One reason taxes are so confusing is that they have their own language. You've got all the forms and instructions, but it seems they're harder to decipher than that first lesson in your high school Latin class. Here are 10 key tax terms to help you start talking taxes.
Key tax terms to know
- Tax credits.
- Tax deductions.
- Standard deduction.
- Itemized deductions.
- Tax exemption.
- Progressive taxation.
- Taxable income.
- Voluntary compliance.
Adjusted gross income, or AGI, is all the income you receive over the course of the year, including wages, interest, dividends and capital gains, minus things such as contributions to a qualified IRA, some business expenses, moving costs and alimony payments. AGI is the first step in calculating your final federal income tax bill.
2. Tax credits
Tax credits are much like credits you get from a store. After you calculate your tax bill, you can use the credit to reduce the amount of the check you must write to Uncle Sam. Tax credits are more valuable than tax deductions because they directly cut the amount of tax you owe, rather than reducing the amount of taxed income. A $200 credit, for example, will turn a $1,000 tax bill into only $800. A few credits could even give you a refund you weren't expecting.
3. Tax deductions
Tax deductions are expenses the Internal Revenue Service allows you to subtract from your AGI to arrive at your taxable income. In most cases, the lower your income, the lower your tax bill. If, for example, a single filer has income of $38,000 and $8,000 in deductions, then he would pay taxes on only $30,000. The IRS offers all filers a standard deduction amount (more on this later).
Some other deductions -- such as student loan interest, moving expenses, deductible IRA contributions and alimony payments -- also are listed directly on the 1040A or long Form 1040. The term "deductions" is most commonly associated with the itemized deductions (more on this later, too) that taxpayers who file Schedule A claim.
4. Standard deduction
This is a fixed dollar amount that taxpayers can subtract from their income. The standard deduction is available to all filers and is determined by the taxpayer's filing status. The amounts change each year because of inflation adjustments. You can find the current standard deduction levels listed on each of the 3 individual tax forms. Most taxpayers use this deduction method, which eliminates the need to itemize actual deductions such as medical expenses, charitable contributions and state and local taxes.