If you want to prepare and file your own tax return, you’re not alone. More than 27 million people did their own taxes[1] in 2014, a nearly 6 percent increase from the year before.
However, joining the 27 million-person-strong tax preparers and filers around the United States doesn’t mean that understanding your taxes is easy. Taxes can be daunting, especially if you don’t know the terms.
To help, here’s a list of 10 tax terms that you need to know if you’re doing your taxes yourself this year.
Adjusted Gross Income
Your adjusted gross income (AGI),[2] sometimes referred to as gross income, refers to all the income you’ve received in the year. This includes income you’ve earned, such as wages and income you may have received because of owning stocks, bonds or money market accounts. Interest, dividends and capital gains all fall into this category.
The “adjusted” part of AGI comes in because you can subtract certain items from the income you’ve received. Contributions to an IRA, for example, might be subtracted, along with alimony costs. Be sure to read the fine print for what you can subtract. AGI is an important step in determining how much you owe.
Tax Deductions
Deductions are amounts of money that you can subtract from your AGI. They come in two forms: standard and itemized. The key to deductions is that they lower your AGI so that you do not have to pay as much tax. In general, the lower your income, the less tax you have to pay. So if, for example, you’ve earned $40,000 in a year and have a $9,000 tax deduction, you’ll only pay tax on $31,000, not the entire $40,000.
The Internal Revenue Service (IRS) lists a certain number of deductions right on the Form 1040A or longer and more detailed Form 1040. These include student loan interest, deductible individual retirement accounts contributions, alimony payments and moving expenses.
Standard Deductions
The IRS is the agency that determines tax code. Every year, all tax filers get a standard deduction. The standard deduction is an amount that you can deduct from your AGI to lower your taxes. The amount of standard deduction for the year will be given in the IRS instructions for 1040 and 1040A. The standard deduction depends on your income and is usually given in a table. The IRS adjusts this figure every year for inflation.
Itemized Deductions
You can deduct items such as mortgage interest, state, local and property taxes, medical expenses, travel expenses if for work or medical needs, charitable contributions, casualty and theft losses and more from your AGI as well.
Note that in some states, medical expenses must exceed a certain percentage of your AGI. It’s a good idea to keep track of your expenses[3] so you know what your medical expenses, including health insurance deductibles, totaled for the year. These are called “itemized deductions” because they need to be itemized, on Schedule A of Form 1040.
If your itemized deductions equal more than the IRS’s standard deduction in a given year, it’s good tax news for you, as you’ll have to pay tax on less of your AGI. You can take itemized deductions or the standard deduction in a given year, not both. Be sure to read the fine print about what’s allowed as an itemized deduction and how much.
Exemption
An exemption is an amount the IRS allows you to subtract from income to reflect people who share your household and may depend on you for income. You can take exemptions, for example, for yourself, any dependents and your spouse. A fixed amount of money is provided for every exemption. You’ll subtract the amount of all exemptions, including for yourself, from your AGI to arrive at your taxable earnings.
Withholding
Withholding refers to the amount of money taken out of your wages or other income as you earn it, but before you get your paycheck. Paycheck stubs will list the amount of withheld money and what it’s for. Employers withhold taxes for Federal, state and local tax, as well as Social Security.[4] The withholdings go to your tax accounts. For example, your Federal taxes go into an IRS account.
When you calculate your taxes, you’ll arrive at the taxes you owe for the year. The final step is to subtract any taxes that have already been withheld. These are given on your W-2 and other income forms. If you owe $10,000 in Federal tax, for example, and have had $9,800 in Federal tax withheld from your paycheck, you’ll owe just $200 when you file. If you owe $10,000 in Federal tax and you have $10,100 withheld, you’ll receive a Federal tax refund of $100.
Tax Credits
You can compare tax credits to credits from a store. After you calculate your tax bill, you can use tax credits to reduce the amount you owe.[5] They’re more valuable to the individual taxpayer than deductions because they reduce the amount of tax itself, rather than just the amount of taxed income.
If you have a $1000 tax credit and owe $10,000 in taxes, you’ll end up owing $9,000 instead. You may receive tax credits for some educational programs and home solar power installation, for example. These are revised every year, so be sure to read the IRS’s information about available tax credits carefully.
Taxable Income
Taxable income refers to your total before tax — or gross — income with every allowable deduction, exemption and adjustment subtracted. Taxable income is the final step in determining how much you owe in taxes.
Basis
If you have stocks, you’ll need to know its basis. Any asset’s basis is the value original paid for it. If you’ve sold stocks this year, you’ll need to know what you paid originally, in order to calculate the gain or loss upon sale. You’ll then use those gains or losses to calculate your tax.
Capital Gains
Capital gains refer to any profit you made from selling a capital asset. Real estate, stocks and bonds are all examples of capital gains. You’ll have to pay capital gains tax on the profit from sale. If you sold at a loss, the loss can generally be deducted.
Doing your taxes yourself may seem like a daunting task, but understanding the language is half the battle. Now you’re ready to get a head start on tax season!
Reference
| [1] | ^ | USA Today: IRS: More Americans filing taxes on their own |
| [2] | ^ | Bankrate: 10 Key tax terms to know |
| [3] | ^ | Fort Bragg: Budgeting |
| [4] | ^ | HodgsonRuss: State & Local Tax |
| [5] | ^ | FOX: 10 Key Tax Terms to Know |
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Source: lifehack.org
