One of the hardest things about filing your taxes is trying to decipher the forms. You practically have to learn a new, tax- specific language. And the IRS-speak makes that dang VCR manual (yes, a few of us still use those antiquated devices!) seem almost coherent!
To help out, Don't Mess With Taxes is gathering some common tax terms and phrases and their plain English meanings in this post. This is an ongoing list, so don't be discouraged if the word that's stumping you isn't here yet. It soon will be. In fact, just go ahead and e-mail it to me to make sure it gets included!
AARRGGHH!!! -- Most common nonprofane exclamation used during tax filing season.
Adjusted gross income (AGI) -- This amount is your total income reduced by certain deductions, more appropriately known as adjustments, that you claim at the bottom of Form 1040 or 1040A. You tabulate your AGI before you take your itemized deduction or standard deduction or claim your personal exemption amount. Your AGI appears on Form 1040 or Form 1040A at the bottom of page 1 of both those forms (and is re-entered as the first number at the top of page 2). On the 1040EZ, your AGI is on line 4.
Credit -- A tax credit reduces the amount of the tax you owe, unlike deductions which reduce your amount of income upon which your tax liability is figured. Because credits are taken after you figure your tax amount, they make a direct dollar-for-dollar difference in your tax bill. There are two types of credits: refundable and nonrefundable (see below).
Deduction -- The amount subtracted from your income before computing your income tax. If you have taxable income of $30,000 and deductions of $3,000, then you would figure how much tax you owe on the difference of $27,000. Every taxpayer can take the standard deduction amount, which is based on filing status and is adjusted annually for inflation. Or, if a taxpayer can document deductions that are greater than the standard amount, they can deduct them by itemizing on Schedule A.
Earned income -- Essentially, it's just like it sounds. It's compensation you receive from work, including wages, salaries, tips, commissions, and net earnings from self-employment endeavors. This money is what is taxed at the ordinary income rates that range from 10 percent to 35 percent. See income tax rates/brackets for details.
Modified adjusted gross income (MAGI)
Nonrefundable credit -- A credit that cannot be more than your tax liability. You can use the credit to reduce your tax bill to zero, but any excess credit is lost. For example, if you owe $300 and can claim a $500 nonrefundable credit, $200 of the credit cannot be used. Popular nonrefundable credits include the child tax credit, child- and dependent-care credit, credit for the elderly or disabled, retirement savings contributions credit, adoption expenses credit and the Hope and Lifetime Learning education credits.
Refundable credit -- A credit for which you can get a refund, even if it exceeds your tax liability. For example, if you owe $300 and can claim a $500 fundable credit, you'll get a $200 check back from the IRS. Refundable credits include the earned income tax credit (EITC), additional child tax credit and credit for taxes withheld on wages and other amounts.
Tax rates/brackets -- The U.S. tax system is a progressive one, in which the greater the earnings, the higher the tax rate. Currently, there are six tax brackets: 10, 15, 25, 28, 33 and 35 percent. You can find specifics on the 2006 tax rates and brackets here; the 2007 tax rates and brackets here.
Unearned income -- Money that is not gained by work or delivery of a service or product. It's most well-known source is from investments: interest, dividends or capital gains produced by savings accounts, stocks and bonds, certificates of deposit or mutual funds. But it also includes unemployment compensation, alimony, taxable Social Security benefits, pensions, annuities, royalties, and distributions of unearned income from a trust. Some unearned income receipts, e.g., investment earnings, are taxed at a lower rate (usually 15 percent) than the rates applied to ordinary earned income.
Zero -- Worst-case tax scenario, this is the amount left in your bank account after you finish filing your taxes. But we're aiming at the opposite target, so that zero will be what you end up owing the IRS when all the filing screaming and shouting is done. Synonyms: zilch, zip, nada, nothing, @#&*#!; See also AARRGGHH!!!
Updated Feb. 26, 2007