Glossary of Tax Terms

Here is a glossary of tax terms (a work in progress) with simplified definitions:

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Accrual: An accounting method where income is reported when it is earned rather than when the customer pays, and expenses are recorded when they are incurred rather than when the business pays the expense. (Also see Cash-basis)

Affordable Care Act Surtaxes: Refers to two different surtaxes created as part of the Affordable Care Act: a 3.8% surtax on investment income for taxpayers whose income is above $200,000 (if single) or $250,000 (if married) and a 0.9% surtax on earned income for taxpayers whose earned income is above $200,000 (if single) or $250,000 (if married).

After-tax: After-tax means a deduction from an employee’s wages that does not reduce the employee’s taxable income. (Also see pre-tax)

After-tax Basis: When a taxpayer makes non-deductible contributions to an IRA, the non-deductible contributions give the taxpayer after-tax basis in the IRA. When the taxpayer withdraws money from the IRA, the after-tax portion is not taxable. (Also see IRA)

AGI: Stands for Adjusted Gross Income. AGI is a key number on an individual’s tax return, as many calculations refer back to AGI. AGI is the number on the bottom line of page 1 of the Form 1040. The calculation of AGI can be complicated but the basic formula is: Income minus certain “front-side” deductions such as student loan interest and IRA contributions.

American Opportunity Credit: A tax credit available for college expenses of students completing their first 4 years of college education. Part of the credit is non-refundable and part of the credit is fully refundable. (Also see Lifetime Learning Credit, Non-refundable Credits, Refundable Credits)

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.

Annual Filing Season Program: An IRS program launched in 2014 for unlicensed tax preparers. Preparers can voluntarily take an annual tax update quiz and be a part of the program. The IRS will list the preparer in a directory along with EAs, CPAs and attorneys. (Also see Enrolled Agent, RTRP)

Asset: 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.

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Basis: Refers to the taxpayer’s stake in an asset or business, usually what the taxpayer originally paid for the asset or business. Basis is used to determine capital gain or capital loss. (Also see Asset, Capital Gain/Capital Loss)

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 of the 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%). (Also see Asset, Depreciation, Section 179)

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Capital Gain/Capital Loss: Gain or loss from the sale of an asset. Long-term capital gains may be subject to special, preferential tax rates. Capital losses are limited to $3,000/year. (Also see Asset)

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. (Also see Capital Gain/Capital Loss)

Cash-basis: A method of accounting where a business reports income when the customer pays, and expenses are recorded when the business pays the expense. Contrast with Accrual-basis.

Casualty and Theft Loss: A deduction allowed for destruction or theft of property. For individuals, the allowable deduction is based on the taxpayer’s basis, the change in the market value of the property after the casualty event, and the taxpayer’s AGI. Individuals take a casualty loss as an itemized deduction. (Also see Basis, AGI)

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. However, part of the credit may be refundable depending on the amount of earned income the taxpayer has. (Also see Refundable Credits, Refundable Child Tax Credit)

College Savings Iowa: A type of 529 Plan for people in the state of Iowa. For more information, visit the College Savings Iowa website. (Also see 529 Plan)

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 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.

Coupling/De-coupling: In tax terminology, this refers to whether or not a state will follow federal tax law on state tax returns. For example, some states “de-couple” from federal bonus depreciation rules, requiring a recalculation of depreciation deductions on the state return. (Also see Bonus Depreciation)

CPA: Stands for Certified Public Accountant. CPAs are licensed by and regulated by states. Only CPAs are allowed to perform audits of financial statements. In the tax world, CPAs have unlimited practice rights, same as Enrolled Agents and attorneys. (Also see Enrolled Agent)

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Death Master File: A file published by the federal government that lists the name, Social Security Number and date of birth of people who have died. For years, the file was available as a public document, which made it a gold mine for identity thieves. In 2013, Congress passed legislation that limits who has access to the file.

Defense of Marriage Act (often abbreviated as DOMA): A federal law 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. The U.S. Supreme Court ruled the law unconstitutional on June 26, 2013.

Dependent: Refers to a taxpayer’s child (if the taxpayer claims the child on the tax return) or others that the taxpayer supports. A dependency exemption and certain other tax benefits are available for claiming dependents on a tax return. (Also see Personal Exemptions)

Depreciation (for financial statements): Under Generally Accepted Accounting Principles, an asset is depreciated over its estimated useful life. For example, if a business determines that it will use a computer for 3 years and then replace it, the computer is depreciated over 3 years. (Also see Asset, Depreciation [for taxes])

Depreciation (for taxes): 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. (Also see Asset, Depreciation [for financial statements], MACRS)

Depreciation Recapture: When an asset is sold for a gain, the gain is generally a capital gain. However, if depreciation has been claimed on the asset, some or all of the gain may instead be treated as ordinary income. This is referred to as depreciation recapture. (Also see Depreciation [for taxes])

Draws: Withdrawals from a sole proprietorship or partnership by the proprietor. In a sole proprietorship, Draws are not deductible. In a partnership, draws are also not deductible but must be tracked because draws reduce the partner’s basis in the partnership. (Also see Sole Proprietorship)

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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 filing status and how many children the taxpayer has. The credit is fully refundable. (Also see Filing Status, Refundable Credits)

Educator Expenses: public-school teachers in grades K-12 can deduct up to $250 of unreimbursed expenses that they paid for classroom supplies. The deduction is taken as a front-side deduction that reduces Adjusted Gross Income. Any expenses above $250 are claimed as miscellaneous itemized deductions. (Also see Adjusted Gross Income, Miscellaneous Itemized Deductions)

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.

Estimated Tax Payments: Quarterly tax payments that self-employed taxpayers are encouraged to make to the IRS. Similar in concept to withholding from paychecks.

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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). (Also see Self-Employment Tax)

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. (Also see College Savings Iowa)

Form 8332: A form signed by a custodial parent that releases their claim to a dependency exemption and gives the exemption to the non-custodial parent. (Also see Dependent)

Form K-1: A reporting form issued by partnerships, S-Corporations, estates and trusts. Form K-1 reports an individual shareholder’s or beneficiary’s share of the entity’s income and deductions for the year.

Form W-2: A reporting form issued by employers to employees. Form W-2 reports wages paid to the employee and taxes withheld on the employee’s behalf during the calendar year. (Also see Withholding)

Form W-4: A form employees fill out to determine how much income tax is withheld from their wages. (Also see Withholding)

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.

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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.

Gross Profit (business): When used in connection with a business, gross profit refers to the business’s income before any deductions are taken.

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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. (Also sees Filing Status)

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.

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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.

Itemized Deductions: Taxpayers can choose to take either the standard deduction or itemized deductions on their tax return. Itemized deductions are for things such as mortgage interest, property taxes, charitable contributions, and medical expenses. (Also see Standard Deduction)

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Lifetime Learning Credit: A tax credit available for college tuition expenses. Similar to the American Opportunity Credit except the Lifetime Learning Credit is less restrictive (anyone taking college classes, even part-time, can take the credit) but the credit amount is smaller than the American Opportunity Credit. Also the Lifetime Learning Credit is non-refundable. (Also see American Opportunity Credit, Non-Refundable Credit)

Listed Property: For tax purposes, “listed property” means depreciable property 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. (Also see Depreciation)

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. (Also see Sole Proprietorship, S-Corporation, C-Corporation)

Long-term Capital Gain/Loss: A capital gain resulting from the sale of an asset held for more than 1 year. Taxpayers can often receive preferential tax rates on gains from the sale of long-term assets. (See also Capital Gain/Loss, Short-term Capital Gain/Loss)

LPA: Stands for Licensed Public Accountant. The LPA license is awarded in 3 states: Iowa, Delaware and Minnesota. LPAs are public accountants and can do the same things a CPA can do except for audits and reviews of financial statements.

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MACRS: Stands for “Modified Accelerated Cost Recovery System.” MACRS is the default method of depreciation for tax purposes. (Also see Depreciation [for taxes])

Marriage Penalty: An informal term referring to the fact that married couples will sometimes pay more in taxes as a married couple than they did as two single people. The marriage penalty is not a literal penalty. Historically, about 50% of married couples experience the marriage penalty.

Married Filing Jointly: a filing status on tax returns for taxpayers who are married at the end of the year. (Also see Filing Status, Married Filing Separately)

Married Filing Separately: A filing status on tax returns for married taxpayers who choose to file separate tax returns. (Also see Filing Status, Married Filing Jointly)

Married Filing Separately on a Combined Return: A filing status on Iowa income tax returns. Taxpayers using this status calculate taxable income separately and then combine the tax liability into one lump sum at the end of the return.

Medical Dependent: A person can be a dependent for purposes of medical expenses and health insurance coverage, without the taxpayer actually claiming the person as a dependent on a tax return. The test for someone to be a medical dependent is: did they live with the taxpayer all year and did the taxpayer provide more than half of their support? If so, they might be the taxpayer’s medical dependent.

Miscellaneous Itemized Deductions: Deductions for things such as unreimbursed employee expenses, expenses relating to investments, and fees for safe-deposit boxes at banks, among many other possibilities. The total of a taxpayer’s miscellaneous itemized deductions must exceed 2% of their AGI in order to be deductible. (Also see 2% of AGI Rule)

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Net Income or Net Loss: For businesses, net income or net loss refers to what’s left after expenses are accounted for. The formula is gross income minus expenses. (Also see Gross Income)

Net Operating Loss: When business losses exceed business income, a net operating loss may exist. 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 the taxpayer’s circumstances.

Non-deductible Contributions: Refers to deposits into a traditional IRA that are not deductible because of income restrictions. The deposit can still be made, but is not deductible on the taxpayer’s tax return. Non-deductible contributions give the taxpayer after-tax basis in their IRA. (Also see IRA, After-Tax Basis)

Non-refundable Credit: A tax credit that reduces taxable income to $0 but cannot generate a refund in and of itself.

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Partnership: A business entity involving two or more people who are conducting business together but who are not incorporated.

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.

Patient Centered Outcomes Research Fee: A fee created as part of the Affordable Care Act. The fee is imposed on businesses or insurance companies at a rate of $2.18 per participant in a health plan.

Payroll Taxes: Taxes paid by an employer. These taxes include the employer half of FICA taxes, and unemployment taxes. (Also see FICA)

Personal Exemptions: A deduction for exemptions claimed on a tax return. Exemptions refers to the taxpayer, the taxpayer’s spouse, and people listed as a dependent on the tax return.

Pre-tax: Pre-tax means a deduction from an employee’s wages that reduces the employee’s taxable income. (Also see After-tax)

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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. (Also see Filing Status)

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Railroad Retirement Benefits (RRB): Refers to retirement benefits for employees of railroad companies. Taxation of these benefits depends on whether the benefits are Tier I or Tier II benefits. (Also see Tier I/Tier II Railroad Retirement Benefits)

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.

Retirement Savers Credit: A non-refundable tax credit available to certain taxpayers who contribute to a retirement plan. The credit is 10% of the amount contributed, with a maximum credit of $200. Income restrictions apply and the credit is unavailable to taxpayers above certain income levels.

RMD: Stands for Required Minimum Distribution. When a taxpayer has money in tax-deferred retirement accounts such as an IRA or a 401(k), they generally must start taking yearly withdrawals from those accounts when they turn age 70 1/2. The required withdrawal amount varies from year-to-year based on IRS tables.

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 Conversion: Refers to converting a traditional IRA into a Roth IRA. The taxpayer claims the value of the traditional IRA as income in the year of the conversion. (Also see Individial Retirement Account, Roth IRA)

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.

Roth Recharacterization: Refers to a reversal of a Roth conversion. A recharacterization restores the IRA back to a traditional IRA and the conversion is treated as though it never happened, thus saving the taxpayer from claiming the conversion as income. The recharacterization must generally be done by October 15th of the year following the date of conversion. (Also see Roth Conversion, Traditional IRA, Roth IRA)

RTRP: Stands for “registered tax return preparer.” The IRS tried to make the RTRP program mandatory but it was struck down in the courts. The program would have required unlicensed preparers to pass an open-book test before they could prepare tax returns.

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Schedule C Business: Another term for a sole proprietorship. (Also see Sole Proprietorship)

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. The deduction is limited to the business’s net income for the year.

Section 1231/1245: Both terms refer to business assets. Section 1245 refers to depreciation taken on assets. When those assets are sold at a gain, the depreciation that has been taken over the life of the asset may need to be claimed as ordinary income in the year of the sale. Any remaining gain after depreciation recapture is treated as a Section 1231 gain, which means losses are deductible in full, while gains are treated as capital gains.

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.

Short-term Capital Gain/Loss: A capital gain resulting from the sale of an asset held for less than 1 year. Income from the sale of a short-term asset is usually treated as ordinary income and is not subject to special tax treatment, as opposed to income from long-term capital gains. (Also see Capital Gain/Loss, Long-term Capital Gain/Loss)

Single: In tax terminology, “single” is a filing status for taxpayers who are unmarried. (Also see Filing Status)

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.

Special Enrollment Exam: Often abbreviated “SEE.” This is the 3-part test a person must pass in order to become an Enrolled Agent. (Also see Enrolled Agent)

Standard Deduction: A deduction all taxpayers are entitled to, as a reduction of taxable income, on their tax return. The amount of the standard deduction depends on the taxpayers’ filing status. Taxpayers can choose between taking the standard deduction or taking itemized deductions. (Also see Itemized Deductions)

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1099: A reporting for issued to the IRS and to taxpayers that reports certain payments made to the taxpayer. There are more than a dozen types of 1099.

Tier I/Tier II Railroad Retirement Benefits: Tier I RRB benefits are considered the equivalent of Social Security benefits and are taxed in the same manner as Social Security. Tier II RRB benefits are considered the equivalent of pension distributions and are taxed in the same manner as any other withdrawal from an IRA or pension. (Also see Railroad Retirement Benefits)

2% of AGI Rule: For miscellaneous itemized deductions, those deductions can only be taken if the total amount of deductions exceeds 2% of the taxpayer’s Adjusted Gross Income.

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Varnum Ruling: A 2009 ruling by the Iowa Supreme Court that legalized same-sex marriage in Iowa.

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Withholding: Refers to income taxes and FICA taxes withheld from income before the income is paid to the recipient. For example, employers withhold taxes from wages paid to employees. The pay the employees receive is reduced by the taxes withheld from the pay. (Also see FICA)

W-2: (See Form W-2)