Important Tax Terms

For every person that files their taxes each year, it should be clear that comprehending your own tax return can sometimes be difficult but is still crucial.  It is important to understand the relevant tax terms so that no mistakes are made because you didn’t understand the return.  Some common tax terms are presented below that are key to know, even in the case where you have hired any one of many tax professionals to complete your return.    

Adjusted Gross Income:  Adjusted gross income is also abbreviated as AGI.  This is calculated by starting with your total gross income then minus your deductions.  Your AGI is dollar amount used to determine your tax liability and as an income level marker for other types of benefits.     

Deduction:  A deduction is an allowable expense that reduces your AGI.  The IRS determines the allowable tax deductions, and they change slightly from year to year.  By lowering your AGI, you also lower your tax liability.  The IRS allows a standard deduction for everyone that files a tax return.  The other option is to itemize deductions, providing that the total amount of the deductions will be a greater amount verses the preset standard deduction for relevant filing status.   

Standard Deduction:  The IRS sets a preset amount that may be used to lower the AGI, which is based on the filing status of the tax return.  The standard deduction increases according to the inflation rate.  The majority of tax payers take their allowed standard deduction rather than itemizing their deductions.      

Itemized Deduction:  The IRS determines each year which expenses may be used as deductions to lower your AGI.  Several common expenses that are deductible every year include charitable contributions, mortgage interest, medical expenses and property taxes.  In most cases, you cannot itemize deductions if the total is lower than your standard deduction. 

Exemption:  The IRS legally allows part of your income to avoid taxation through an exemption.  The most common exemption is based on how many individuals are dependant on you, including yourself, any dependants (not just children), and your spouse.  Every exemption has a dollar amount that reduces your tax liability.     

Taxable Income:  The IRS cannot tax every dollar you make.  They are only legally able to tax you based on your calculated taxable income.  Taxable income is your AGI minus your deductions and claimed exemptions.    

Withholding:  Every time you are paid by your employer, and part of your check is taken for taxes.  This is called withholding.  It is this process that prevents you from paying a large lump sum in taxes to the IRS once a year.  All the withheld taxes are deposited into an account with the IRS on your behalf.  At the close of the fiscal year, you are issued a credit in the amount of the taxes which you have already paid.  If you did not pay enough into your IRS account, you might still have to pay.  Or, you might receive a refund if you overpaid.