Decoding Your Taxes: A Glossary of Tax Terms You May Need to Know

31 October 2024

Navigating the maze of federal taxes can be daunting. Many tax terms are confusing, whether you're a business owner, a seasoned individual taxpayer or someone filing a tax return for the first time. To make matters worse, significant tax law changes may be on the horizon due to the upcoming election and provisions in the Tax Cuts and Jobs Act that are scheduled to expire at the end of 2025.

Here's a glossary of 20 key terms to help demystify tax terminology.

Adjusted gross income (AGI). This is your total gross income minus specific deductions. AGI is used to determine your taxable income.

Basis. This refers to the amount of your investment in property for tax purposes. It's used to determine gain or loss on the sale, exchange or other disposition of property. Basis is usually the cost of an asset, but it can be adjusted for various items, such as depreciation or improvements.

Capital gains. This is your profit from the sale of an asset or investment. Capital gains can be short-term (for assets held for less than a year) or long-term (for assets held one year or longer). Short-term tax gains are taxed as ordinary income, with rates ranging from 10% to 37%. Long-term gains are taxed at capital gains tax rates of 0%, 15% or 20%, depending on your taxable income.

Deductions vs. credits. A tax deduction involves expenses that can be subtracted from your gross income to reduce your taxable income. Examples include itemized deductions for mortgage interest and charitable contributions. A tax credit is an amount that can be subtracted directly from your tax liability. Examples include the child credit and the adoption credit.

Dependent. This is a person, typically a child or relative, for whom you provide significant financial support. You may be able to claim tax breaks on your tax return for dependents.

Estate tax. This is a tax on the transfer of assets upon a person's death. It applies only to estates valued over a certain amount. For 2024, the exemption base is $13.61 million for individuals and $27.22 million for married couples.

Filing status. Your tax-filing group determines your tax rate and standard deduction, among other things. The statuses include single, married filing jointly, married filing separately, head of household and qualifying surviving spouse.

Gross income. Your gross income includes all amounts you receive in the form of wages, interest, dividends, gambling winnings and other sources that aren't exempt from tax.

Home office deductions. Self-employed individuals and small business owners may be allowed to deduct certain expenses related to the business use of their homes. If you qualify, deductible expenses may include mortgage interest, rent, utilities, insurance, repairs and depreciation. Alternatively, you can elect a simplified method using $5 per square foot of office space up to a maximum of $1,500. Currently, employees aren't eligible to deduct home office deductions.

Itemized deductions. Taxpayers can deduct these specific expenses from AGI to reduce taxable income. Examples include medical expenses, state and local taxes, charitable contributions, and mortgage interest. If you claim the standard deduction, you can't itemize deductions in the same year.

Kiddie tax. This is designed to prevent parents from moving investment income to their children to take advantage of lower tax rates. It applies to unearned income, including interest, dividends and capital gains of children under age 18 or dependent full-time students under age 24.

Levies vs. liens. According to the IRS, a levy is a legal seizure of your property to satisfy a tax debt. Levies are different from liens. A lien is a legal claim against property to secure payment of the tax debt, while a levy actually takes the property to satisfy the tax debt.

Nanny tax. This refers to the tax you must withhold and pay when you hire household employees who aren't independent contractors. For 2024, if you pay a household worker $2,700 or more, you must withhold and pay Social Security and Medicare taxes on his or her behalf.

Offer in Compromise (OIC). In some cases, a delinquent taxpayer can enter into an agreement with the IRS to settle a tax debt for less than the full amount owed. Nearly half of all OICs are rejected or returned to the taxpayers who file them.

Qualified business income (QBI) deduction. This complex tax break allows eligible taxpayers to deduct up to 20% of their QBI. It's generally available to owners of sole proprietorships, partnerships, S corporations, and some trusts and estates. Enacted as part of the Tax Cuts and Jobs Act, the QBI deduction is scheduled to expire at the end of 2025, unless Congress passes legislation to extend it.

Refundable tax credits. These credits allow you to get a refund even if you don't owe any tax. Nonrefundable tax credits reduce your tax only until it reaches $0.

Stepped-up basis. This is a tax provision that adjusts the cost basis of an inherited asset to its fair market value at the time of the original owner's death. When an heir sells the asset, the stepped-up basis can significantly reduce the capital gains tax owed.

Tax Cuts and Jobs Act. Enacted in 2017, this law made sweeping changes to the federal tax rules. For instance, it reduced tax rates, nearly doubled the standard deduction, lowered the corporate tax rate from a maximum of 35% to 21%, increased the child tax credit, and suspended or limited various tax deductions. Most provisions took effect in 2018, and many are scheduled to expire at the end of 2025 — unless Congress acts to extend them.

Underpayment penalty. The IRS imposes this penalty if you don't pay enough of the taxes you owe throughout the year with withholding from your paycheck or quarterly estimated tax payments.

Wash sale. This happens when an investor sells a security at a loss and then buys the same or a substantially identical security within 30 days before or after the sale. You can't claim a loss deduction on your tax return if you violate the wash sale rule.

Get Professional Help

Understanding tax terminology can be crucial when navigating the complexities of the federal tax system. This glossary covers only some terms and concepts you may encounter. But don't worry: You're not alone. Your tax advisor can assist in filing tax returns, devising strategies to minimize taxes and ensuring compliance with the law.

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