Pronto Tax School

Glossary of Tax Terms

Glossary of Tax Terms

 

A

 

Accelerated Cost Recovery System (ACRS) – A method of depreciation that allows for accelerated depreciation rates, i.e. taking more of the depreciation deduction in the earlier years of an asset’s useful life. Used on most types of property deployed for income-producing business ventures from the years 1981 to 1986. For assets placed into service after 1986, ACRS is replaced by the Modified Accelerated Cost Recovery System (MACRS).

Accelerated Depreciation – A type of depreciation that, unlike straight line depreciation, allows for faster write offs of asset expense by “front-loading” the depreciation deduction into the earlier years of an asset’s useful life.

Accountable Reimbursement Plan – An employer agreement to reimburse employees for business expenses incurred on the job that includes adequate record-keeping controls, so that the reimbursement can be easily tied to the expense that is being reimbursed.

Accrual Method of Accounting – An accounting technique whereby all income and all expenses are reported and deducted when they are incurred, as opposed to the cash method of accounting, which reports income when received and deducts expenses when actually paid.

Acquisition Debt – Any debt that is incurred to purchase, build, create, or construct either a principal residence or second home. Can include additions to an existing home. Up to $1,000,000 of acquisition debt is tax deductible on Schedule A.

Adjusted Basis – Term used to determine the “starting point” for calculating a taxpayer’s profit and loss when selling or exchanging a capital asset such as rental real estate. Ordinarily calculated like this: original cost of the asset, plus the cost of any capital improvements, minus the amount of depreciation or other deduction taken for the asset being sold.

Adjusted Gross Income (AGI) – Gross income of the taxpayer minus certain adjustments, such as educator expenses, student loan interest, IRA deductions. These adjustments are often referred to as above-the-line deductions, with “the line” being Adjusted Gross Income (AGI). AGI serves as a sort of “halfway point” for preparing a federal tax return.

Alimony – Payments made to an ex-spouse as required by a divorce decree or other written agreement. Deductible by the payer and a taxable income for the payee.

Alternative Minimum Tax (AMT) – A “parallel universe” tax system that disallows certain deductions for certain taxpayers, causing the taxpayer to pay more income tax than would be due under the normal federal income tax system. AMT is calculated on Form 6251.

Amended Return – Form 1040X, Amended Return, is filed to correct or change a federal tax return that was previously filed. California’s amended return form is a 540X.

Annuity – Commonly sold as “guaranteed income during retirement,” an annuity is a type of retirement payment distributed to an individual for a fixed period or the remaining life of the individual. Insurance companies are common payers of annuity income.

Appreciation in Value – Increase in the value of a property over time. When the property is then sold, the taxpayer is normally expected to pay income tax on the appreciation in value of the property.

Assignment – A legal transferring of property, rights, or interest to another person referred to as an assignee.

Audit – An examination of a taxpayer’s return by the taxing authority (IRS or FTB). An audit may be due to an underreporting of income, an exaggeration of deductions, or any number of other “questionable” factors that reduce income tax. Audits also occur randomly.

 

B

 

Balloon Payment – The final payment to a loan in one lump sum amount.

Basis – The amount that a taxpayer paid to acquire a property; a number that is used in computing capital gain or loss on the sale or exchange of a capital asset.


C

 

Cancellation of Debt – The release from debt granted by a creditor. Generally, cancelled debt must be reported as income, and will be subject to income tax.

Capital Asset – A piece of property that is subject to capital gain or loss tax treatment. A capital asset is used in the production of income. For example, a stock, bond, or piece of rental real estate.

Capital Gain or Loss – The amount of gain or loss realized from the sale of a capital asset.

Capital Gain Distribution – Most commonly, a mutual fund distribution that is paid as the result of the mutual fund obtaining capital gains income. Always classified as a long term capital gain or loss without regard to time period during which the taxpayer has owned the mutual fund.

Capital Loss Carryover – Any capital loss ineligible for deduction because it is in excess of the allowable yearly amount of $3,000 can be carried forward by the taxpayer to be used as a capital loss on income tax returns for future years.

Cash Method of Accounting – An accounting method that reports income when received, and claims deductions when expenses are paid.

Casualty Loss – A loss resulting from an unforeseen, accidental, or sudden event that may be tax deductible, if the loss amount exceeds 10 percent of the taxpayer’s Adjusted Gross Income.

Child and Dependent Care Credit – A tax credit that is available to taxpayers who pay for child care that is needed because the taxpayer (and spouse, if applicable) is working.

Community Income – The income earned by a couple when married whom are domiciled in a community property state.

Credit – A tax reduction that goes “dollar for dollar” against the tax that is owed and may also become refundable once tax liability reaches zero.

 

D


Deduction – An expense that can be used to reduce taxable income, and thereby reduce income tax.

Deferred Compensation – Income that may not taxable until the money is distributed, such as a 401k retirement plan.

Dependent – An individual who meets IRS guidelines to be listed as a dependent on a taxpayer’s tax return, enabling the taxpayer to claim an exemption deduction for the dependent person.

Depreciable Property – An asset that is business related or income producing and is considered having a useful in excess of one year, and can thus be depreciated for tax purposes.

Depreciation – The writing off or deducting of the cost of a depreciable property over a period of years.

Disaster Losses – A type of casualty loss that is the result of a storm or other natural disaster.

 

E

 

Earned Income – Compensation received for the performance of personal services.

Earned Income Credit – An anti-poverty tax credit that is part of a federal effort to assist low and middle income taxpayers who may be supporting dependent children.

Estimated Tax – Advance payments of income tax that is being incurred as income is being earned, usually paid in quarterly installments. For example, a self-employed taxpayer with a profitable business should make quarterly payments of estimated tax, to cover the tax liability that is attached to the business profit.

Exemption – A fixed deduction amount that is allocated to each and every taxpayer, excluding those who are to be claimed as a dependent by another individual. For tax year 2010, the exemption amount is a fixed amount of $3,650.

 

F

 

Fair Market Value (FMV) – The amount that a willing buyer pays to a willing seller in a circumstance in which neither of the parties is under compulsion to buy or to sell. Often used to determine the deduction that can be claimed for non-cash donations of property to charity.

Fiduciary – A person such as a trustee, executor, or guardian who manages property for another individual and is required to act in the best monetary interests of the owner of the property. For instance, a real estate agent has a fiduciary duty to obtain the seller the best price possible.

Fiscal Year – A designated 12-month span of time that ends on the last day of any month besides December. Businesses such as corporations may choose to use a fiscal year, rather than a calendar year, for accounting or tax purposes.

Foreign Earned Income Exclusion – The exclusion of up to $91,400 of foreign earned income, contingent upon the foreign residence or physical presence test being met by the taxpayer.

Foreign Tax Credit – A tax credit given to a taxpayer who pays income taxes to a foreign country or any U.S. possession, for income that is also being taxed by the U.S. federal government. In this way, the foreign tax credit helps a taxpayer avoid being taxed twice on the same income.

401(k) Plan – A pay deferment plan that is authorized by Section 401(k) of the Internal Revenue Code, in which a percentage of a taxpayer’s salary is withheld by the employer and placed into a separate, tax-deferred account that is not taxed until the money is withdrawn.

 

G

 

Gift Tax – Tax that may, in certain circumstances, be levied on the giver of any gifts that are in excess of $13,000-per-donee annually, although generally the tax can be avoided.

Gross Income – The total amount of income from all sources collected by a taxpayer.

Gross Receipts – Total business receipts reported by the self-employed taxpayer on the form Schedule C before the Cost of Goods Sold and any expenses/deductions are applied.

 

H

 

Head of Household – An unmarried individual, who has a dependent, termed a qualifying child, who has lived with him or her for over half the appropriate tax year and has also paid for over half of the household expenses. A Head of Household taxpayer is eligible for more favorable tax rates than a taxpayer filing Single.

Health Savings Account (HSA) – A tax-deferred savings account to which taxpayers can contribute, in order to build up savings to be used for medical expenses. Must follow extensive IRS regulations, and must be combined with a high-deductible health insurance plan.

Hobby Loss – A deduction from a taxpayer’s allowed for a taxpayer’s hobby expenses; a hobby loss deduction is always limited to the amount of hobby income collected for the year.

Holding Period – Term used to in defining the length of time an asset is held and owned, and this terms is used in the determination of whether the asset is of the short term or long term classification.

 

I

 

Incentive Stock Option (ISO) – A form of compensation whereby a company can give an employee the right to purchase stock in the company. So long as extensive IRS regulations are followed, the transaction obtains favorable tax treatment for both employer and employee.

Income in Respect of a Decedent (IRD) – Income earned by a deceased taxpayer, which is taxable to an estate or heir who receives the estate. For example, interest income earned from the bank account of a deceased taxpayer.

Independent Contractor – An individual who controls most aspects of his or work and is considered to be self-employed for tax purposes.

Individual Retirement Account (IRA) – A type of self-directed, tax-deferred retirement account in which up to $5,000 (or $6,000 if taxpayer is age 50 or older at the end of the tax year) can be contributed for 2010. The earnings placed into such an account accumulate tax free until the funds are disbursed, at which time they are taxed.

Installment Sale – A sale of property in which at least one payment is received by the seller after the end of the tax year. Often, installment sales are stretched out over a period of years, enabling the seller to pay tax on the sale price as the sale price is received.

Investment Interest – The interest on a debt incurred for investing purposes. For instance, margin interest charged by a broker who is lending money to a taxpayer so the taxpayer can buy stocks. Investment interest is in some cases deductible on Schedule A.

Itemized Deductions – Deduction that appear on Schedule A, such as mortgage interest, state and local income and sales taxes, medical expense deductions, charitable contributions, etc.

 

J

 

Joint Return – Tax return filed by a married couple the filing status Married Filing Jointly. All income, deductions, etc. are combined and the couple is treated as “one unit” for the purposes of taxation.

 

Joint Tenancy – The mutual ownership of a property by two individuals. Upon the expiration of one of the individuals, the remaining interest in the property passes to the survivor.

 

K

 

Kiddie Tax – A tax levied on investment income that is in excess of an annual floor ($1,900 for 2010) of a child under the age of 18, or under age 24 but not supporting themselves. The tax applied is based on the parent’s marginal tax rate for the corresponding tax year.

 

L

 

Like-Kind Exchange – A type of exchange in which similar assets or properties held for investment can be “traded” without income tax being due on the transaction. Governed by Section 1031 of the IRS code.

Lump-Sum Distribution – Those payments made to a taxpayer with one tax year of the amount in its entirety due to one who participates in a qualified retirement plan.

 

M

 

Material Participation Test – The set of rules used to determine whether or not an individual taxpayer is an active participant in a business activity. If individual is deemed to be a passive participant, losses and deductions from the activity may be limited or disallowed.

Miscellaneous Itemized Deductions – The itemized deductions on Schedule A that are related to work expenses, investment expenses, and certain other miscellaneous items. Deductions in this area of the Schedule A must be reduced by 2 percent of the taxpayer’s Adjusted Gross Income.

Modified ACRS (MACRS) – A method of accelerated depreciation applicable to depreciable assets placed in service after 1986.

Modified Adjusted Gross Income (MAGI) – A taxpayer’s Adjusted Gross Income, but increased by specified items, such as tax free foreign earned income and IRA contributions. MAGI is used in calculating certain certain phase outs for deductions and credits.

Mortgage Interest – The interest paid on a home mortgage loan, normally 100 percent deductible as an itemized deduction on Schedule A of the federal tax return.

 

N

 

Net Operating Loss (NOL) – A taxpayer’s business loss that exceeds business income for the tax year, and may be carried back and used as a deduction against income of prior years, and also, in certain circumstances, may be carried forward as a deduction against future income.

 

O

 

Ordinary and Necessary – In order to be deductible as a business expense, the expense must be “ordinary and necessary” for the conduct of the business in question.

Ordinary Income – Generally, any income that is not capital gains, qualified dividends, or other income specially categorized for tax purposes.

 

P

 

Partnership – A business or income producing entity that is unincorporated and includes two or more individuals as owners. Partnership income, expenses, and deductions are “passed through” to the individual owners’ tax returns, with the partnership issue each partner a Schedule K-1.

Passive Activity Loss Rules – A set of rules that places limitations on the deduction of losses from what are considered passive activities in which a taxpayer does not materially participate.

Placed in Service – A date fixing the beginning of a depreciation period, describing when the asset being depreciated was first used in the production of income.

Premature Distributions – Any withdrawal from a qualifying retirement plan such as a traditional IRA or a 401(k) that is made by the taxpayer before the age of 59 ½.   The penalty applied is generally 10 percent of the amount distributed.

Provisional Income – If provisional income exceeds a designated base amount, part of a taxpayer’s social security benefits become taxable.

 

Q

 

Qualified Charitable Organization – A nonprofit organization involved in philanthropy that is approved by the U.S. treasury to accept tax deductible contributions. Charitable organizations are governed by Section 503c of the IRS code.

Qualified Dividends – Those dividends distributed by a company to the taxpayer that meet certain guidelines, and are taxable at the more favorable rates of long-term capital gains.

Qualifying Widow(er) – The filing status applicable to the taxpayer who has suffered the death of a spouse and is supporting at least one child dependent. The Qualifying Widow(er)

 

R

 

Real Estate Investment Trust (REIT) – A business entity that invests mainly real estate properties and mortgages, and passes through income from the entity to the individuals who are investors in the entity.

Real Property – The land and any depreciable property situated upon the land.

Recognized Gain or Loss – The gain or loss amount recorded by the taxpayer and reported on Schedule D of the federal tax return.

Refundable Tax Credit – A tax credit that, even when a taxpayer’s tax liability has reached zero, will be refunded to the taxpayer in the form of a tax refund. As opposed to a non-refundable tax credit, which can only reduce a taxpayer’s tax liability to zero.

Retirement Savings Credit – A tax credit that allows eligible low and middle income taxpayers to claim up to 50 percent of their retirement plan contributions as a tax credit.

Rollover – A tax-free transition or reinvestment of qualified retirement funds into either and IRA or another qualified plan. Transfer of funds must be completed within 60 days or else the funds will be taxed as a distribution.

Roth IRA – A nondeductible retirement investment that allows for tax-free accumulation of income and also a tax free distribution upon retirement.

 

S

 

Section 1231 Property – A classification of depreciable property that is employed in a business or trade or business and is held for more than a year.

Self-Employed Person – An individual who operates a business in which he or she controls key aspects of the operation as either a proprietor or independent contractor.

Self-Employment Tax – A tax levied on a self-employed person to pay the Social Security and Medicare tax obligations of the self-employed person. Tax is 15.3 percent of net business profit, as reported on Schedule C.

Short-Term Capital Gain or Loss – The amount of gain or loss on a sale or exchange of an asset in which the holding period is 12 months or less.

Standard Deduction – An “automatic” deduction available to all taxpayers without the need to itemize deductions. Standard deduction amounts are based on filing status of the taxpayer.

Standard Mileage Rate – A per mile deduction that can be used for business mileage, rather than the taxpayer needing to keep track of actual business auto expenses. For tax year 2010, the standard mileage rate is 50 cents per business mile.

 

T

 

Taxable Income – What is left of income after all adjustments and deductions have been applied. The amount of income subject to income tax.

 

W

 

Withholding – The amount that is taken from a taxpayer’s income during the year that is considered a prepayment of tax owed for the tax year.

Glossary of Tax Terms