Tax Basics Terminology Flashcards
Child Tax Credit
The Child Tax Credit can significantly reduce your tax bill if you meet all seven requirements: 1. age, 2. relationship, 3. support, 4. dependent status, 5. citizenship, 6. length of residency and 7. family income. You and/or your child must pass all seven to claim this tax credit.
Pass Through Business
Most US businesses are not subject to the corporate income tax. Rather, profits flow through to owners and are taxed under the individual income tax. Pass-through businesses include sole proprietorships, partnerships, and S corporations. The share of business activity represented by pass-through entities has been rising in recent decades.
mortgage credit certificate
In North America, a mortgage credit certificate, also called an MCC, is a document provided by the originating mortgage lender to the borrower that directly converts a portion of the mortgage interest paid by the borrower into a non-refundable tax credit. Low- or moderate-income homebuyers can use a mortgage credit certificate (MCC) program to help them purchase a home. Mortgage credit certificates can be issued by either loan brokers or the lenders themselves, however, they are not a loan product.
What Is Alternative Minimum Tax (AMT)?
An alternative minimum tax (AMT) is a tax that ensures that taxpayers pay at least the minimum. The AMT recalculates income tax after adding certain tax preference items back into adjusted gross income. AMT uses a separate set of rules to calculate taxable income after allowed deductions. Preferential deductions are added back into the taxpayer’s income to calculate his or her alternative minimum taxable income (AMTI), and then the AMT exemption is subtracted to determine the final taxable figure.
What is the Self-employment tax
Self-employed individuals generally must pay self-employment tax (SE tax) as well as income tax. SE tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. In general, anytime the wording “self-employment tax” is used, it only refers to Social Security and Medicare taxes and not any other tax (like income tax).
Before you can determine if you are subject to self-employment tax and income tax, you must figure your net profit or net loss from your business. You do this by subtracting your business expenses from your business income. If your expenses are less than your income, the difference is net profit and becomes part of your income on page 1 of Form 1040. If your expenses are more than your income, the difference is a net loss. You usually can deduct your loss from gross income on page 1 of Form 1040. But in some situations your loss is limited. See Pub. 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ) for more information.
401(k) Plan
An employer-sponsored retirement savings plan through which employees 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, although most plans allow employees to borrow limited amounts tax- and penalty-free from their accounts. See also Roth 401(k).
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 (see definition below.) For example, automobiles and computers are assumed to have a five-year life for tax purposes. With straight-line depreciation you would be permitted to write off 20 percent of the cost each year; the accelerated method generally lets you deduct 20 percent of the business cost the first year, 32 percent the second, 19.2 percent the third, 11.52 percent in years four and five, and the remaining 5.8 percent in the sixth year. It takes six years to fully depreciate the property, thanks to the “midyear” convention, which basically assumes that business assets are put into service in the middle of the year.
Acquisition indebtedness
This is the technical term that Congress uses for what most of us call home mortgage debt, on which the qualifying interest is deductible. To qualify, the debt must be used to buy, build or improve your principal residence or second home and must be secured by the property.
For tax years before 2018, the interest paid on up to $1 million of acquisition indebtedness is deductible if you itemize deductions. The interest on an additional $100,000 of debt can be deductible if certain requirements are met.
Beginning in 2018, deductible interest for new loans is limited to principal amounts of $750,000. Loans originated prior to 12/16/2017 or under a binding contract that closes prior to 4/1/2018 remain under the old rules for tax years prior to 2018.
Active participation
The level of involvement that real estate owners must meet to qualify to deduct up to $25,000 of passive losses from rental real estate. Failure to pass this test could make such losses nondeductible under passive-loss rules. (see passive loss rules below.)
Additional child tax credit
You may qualify for this credit if the regular child credit more than wipes out your tax liability. This additional credit can trigger a refund check from the IRS even if you don’t owe any tax.
Adjusted basis
Your basis in property is the starting point for determining whether you have a gain or loss when you sell it. (This is sometimes referred to as cost basis, 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.
Adjusted Gross Income (AGI)
This is your income from all taxable sources, minus certain adjustments, and is the key to determining your eligibility for certain tax benefits and the phase-out of your eligibility for others. Adjusted Gross Income is also the amount from which deductions (the standard deduction or itemized deductions) and personal and dependent exemptions are deducted to arrive at the amount of taxable income that will actually be taxed. The adjustments—sometimes called above-the-line deductions because you can claim them whether or not you itemize deductions—include (among other things) deductible contributions to Individual Retirement Accounts (IRAs), SIMPLE and Keogh plans, contributions to Health Savings Accounts (HSAs), job-related moving expenses, any penalty paid on early withdrawal of savings, the deduction for 50 percent of the self-employment tax paid by self-employed taxpayers, alimony payments, up to $2,500 of interest on higher education loans and certain qualifying college costs.
Adoption credit
This credit effectively refunds to you part of what you pay to adopt a qualifying child. An eligible child is generally one under age 18 or one who is physically or mentally incapable of caring for him or herself. If you adopt a special-needs child, you may be eligible for a credit that exceeds your actual costs. The right to the credit phases out as AGI rises.
Alimony
Qualifying payments to an ex-spouse. For agreements entered into prior to 2019 these amounts can be deducted as adjustments to income whether or not you itemize and the recipient must include the payments in his or her taxable income. For agreements entered into after 2018, alimony payments are not a deduction adjustment for the paying ex-spouse, nor are they taxable income for the recipient.
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. 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. You can deduct actual costs or use the standardized mileage rate published by the IRS, plus what you spend for parking and tolls while driving on business.
Automobile, donating to charity
Strict rules control your charitable deduction of a donated vehicle. In most cases, your deduction is limited to the amount the charity gets for the car when it sells it. The charity should give you this information within 30 days of the sale. Without it, the maximum deduction you’ll be able to claim for the vehicle donation is $500.
Automobile, driving for charity
The cost of using your car while doing charitable work is deductible. For 2019, you can deduct 14 cents per mile you drove while performing services for a charity. You can also deduct what you pay for parking and tolls.
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.
Below-market-rate loans
If you make an interest-free or bargain-rate loan to a friend or relative, 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 above 20/200 in the better eye with glasses or contact lenses.
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.
Bonus Depreciation
Bonus depreciation is specified in the tax law and allows for taking more depreciation sooner than is generally permitted under ordinary depreciation rules. Bonus depreciation has been changed for qualified assets acquired and placed in service after September 27, 2017. The old rules of 50% bonus depreciation still apply for qualified assets acquired before September 28, 2017. These assets had to be purchased new, not used. The new rules allow for 100% bonus “expensing” of assets that are new or used. The percentage of bonus depreciation phases down in 2023 to 80%, 2024 to 60%, 2025 to 40%, and 2026 to 20%. After 2026 there is no further bonus depreciation. This bonus “expensing” should not be confused with expensing under Code Section 179 which has entirely separate rules, see “expensing”.
This 100% expensing is also available for certain productions (qualified film, television, and live staged performances) and certain fruit or nuts planted or grafted after September 27, 2017.
50% bonus first year depreciation can be elected over the 100% expensing for the first tax year ending after September 27, 2017.
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, the burden of proof remains on your shoulders.
Cancelled Debt
Generally, when a debt is cancelled or forgiven, the borrower who benefits is considered to have received taxable income equal to the amount of the cancelled 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. And, up to $2 million of debt forgiven on a mortgage on a principal residence—in a foreclosure, for example, or short sale—can also be tax-free but only through Dec 31, 2019. However, this can apply to debt that is discharged in 2020 provided that there was a written agreement entered into in 2019. 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. Other provisions grant tax-free treatment for cancelled debts in specific circumstances.
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 such property as 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 0, 15, or 20 percent. Taxpayers who otherwise fall in the 10 percent or 15 percent bracket get an even better deal. Their rate on long-term gains is 0% percent. The special rates for long-term gains do not, however, apply to all gains from investment real estate. To the extent that gain results from depreciation (depreciation deductions reduce your basis in the property and therefore increase gain dollar for dollar upon sale), a 25 percent maximum rate applies (unless you are in the 10 percent or 12 percent bracket, in which case that rate applies) to this “recaptured” depreciation. Also, long term-gains from the sale of collectibles are taxed at a maximum rate of 28 percent.
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 gains and then up to $3,000 of excess losses can be deducted against other income, such as your salary. Long- and short-term losses (distinguished by whether the property was held for more than one year or a shorter period of time) are first used to offset gains of a similar nature. Any excess first offsets the other kind of gain, then other types of income.
Capital-loss carryover
Capital losses can be used to offset capital gains, and up to $3,000 of any net capital loss can be deducted against other income, such as your salary or bank account interest. Net capital losses not currently deductible because of the $3,000 limit can be carried over to future years.
