What Tax Terminology You Need To Know

While you’re striving for knowledge about how the tax world operates, you must have heard or read some terms that you’re unfamiliar with or confuses you. For average taxpayers, it is not that easy to understand the differences between terms that might look alike or might include the same words. Even if you have a tax professional that you can lean on, it pays to know basic terms used in the tax industry. This is to help you understand how your taxes are being calculated, what deduction you can get, or just to understand what your expert is trying to say. Read on for some of the words you need to know.
Adjusted Gross Income (AGI) – This is the total amount of income you received on a single year minus itemized deductions such as medical expenses, moving expenses, contributions to qualified IRA, alimony payments, and student loan interests. Those adjustments or deductions can be claimed even if you do not itemize.
Gross Income – Don’t confuse this with your AGI. Gross income is the total amount of your income before any deductions. This can be in form of cash, services, property and goods that is not exempt from taxation.
Taxable Income – Taxable income is your AGI minus your standard or itemized deductions and personal exemptions. Your taxable income can be found on line 43 of your 1040. It goes without saying that your taxable income should be lower than your AGI.
Standard Deduction – Standard deductions is a fixed dollar amount that you can subtract from your income. This is available to all filers and the amount can be determined by their filing status. This rate, however, changes every year due to inflation adjustments. Standard deductions are used by those taxpayers who do not prefer the itemized deduction.
Itemized Deduction – Itemized deduction, on the other hand, is an option to get deductions for medical expenses, charitable donations, theft and casualty loss, home mortgage interests, and miscellaneous deductions. Itemized deduction cannot be claimed if you already chose standard deduction. If you chose to itemize, you must file the Form 1040 and detail your tax deductions on Schedule A.
Tax Credit – This credit is used to directly reduce your tax owed. Tax credits are more valuable because it directly reduces the amount you need to pay Uncle Sam instead of reducing the taxed income. For example, your tax bill of $2,000 will be down to $1,500 when a tax credit of $500 is applied. Couple of tax credits can even give you a refund once it exceeds your tax bill.
Withholding – This is the process by which you automatically pay your taxes as you earn your income. Employers set this up so that every time you receive your salary, there is already a certain amount that is withheld every period for your taxes. If you or your employer over-withheld your taxes, you will receive a refund.
Exemption – This is the amount a taxpayer can be free from paying. This can be for himself or herself, spouse and eligible dependents. The total of your exemption is then deducted from your adjusted gross income before tax is calculated based on your remaining taxable income.
You don’t have to absorb and understand all these overnight. These terms and the tax world in general are really confusing. However, it is ideal to have basic knowledge of the terms being used in the industry. Also, it is highly recommended to hire a professional who is more fluent in this language to help you organize your taxes and be aware of what is going on. Having an experienced tax professional by your side can be very vital once the numbers, or even words, gets too confusing.

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