non-refundable. However, part or all of it may be fully refundable, depending on a taxpayer’s earned income for the year.
Refundable Credits: Tax credits that are fully refundable on a tax return even if the taxpayer’s tax liability is $0.
Registered Domestic Partner (RDP): Same-sex couples in Nevada and Washington are not allowed to get married but they are allowed to enter into “registered domestic partnerships.” These partnerships are similar to marriage. For tax purposes, couples in a domestic partnership can’t file as married but they must apply community property rules (see also) to their federal tax return.
Rollover: A tax term that means a transfer from one retirement account to another retirement account. For example, a transfer from an IRA to a 401(k) account or vice-versa.
Roth IRA: A type of individual retirement account in which contributions into the account are not tax deductible, but qualified withdrawals from the account are tax-free.
RTRP: Stands for “registered tax return preparer.” RTRPs are federally authorized to prepare tax returns but have less power than enrolled agents, CPAs or attorneys when dealing with the IRS. The status of the RTRP designation is presently unknown. A court ruled in early 2013 that the IRS did not have the authority to go through with the RTRP program, but the IRS has appealed. As of April 2013, the outcome of the court case is unknown.
Schedule C Business: Another term for a sole proprietorship (also see).
S-Corporation: A corporation that elects to be taxed under subchapter S of the Internal Revenue Code. S-Corporations are required to file an informational tax return on Form 1120-S, but generally do not pay taxes themselves. Instead, as with a partnership, S-Corporations are “flow-through” entities, meaning the results of the corporate operations flow through to the individual shareholders, who are taxed on the corporation’s operations on their personal tax returns
Section 179: A deduction, similar to depreciation, that allows a business to expense 100% of the cost of an asset in the year of purchase. A business can take the Section 179 deduction on any assets it purchases, whether new or used.
Self-employment tax: the self-employed person’s version of FICA taxes (see also). Self-employment tax is equal to 15.3% x self-employment earnings. The full formula is: (self employment earnings x .9235) x .153.
Single: In tax terminology, “single” is a filing status (also see) for taxpayers who are unmarried.
Sole Proprietorship: A business entity that involves one person and that is not incorporated. Results of sole proprietorship operations are reported on Schedule C, which is attached to the business owner’s personal Form 1040.
Varnum Ruling: A 2009 ruling by the Iowa Supreme Court that legalized same-sex marriage in Iowa.