401(k) plan
An employer-sponsored retirement savings plan that allows employees to divert part of their salary to a tax-deferred
investment account. Salary put in the plan is not taxed until it is later withdrawn, presumably in retirement.
Employers often match part or all of the employee's deposits. Penalties usually apply to withdrawals before age 55
if you leave your job or 59 1/2 if you're still on the job, although most plans allow employees to borrow limited amounts
tax- and penalty-free from their accounts. The maximum contribution limits will likely increase in the future with inflation.
The same limits apply for 403(b) plans - used by public schools and non-profits, for example - and 457 plans
(used by some local governments). See also Roth 401(k).
1040
The 1040 is the official income tax return form printed and distributed by the Internal Revenue Service. It was introduced
in 1913, after the 16th Amendment to the Constitution, which authorized the income tax, was ratified. Today there are
three versions of this tax form designed for increasingly complex returns: 1040-EZ, the 1040A and the full fledged 1040.
You should use the simplest form that covers all the tax benefits you deserve.
Prior to 2011, the IRS automatically mailed forms to taxpayers of record who had filed on paper the previous year. To save money, however, the IRS no longer automatically mails the forms. You can download the copies you need or pick up forms at libraries, post offices or walk-in IRS offices around the country. You can also request that the IRS send you a form by calling 800-829-3676.
A
Above-the-line deduction
Certain expenses can be deducted to reduce taxable income even if you don't itemize deductions. These money-saving write-offs,
officially called adjustments to income, include: deductible contributions to traditional IRAs
(individual retirement accounts), SIMPLE and Keogh plans, contributions to HSAs (health savings accounts), job-related
moving expenses, any penalty paid on early withdrawal of savings, the deduction for 50% of the self-employment tax paid by
self-employed taxpayers, alimony payments, interest on higher education loans and certain qualifying college costs, any
jury duty pay forfeited to your employer and qualifying travel expenses for members of the Reserves and National Guard.
They are called above-the-line deductions because they are subtracted before arriving at adjusted gross income. Exemptions
and itemized deductions are subtracted from AGI to arrive at taxable income.
Accelerated depreciation
For most business property, except real estate, the law allows you to depreciate the cost at a rate faster than would be
allowed under straight-line depreciation.
Acquisition indebtedness
This is the technical term that Congress uses for what most of us call home mortgage debt on which the interest is deductible.
To qualify, the debt must be used to buy, build or substantially improve your principal residence or a second home and must
be secured by the property.
Active participation
The level of involvement that real estate owners must meet to qualify to deduct losses from rental
real estate. Failure to pass this test could make such losses nondeductible under passive-loss rules.
Additional child tax credit
You may qualify for this credit if the regular child credit you deserve more than wipes out your tax liability.
This additional credit can trigger a refund check from the IRS.
Adjusted basis
Your basis in property is the stepping-off point for determining gain or loss when you sell it. (This is sometimes referred
to as cost basis or tax basis or, simply, basis.) The basis generally starts out as what you pay for the property, although
special rules apply to assets you inherit or receive as a gift. The basis can be adjusted while you own property. When you
buy rental property, for example, the basis begins at what you pay for the place, including certain buying expenses, and it
is adjusted upward by the cost of permanent improvements. The basis is reduced by the amount of any depreciation you are
allowed to deduct while you own the property. You use your adjusted basis to figure the gain or loss on the sale. When
stock or mutual fund shares are involved, your adjusted basis is the cost of the shares, including any brokerage commissions
or load fees minus any return of capital payouts.
Adjusted gross income (AGI)
This is your income from all taxable sources minus certain adjustments to income, and is the key to determining your
eligibility for certain tax benefits. AGI is reduced by the value of personal and dependency exemptions and by either
the standard deduction or the total of your itemized deductions. The resulting amount is your taxable income, the
amount on which you income tax bill will be based. See Above-the-line deduction.
Alimony
Qualifying payments to an ex-spouse that can be deducted as adjustments to income regardless of whether you itemize. The
recipient must include the payments in his or her taxable income.
Alternative minimum tax (AMT)
A special tax designed primarily to prevent the wealthy from using so many legal tax breaks that their regular tax bill is
reduced to little or nothing. In recent years, it has hit more and more taxpayers who live in high-tax states, have many
children or exercise incentive stock options. The AMT ignores certain tax benefits allowed by the regular rules and applies
special rates to a larger amount of income than is hit by the regular tax. The taxpayer pays either the AMT or the regular
tax bill, whichever is higher.
Amended return
A revised tax return, filed on Form 1040X, to correct an error on a return filed during the previous three years. An amended
return can result in owing extra tax or getting a refund, depending on the mistake you correct.
Audit
As if you didn't know, this is a review of your tax return by the IRS, during which you are asked to prove that you have
correctly reported your income and deductions. Only about 1% of all returns are audited each year and most audits are done
by mail and involve specific issues, not the entire return.
Automobile, business use
The cost of driving your car on business can be deducted as a business or employee expense.
B
Bargain sale to charity
Selling property to a charity for less than the property's actually worth. Depending on the circumstances,
this could result in a tax deduction or extra taxable income.
Basis
See adjusted basis.
Below-market-rate loans
If you make an interest-free or bargain-rate loan to a friend or relative - or anyone else - you may be required to include
in your taxable income some of the interest the IRS believes you should have charged.
Blind
A person is considered legally blind for purposes of qualifying for a larger standard deduction if:
- He or she is totally blind.
- He or she can't see better than 20/200 in the better eye with glasses or contact lenses; or
- His or her field of vision is 20 degrees or less.
Bond premium
The amount over face value that you pay to buy a bond paying higher than current market rates. With taxable bonds, a
portion of the premium can be deducted each year that you own the securities.
Burden of proof
The responsibility of the taxpayer to prove that his or her tax return is accurate, rather than the IRS having to provide
convincing evidence that it is inaccurate. Although Congress has shifted the burden of proof to the IRS in certain tax
disputes, don't throw away your records. The change will have no effect on the vast majority of taxpayers. The burden
shifts only if a case gets to court - which happens very rarely - and then only if the taxpayer has complied with all
record-keeping requirements and has cooperated with IRS requests for information. In almost all cases, then, the burden
of proof remains on your shoulders.
C
Cancelled debt
Generally, when a debt is canceled or forgiven, the borrower who benefits is considered to have received taxable income
equal to the amount of the canceled debt. There are exceptions. For example, some student loans contain agreements that
debt will be forgiven if the borrower works for a certain period of time in a certain profession.
Also, forgiven debt is not taxable to the extent the borrower is insolvent (that is, whose liabilities exceed his or her assets) or when the debt is waived by a bankruptcy court. You
should receive a 1099-C form showing the amount of any cancelled debt; be sure to check to see if you qualify for any
exceptions before reporting the amount as taxable income.
Capital expenditure
The cost of a permanent improvement to property. Such expenses, such as adding central air conditioning or an addition to your
home, increase the property's adjusted tax basis.
Capital gain
The profit from the sale of assets including stocks, mutual-fund shares and real estate. Gains from the sale of assets
owned for 12 months or less are "short-term capital gains" and are taxed in your top tax bracket, just like salary.
For most assets owned more than 12 months, profits are considered "long-term capital gains" and are taxed at preferential
rates. The special rates for long-term gains do not, however, apply to all gains from investment real estate.
Capital loss
The loss from the sale of assets such as stocks, bonds, mutual funds and real estate. Such losses are first used to
offset capital gainst and then excess losses can be deducted against other income, such as your salary
and retirement plan distributions.
Capital-loss carryover
Capital losses can be used to offset capital gains, a limit of any excess loss can be deducted against other
income, such as your salary. Losses not currently deductible because of the limit can be carried over to future
years.
Carryback losses
Firms can normally use net operating losses in the current year to reclaim taxes paid for the previous two years.
Casualty loss
Damage that results from a sudden or unusual event.
Charitable contribution
A gift of cash or property to a qualified charity for which a tax deduction is allowed.You must also have either a
receipt or a bank record (such as a cancelled check) to back up any donation.
Child credit
This credit reduces your tax liability for each child under age 17 you claim as a dependent on your return.
Child- and dependent-care credit
Not to be confused with the child credit, this one offsets part of the cost of paying for care for a child under the age of
13 or disabled dependent while you work.
Child support
Payments made under a divorce or separation agreement for the support of a child. The payments are neither deductible by the
person who pays them nor considered taxable income to the person who receives the money.
College Credits
See education credits
Combat pay
Pay received by members of the U.S. Armed Forces and support personnel in combat zones, including peace-keeping efforts.
Military pay received by enlisted personnel serving in combat or designated peace-keeping efforts is tax-free. Officer pay
is tax-free up to the maximum pay for enlisted personnel (plus imminent danger/hostile fire pay), an amount that increases
each year. Although tax-free, combat pay may now be counted as compensation when determining whether the taxpayer can
contribute to an IRA or Roth IRA.
Conservation easements
If you donate to a conservation group or a state or local government an easement to restrict development of your property,
you can deduct the resulting decline in value of your property. Your deduction can offset up to 50% of your adjusted gross
income. You can carry forward any excess for 15 years.
Constructive receipt
A concept of tax law that taxes income at the time you could have received it, even if you don't actually have it.
A paycheck you could pick up in December is considered constructively received and taxed in that year, even if you don't
get and cash the check until the following January. Also, interest paid on a savings account is considered constructively
received and taxable in the year it is credited to your account, regardless of whether you withdraw the money.
Consumer interest
See personal interest.
D
Damages
If you receive a settlement in a personal injury damage lawsuit that includes money for future medical expenses, the
amount is not taxable. But neither can you deduct those future medical expenses covered by the amount of the award
allocated to medical care.
Deductions
Expenses you are permitted to subtract from your taxable income before figuring your tax bill.
Dependent
Someone you support and for whom you can claim a dependency exemption on your tax return.
Depreciation
A deduction to reflect the gradual loss of value of business property as it wears out. The law assigns a tax life to various
types of property, and your basis (cost) in such property is deducted over that period of time. See Accelerated
Depreciation.
Direct transfer
A method to move funds from one individual retirement account (IRA) or Keogh plan to another or from a company plan to
another company plan or an personal IRA.
E
Earned income
Compensation, such as salary, commissions and tips, you receive for your personal services. This is distinguished
from "unearned" income from investments such as interest, dividends and capital gains.
Earned income credit
If your adjusted gross income is below a certain level, you may be able to claim the earned income credit,
which can wipe out your income tax bill and could give you a refund of part of the Social Security taxes
you paid. The exact credit amount depends on your income level, as well as how many qualifying children you have.
Education Credits
Education interest
A type of tax credit available to students of a post-secondary educational institution, such as a college or university.
Education credits may be claimed by those who incur qualifying educational expenses, such as tuition and fees. Parents
who pay these expenses for their children may be able to claim this type of credit on their tax returns, subject to certain
income restrictions.
Elderly or disabled credit
This credit is for low-income taxpayers age 65 or older at the end of 2010, or those who are retired on permanent and
total disability. This is not an automatic credit for seniors; in fact, relatively few taxpayers qualify for it.
Electronic filing
The fastest way to get your tax return (or a request for an extension of time to file) to the IRS (and state revenue office).
The majority of returns are now filed electronically, including tens of millions from home computers.
Enrolled agent
A tax preparer who, by virtue of passing a tough IRS test or prior IRS work experience, can represent clients at IRS audits
and appeals.
Estate tax
A tax levied on the net value of the estate of a deceased person before distribution to the heirs.
Estimated tax
If you have income that's not subject to withholding, such as investment or self-employment income or taxable retirement
plan distributions, you may have to make quarterly payments of the estimated amount needed to cover your expected tax
liability for the year.
Excess Social Security tax withheld
If you hold more than one job during the year - either at the same time or successively - too much Social Security could be
withheld from your pay. Each employer is required to withhold the full tax rate. But no taxpayer has to pay the full tax on
more than the annual limits. If wages from two jobs pushes you over the limit, too much tax will be withheld. You get a credit
for the excess when you file your tax return for the year.
Exemptions
You can claim a personal exemption for yourself. On joint returns, a personal exemption is claimed for each spouse.
You also get an exemption for each dependent you claim on your return.
Expensing
Also known as the Section 179 deduction, expensing lets you deduct in full up to a certain amount worth of business
expenditures that normally would be depreciated over a number of years.
F
Fellowships
See scholarships and fellowships.
FICA
The Federal Insurance Contribution Act tax that pays for Social Security and Medicare is split 50/50 between employers and
employees.
Filing status
Your status determines the size of your standard deduction and the tax-rates that apply to your income. For tax purposes,
you are considered single, married filing jointly, married filing separately, head of household or qualifying widow or
widower.
Flexible spending account
See reimbursement account.
Forgiven debt
See cancelled debt.
G
Gift tax
A gift tax is a federal tax applied to an individual giving anything of value to another person. For something to be considered
a gift, the receiving party cannot pay the giver full value for the gift, but may pay an amount less than its full value.
It is the giver of the gift who is required to pay the gift tax.
Gross income
All of your income from taxable sources, before subtracting any adjustments, deductions or exemptions.
H
Head of household
A filing status with lower tax rates for unmarried or some married persons considered unmarried (for purposes of this
filing status) who pay more than half the cost of maintaining a home, generally, for themselves and a qualifying person,
for more than half the tax year.
Health Savings Account
A Health Savings Account (HSA) is an account created for individuals who are covered under high-deductible health plans
(HDHPs) to save for medical expenses that HDHPs do not cover.
Hobby-loss rule
One requirement for deducting business losses is that you show you are trying to make a profit. The law presumes you're
in business for profit if you report a taxable profit for three years out of any five-year period (or two out of seven years
if you're into breeding, showing or racing horses). Otherwise, your activity is assumed to be a hobby, unless you can prove
otherwise. The distinction is important because if the expenses of a hobby exceed the income, the difference is considered a
personal expense, not a tax-deductible loss.
Home office expenses
Expenses incurred from the operation of a business or the performance of employment-related activities within your residence.
To be able to deduct home office expenses, an individual must spend at least half his or her time working at home.
Home sale profit
For many people, their homes are their greatest assets - ones that they might plan on selling someday to relocate to another
part of the country, upgrade to a larger home or help finance retirement. Unless you've sold a home over the past few years,
you may not realize that revisions in the tax code could impact how much you end up with after the sale. Learn how the newest
tax laws will affect you if you decide to move.
Hope credit
See education credits.
Holding period
The period of time you own an asset for purposes of determining whether profit or loss on its sale is a short- or
long-term capital gain or loss. Sales of assets owned one year or less produce short-term results. The sale of assets
owned more than 12 months produces long-term results. The holding period begins on the day after you purchase an asset
and ends on the day you sell it. If you buy on January 4, for example, your holding period begins January 5. If you sell
the following January 4, you have owned the asset for exactly one year ... and are stuck with short-term treatment. To
be eligible for the gentler long-term tax treatment, you'd need to hold on until January 5, so that you have owned the
asset for more than one year. See capital gain.
Home-equity loans
Debt secured by your principal residence or second home - such as a second mortgage or home-equity line of credit -
that is not used to buy, build or substantially improve the property.
Household employee
If someone works in your home - as a child-care provider, for example, or housekeeper or gardener - as your employee
(rather than as an independent contractor or an employee of a service company), you may be responsible for paying Social
Security and Medicare taxes for the employee. This is also sometimes called the "nanny tax."
I
Imported drugsThe cost of prescription drugs imported from Canada or any other foreign country is not deductible.
Imputed interest
Interest you are considered to have earned - and therefore owe tax on - if you make a below-market-rate loan. The term is
also used to refer to the interest income you must report on taxable zero-coupon bonds. Although the bonds pay no interest
until maturity, you must report and pay tax on the interest as it accrues.
Incentive stock option
An option that allows an employee to purchase stock of the employer below current market price. For regular income tax
purposes, the "spread" or "bargain element" - the difference between the price paid and market value of the stock - is
not taxed when the option is exercised. Rather, it is taxed when the stock is sold. For alternative minimum tax purposes,
however, the spread is taxed in the year the option is exercised.
Indexing
An adjustment to prevent inflation from eroding certain tax benefits including standard deductions, exemption
amounts, and the beginning and end of each tax bracket. These are automatically adjusted annually based on increases
in the consumer price index (CPI).
Individual 401(k) plan
The 401(k) rules now allow a self-employed person with no employees (other than his or her spouse) to use a 401(k) plan to
sock away - and deduct - far more for his or her retirement than in the past.
Individual retirement account
An individual retirement account is an investing tool used by individuals to earn and earmark funds for retirement savings.
There are several types of IRAs as of 2016: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs. Sometimes referred to as
individual retirement arrangements, IRAs can consist of a range of financial products such as stocks, bonds or mutual funds.
Innocent-spouse rules
Tax rules designed to protect married taxpayers who file joint returns from being held responsible for taxes due to
erroneous actions by their spouses - such as failing to report income or claiming unsubstantiated deductions.
Basically, if you can show that you didn't know and didn't have reason to know about an error that resulted in the
underpayment of tax on the joint return, you can be relieved of responsibility for that underpayment. You have two years
from the time the IRS begins trying to collect the underpayment to petition for innocent-spouse relief.
Installment sale
With an installment sale, you agree to have the purchaser pay you over a number of years, and you report the profit on
the sale as you receive the money instead of all at once in the year of the sale.
Investment interest
Interest paid on loans used for investment purposes, such as to buy stock on margin. You can deduct this interest on
Schedule A if you itemize, up to the amount of investment income (not including capital gains or dividends that qualify for
preferential tax rates) you report.
Itemized deductions
See deductions
J
Job-hunting costs
The costs of looking for a new job in your same line of work are deductible. Qualifying expenses include the cost of
want ads, employment-agency fees, printing and mailing resumes, and travel expenses such as transportation, lodging,
and 50% of food, if your job hunting takes you away from home overnight. This write off is a "miscellaneous expense",
deductible to the extent that all your miscellaneous expenses exceed 2% of your adjusted gross income.
Job-related education
The cost of education that maintains or improves skills you use on the job, or that is required to maintain your job is
deductible. Education that qualifies you for a new trade or business, such as law school, is not eligible for this deduction.
Job-related move
See moving expenses.
Jury duty pay forfeited to employer
Jury fees you are required to turn over to your employer - in exchange for your salary continuing while you do your
civic duty - are deductible. This will offset the jury fee income you are required to report if the money only passes
through your hands.
K
Kiddie cards
A reference to the Social Security cards needed by any child you claim as a dependent on your tax return.
The nine-digit identifying number shown on the card must be reported on the tax return of the parent who claims the child
as a dependent. What if a child is born late in the year, and you haven't received a Social Security number by the time
you're ready to file? The IRS says you must delay filing, even if it means getting an extension to file past the April 15
deadline. If you claim a dependent and fail to include the number, the exemption will be rejected and your tax bill hiked
accordingly.
Keogh Plan
A Keogh plan is a tax-deferred pension plan available to self-employed individuals or unincorporated businesses for
retirement purposes. A Keogh plan can be set up as either a defined-benefit or defined-contribution plan, although
most plans are defined as contributions. Contributions are generally tax deductible up to a certain percentage of
annual income with applicable absolute limits in U.S. dollar terms, which can be changed from year to year by the U.S.
Internal Revenue Service (IRS).
L
Lifetime Learning Credit
See education credits.
Like-kind exchange
The tax-free exchange of similar assets, such as real estate for real estate. The tax on profit accrued on the
first property is deferred until the subsequent property is sold.
Limited partnerships
Investments - in real estate and oil and gas, for example - that pass both profits and losses on to investors.
By definition, limited partnerships are passive investments, subject to the passive-loss rules.
Listed property
"Listed property" is the term used for depreciable assets that Congress has put on a special list for special scrutiny
by the IRS. Basically, this includes things Congress worries you might use for personal as well as business purposes -
a car, computer, boat, airplane and photographic and video equipment. (If a computer or photographic or video equipment
is used exclusively at your regular place of business, however, it is not considered listed property.) There are special
restrictions on the depreciation of listed property if business use does not exceed 50%. And IRS can deny deductions if
you can't document the business usage of listed property.
Long-term care insurance premium
Premiums paid for long-term care insurance can be deducted as a medical expense.
Long-term gain or loss
See capital gain or capital loss.
Lump-sum distribution
The payment within one year of the full amount of your interest in a pension or profit-sharing plan. To qualify as a
lump-sum distribution - and potentially for favorable tax treatment - other requirements must be met.
Luxury-car rules
Special rules restrict the depreciation write offs businesses can claim on vehicles. Basically, Congress doesn't want to
be subsidizing opulent luxury cars when less expensive vehicles can adequately serve the purpose of getting workers
from point A to point B.
M
Margin interest
See investment interest
Marginal tax rate
The share of each extra dollar of income that will go to the IRS. It's not necessarily the same as the rate in your
top tax bracket because, in many cases, rising income squeezes the value of tax breaks. The extra income is effectively
taxed more harshly than advertised. Knowing your marginal rate tells you how much of each additional dollar you make will
go to the IRS and how much you'll save for every dollar of deductions you claim.
Marital deduction
A tax deduction that allows an individual to transfer some assets to his or her spouse tax free, creating a reduction in
taxable income. A marital deduction is mainly used for the purposes of estates and gifts.
Market discount
The difference between what you pay for a bond and its higher face value. The tax treatment varies depending on whether
the bond is taxable or tax-free and whether you redeem it at maturity or sell it before that time.
Master limited partnerships
Similar to regular limited partnerships, but MLPs shares are traded on the major exchanges, making for a much more
liquid investment. Although limited-partnership losses are considered passive, income from an MLP is considered
investment income rather than passive income. That means passive losses can't be used to shelter MLP income.
Material participation
The test used to determine whether you are involved enough in a business to avoid the passive-loss rules.
To be considered a material participant, you must be involved on a "regular, continuous and substantial basis."
One way to pass the test is to participate in the business for more than 500 hours during the year.
Medicare tax
An employee's earnings that are subject to a U.S. payroll tax known as the "Medicare tax." Similar to the other U.S.
payroll tax - Social Security - the Medicare tax is used to fund the government's Medicare program, which provides
subsidized healthcare and hospital insurance benefits to retirees and the disabled. Medicare and Social Security taxes
are levied on both employees and employers.
Midmonth convention
The rule that treats certain kinds of depreciable property, including real estate, as though it were placed in service
in the middle of the month it was first used.
Midquarter convention
In general, business property is depreciated under a midyear rule that allows half a year's depreciation
for the first year, whether you buy property in January or December. However, if you buy more than 40% of the business
property you put into service for the year during the fourth quarter, the midquarter convention takes over.
With it, you depreciate each piece of property as though it were placed into service in the middle of the calendar
quarter in which it was purchased. You claim just six weeks' worth of depreciation for property put in service during
the final quarter, for example.
Mileage rate
See standard mileage rate.
Mortgage interest
A term often used to refer to deductible interest paid on debt that qualifies as acquisition indebtedness or
home-equity debt.
Moving expenses
Some of the costs of moving in connection with taking a new job are deductible. To qualify for the deduction, the new job
must be at least 50 miles farther from your old home than your old job was. Deductible expenses include
the cost of moving your household goods, as well as travel and lodging expenses for you and your family.
If you moved to take your first job, the 50-mile test applies to the distance between your old home and your
new job. You can take this deduction even if claim the standard deduction rather than itemizing deductions on your return.
Multiple-support agreement
An agreement under which two or more taxpayers, who together provide more than half the support for someone else,
agree that one will claim that person as a dependent and the others will not.
N
Nanny tax
See household employee.
Net operating losses
Net operating losses from your business generally are carried back for two years (triggering a refund of
taxes paid) unless you specifically elect to carry them forward to future tax years.
Net unrealized appreciation (NUA)
NUA comes into play if you take a total payout from a company retirement plan that includes appreciated stock of
the company for which you work. Rather than make a tax-free rollover of the entire amount to an IRA, you can roll the
employer stock into a taxable account and owe tax only on the stock's value when you acquired the shares.
The net unrealized appreciation that accrued while the stock was inside the plan will not be taxed until you ultimately
sell the stock. At that point, the profit can qualify for special long-term capital gain treatment. If you rolled the
stock into an IRA, the tax would be delayed until you withdrew the money from the IRA, but all appreciation would be
taxed as ordinary income when withdrawn, at your top tax rate.
Nonbusiness bad debt
A bad debt not connected with your trade or business. An uncollectible loan to a friend or a deposit to a
contractor who becomes insolvent are examples. If your efforts to collect the debt are unsuccessful, a nonbusiness bad
debt is deductible as a short-term capital loss in the year the debt becomes entirely worthless.
Noncash contributions
You can deduct as a charitable contribution the full fair-market value of assets that you have owned for more than a
year before you donate them to charity. The deduction for assets owned one year or less is limited to your tax basis,
which is generally what you paid for the property.
Nonqualified stock options
Options to purchase company stock that are granted to employees as compensation but do not meet restrictions necessary
to qualify as incentive stock options. (See Incentive stock option.) There is no tax consequence when
the options are granted but when employees exercise the options to purchase stock, the "spread" or "bargain element" -
the difference between purchase price and the stock's value - is taxed as additional compensation.
O
Out-of-pocket contributions
Expenses you incur while working for a charity - from the cost of driving your car to the cost of stamps for a
charitable fundraiser - can be included in your charitable contribution deduction. Treat the cost as a cash
contribution to the charity.
Original issue discount (OID)
The amount by which the face value of a bond exceeds its issue price. Part of the discount on taxable bonds must be
reported as taxable interest income each year that you own the securities.
P
Passive-loss rules
A set of rules that prohibits using passive losses to offset earned or ordinary income. Passive activity loss rules prevent
investors from using losses incurred from income-producing activities in which they are not materially involved.
Being materially involved with earned or ordinary income-producing activities means the income is active income and may not be reduced by passive losses. Passive losses can be used only to offset passive income.
Personal exemption
See exemptions.
Personal interest
Basically, this is interest that doesn't qualify as mortgage, business, student loan or investment interest.
Included is interest you pay on credit cards, car loans, life insurance loans and any other personal borrowing
not secured by your home. Personal interest cannot be deducted.
Points
In connection with getting a home mortgage, each point is equal to 1% of the mortgage amount. Points paid on a
mortgage to buy or improve your principal residence are generally fully deductible in the year you pay them.
You get to deduct the points even if you convince the seller to pay them for you, as long as you paid enough cash at
closing - as a down payment, for example - to cover the points. Points paid to refinance the mortgage on a principal
home or to buy any other property must be deducted over the life of the loan.
Portability
An employee's ability or right to retain certain benefits when switching employers. Benefits such as certain pension
plans and health insurance have portability. Most 401(k) plans have portability of benefits, as well as health savings
accounts (HSAs).
Preference items
Tax breaks allowed under the regular income tax but not under the alternative minimum tax, including the deduction of
state and local taxes and interest on home-equity loans. One that is becoming more and more important to more and
more taxpayers is the "spread" between the exercise price and the value of stock purchased with incentive stock options.
Although that amount is not taxed under the regular tax, it is a preference item subject to tax if you're hit by the AMT.
Prizes and awards
The value of a prize or award is generally taxable, so if you win the lotto, Uncle Sam is a winner, too.
One exception is that certain non-cash employee awards - the proverbial gold watch, for example - can be tax-free.
Premature distribution
Any distribution taken from an IRA, qualified plan or tax-deferred annuity that is paid to a beneficiary that is
under age 59.5. Premature distributions are subject to a 10% early-withdrawal penalty by the IRS as a means of
discouraging savers from spending their retirement assets prematurely.
Property taxes
See real estate taxes.
Q
Qualified plan
An employee benefit plan - such as a pension or profit-sharing plan - that meets IRS requirements designed to protect
employees' interests.
R
Real estate taxes
Real estate taxes you pay are deductible. You can deduct state and local property taxes paid on any number of
personal residences or other real property you own. There is no limit as there is with mortgage interest.
Recapture of depreciation
When you depreciate investment real estate, your tax basis declines. To the extent that profit when you sell is due to the reduced basis (rather than appreciation), the law recaptures part of the depreciation tax break by taxing that part of your profit.
Reimbursement account
A fringe benefit, sometimes called a flexible spending account or salary reduction plan, that allows an
employee to divert some of his or her salary to a special account that is used to reimburse the employee
for medical or child-care expenses. Funds channeled through the account escape federal income, Social Security
taxes and state income taxes.
Rollover
A rollover occurs when reinvesting funds from a mature security into a new issue of the same or a similar security;
transferring the holdings of one retirement plan to another without suffering tax consequences; or moving a forex
position to the following delivery date. The distribution from a retirement plan is reported on IRS Form 1099-R and
may be limited to one per annum for each IRA. The forex rollover fee arising from the difference in interest rates
between the two currencies underlying a transaction is paid to the broker.
Roth 401(k)
A Roth 401(k) is an employer-sponsored investment savings account that is funded with after-tax money up to the
contribution limit of the plan. This type of investment account is well-suited to people who think they will be in a
higher tax bracket in retirement than they are now. The traditional 401(k) plan is funded with pretax money which
results in a tax levy on future withdrawals.
Roth IRA
Named for Delaware Senator William Roth and established by the Taxpayer Relief Act of 1997, a Roth IRA is an individual
retirement plan (a type of qualified retirement plan) that bears many similarities to the traditional IRA. The biggest
distinction between the two is how they're taxed. Since traditional IRAs contributions are made with pretax dollars,
you pay income tax when you withdraw the money from the account during retirement. Conversely, Roth IRAs are funded
with after-tax dollars; the contributions are not tax deductible (although you may be able to take a tax credit of
10 to 50% of the contribution), depending on your income and life situation). But when you start withdrawing funds, these
qualified distributions are tax free.
S
S corporation
Named after the subchapter of the tax law that authorizes it, an S corporation generally pays no tax because
profits and losses are passed on and taxed to the shareholders.
Sales taxes
State and local sales taxes you pay may be deductible. But you must choose between deduction sales taxes or
deducting city and state income taxes. If you live in a state that does not impose an income tax, claim the
sales tax deduction. You don't need to keep all your receipts, either. The IRS has a handy table with estimates
based on your income, family size, and where you live. You can add to the table amount sales taxes paid on cars,
boats, aircraft, and other big ticket items. Purchase of such items could lead some taxpayers in income-tax
states to pay more sales tax than income tax. You can choose whichever deduction is most valuable to you.
Salary reduction plan
See
Scholarships and fellowships
Scholarships and fellowships received by degree candidates to cover tuition, fees, books and supplies are
generally tax-free. But amounts for room and board are taxable.
Section 179 deduction
See expensing.
SECA
A form of taxes that self-employed business owners must pay based on their net earnings from self-employment. Self Employed
Contributions Act Tax (SECA Tax) was first imposed by the SEC Act of 1954.
Similar to the Federal Insurance Contributions Act Tax (FICA Tax) that employees pay, the payments fund Social Security, Old Age Survivors and Disability Insurance (OASDI) and Medicare programs.
Self-employed health insurance premiums
Premiums paid by a self-employed person for medical insurance for yourself, your spouse, or dependents can be deductible,
even if you don't itemize deductions.
SEP
A simplified employee pension (SEP) is a retirement plan that an employer or self-employed individuals can establish.
The employer is allowed a tax deduction for contributions made to the SEP plan and makes contributions to each eligible
employee's SEP IRA on a discretionary basis.
Short sale
The sale of borrowed stock, usually with the hope that the stock price will fall. If it does, the investor profits
by repaying the loan with shares purchased at the lower price. If the stock price increases, the investor loses and
has to repay the loan with shares that cost more than those sold. As far as the IRS is concerned, the transaction
doesn't count for tax purposes until the investor delivers stock to the lender to close the sale.
Short-term gains and losses
See capital gain or capital loss.
SIMPLE
A retirement plan that may be established by employers, including self-employed individuals. The employer is allowed a
tax deduction for contributions made to the SIMPLE. The employer makes either matching or non-elective contributions to
each eligible employee's SIMPLE IRA and employees may make salary deferral contributions.
Social Security tax
See FICA.
Social Security Tax, excess withheld
When one or more employers withhold more than the aggregate maximum amount of Social Security and/or railroad retirement
contributions that should have been withheld from a single taxpayer during a taxation year.
Excess employer withholdings are reported on line 67 of Form 1040, and all Copy Bs of the taxpayer's W-2s must be filed with Form 1040.
Spousal IRA
A type of individual retirement account that allows a working spouse to contribute to a nonworking spouse's
retirement savings. A spousal IRA creates an exception to the provision that an individual must have earned
income to contribute to an IRA. The working spouse's income, however, must equal or exceed the total IRA
contributions made on behalf of both spouses.
Standard deduction
A no-questions-asked write-off that reduces taxable income, the amount of which varies depending on your filing status.
Standard deduction for a dependent
If you can claim a child as your dependent on your tax return, the child may not claim a personal exemption on his
or her tax return. But, if the child files a tax return, he or she still gets a standard deduction, the amount,
depends on how much money they earn and the source of that income.
Standard mileage rate
A set rate the IRS allows for each mile driven by the taxpayer for business, charitable, medical or moving purposes.
The standard mileage rate can be taken in lieu of actual expenses incurred when calculating deductible automobile
expenses related to any of the four activities above.
Stepped-up basis
The basis of inherited property is stepped up to its value on the date of death of the owner, or a slightly later
date if chosen by the executor of a taxable estate. In other words, tax on any appreciation during his or her
lifetime is forgiven. The heir uses the higher basis to figure his or her gain when the property is ultimately
sold. If the value of property declined while it was owned by the decedent, the basis is stepped down to date of
death value.
Student loan interest deduction
A tax deduction for interest paid on higher education loans during the tax year in the U.S.
T
Taxable income
This can mean different things. It can refer to income that is taxable (such as wages, interest and dividends) rather
than tax-exempt (such as the interest on municipal bonds). On tax returns, "taxable income" is your income after
subtracting all adjustments, deductions and exemptions - that is, the amount on which your tax bill is computed.
Tax bracket
A tax bracket refers to a range of incomes that are subject to a certain income tax rate. In most income tax systems,
low incomes fall into tax brackets with relatively low income tax rates, while higher earnings fall into brackets
with higher rates. Tax brackets help create progressive income tax schedules.
Tax-exempt interest
Interest paid on bonds issued by states or municipalities that is tax-free for federal income tax purposes.
Although you must report this income on your return, it is not taxed. Note that some interest that is exempt from
the regular tax is taxed by the Alternative Minimum Tax.
Tax-free income
Tax free refers to certain types of goods and/or financial products (such as municipal bonds) that are not taxed and
with earnings that are not taxed. The tax free status of these goods and/or funds may incentivize individuals and
business entities to increase spending or investing, resulting in economic stimulus. Governments will often provide a
tax break to investors purchasing government bonds to ensure that enough funding will be available for expenditure projects
Taxpayer advocate
The official inside the IRS who is charged with helping individuals resolve their problems with the IRS,
as well as identifying changes in IRS procedures that could make the agency more taxpayer-friendly. This
official oversees IRS Problem Resolution Officers (PRO) around the country. You should go to a PRO, or
ultimately the Advocate, if you are getting the run-around - or worse - from regular IRS channels.
More on the Taxpayer Advocate Service
Tax preference item
See preference items
Traditional IRA
See IRA.
Tuition credit
See
U
Unearned incomeIncome from investments, such as interest, dividends and capital gains. See
Underpayment penalty
The penalty is the IRS's not-so-subtle reminder that taxes are due as income is earned, not just on April 15 of the
following year. Basically, it works like interest on a loan, with the penalty rate applied to the amount of
estimated tax due but unpaid by each of four payment dates during the year. The penalty rate is set by the IRS
and can change each quarter. It was 3% at the beginning of 2014. There are several exceptions to the penalty.
See estimated tax.
V
Vacation home
Special tax rules apply if you rent out a vacation home, and the rules differ depending on how much you use the
home personally. While all rental income is to be reported, the deductibility of expenses can be limited if you
engage in "too much" personal use - generally defined as using the home for more than 14 days during the year or
more than 10% of the number of days it is rented for fair market rent.
Vested benefits
A vested benefit is a financial incentive of employment that an employee is fully entitled to. Employers sometimes
offer their employees benefits that they acquire full ownership of gradually or suddenly, as they accumulate more
time with the company. This process is called graduated vesting or cliff vesting, and its purpose is to give
employees a reason to stay with the company long term. When the employee has earned full rights to the incentive
after a predetermined number of years of service, those benefits are called fully vested.
Voluntary withholding
You can ask the Social Security Administration to withhold taxes from your social security benefits. This could make
sense if withholding allows you to avoid making quarterly estimated tax payments. To request voluntary withholding,
file form W-4V with Social Security. You can also ask a retirement plan sponsor to withhold from payouts from IRA
distributions.
W
Wage base
Also known as the Social Security Wage Base, this base is the maximum amount of earned income upon which employees
must pay Social Security taxes. Generally, the employee's gross wages will be equal to the taxable wage base. And
typically an employee's employer will handle this calculation and withold the correct amount of taxes from each
paycheck, but the employee is still responsible for reporting the tax.
Wash sale
The sale of stocks, bonds or mutual fund shares for a loss when, within 30 days before or after that sale, you buy
the same or substantially identical securities. The law forbids the deduction of the loss.
Withholding
The amount held back from your wages each payday to pay your income and social security taxes for the year.
The amount withheld is based on the size of your salary and the W-4 form you file with your employer.
Worthless security
If a stock you own becomes completely worthless during the year, you can claim a capital loss as though you sold the
stock for $0 on December 31 of the year the stock became worthless.
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