Tax Definitions & Terminology Flashcards
Withholding
Withholding is the portion of an employee’s wages that is not included in his or her paycheck but is instead remitted directly to the federal, state, or local tax authorities. Withholding reduces the amount of tax employees must pay when they submit their annual tax returns. The employee’s income, marital status, number of dependents, and number of jobs all determine the amount withheld.1
KEY TAKEAWAYS
Withholding decreases the amount of taxes employees pay at the end of the year.
Form W-4 requires information such as marital status and number of dependents so that employers can determine the amount to withhold.
If employers do not withhold enough tax, the employer could end up owing at the end of the year.
What is a W-4 form
provides the employee with information on how much the employer withheld as income tax. The employer uses the information provided by the employee as a guide on the amount of tax to withhold from the employee’s pay. The employer figures out how much to withhold by factoring in the amount an employee earns and whether they want any additional amount withheld. Any new event that unfolds in the employee’s life, such as a change in marital status, an additional dependent, or a new job, would require the employee to fill out a new W-4. The employer uses the new information to re-evaluate the portion of income to withhold for tax purposes.
What is a tax credit
A tax credit is an amount of money that taxpayers can subtract from taxes owed to their government. Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed. The value of a tax credit depends on the nature of the credit; certain types of tax credits are granted to individuals or businesses in specific locations, classifications, or industries.
KEY TAKEAWAYS
A tax credit is an amount of money that taxpayers are permitted to subtract, dollar for dollar, from the income taxes that they owe.
Tax credits are more favorable than tax deductions or exemptions because they actually reduce the tax due, not just the amount of taxable income.
There are three basic types of tax credits: nonrefundable, refundable, and partially refundable.
A nonrefundable tax credit can reduce the tax you owe to zero, but it can’t provide you with a tax refund.
Dependents
Dependents
Dependents can be children, relatives, or other people.
Children
Your child usually qualifies as your dependent if:
You and your spouse are both the child’s parents.
The child lives with you and your spouse.
The child is under age 19.
Depending on the circumstances, you might be able to claim the child if:
You’re divorced or separated from the child’s other parent.
You were never married to the other parent.
Relatives and other people
You might be able to claim others who live with you or whom you support. This includes:
Relatives
Foster children
Other people except for your spouse (You can never claim your spouse as a dependent.)
Some rules that might apply to you for claiming a dependent:
Head of Household
Taxpayers may file tax returns as heads of household (HOH) if they pay more than half the cost of supporting and housing a qualifying person. Taxpayers eligible to classify themselves as an HOH get higher standard deductions and lower tax rates than taxpayers who file as single or married filing separately.
Single Filer
This filing status is used by a taxpayer who is unmarried and does not qualify for any other filing status. According to the Internal Revenue Service (IRS), single filers include people who on the last day of the year are unmarried or are legally separated from a spouse under a divorce or separate maintenance decree and do not qualify for another filing status. And though you may still be married, you are also considered unmarried by the IRS if you did not live with your spouse for the last six months of the tax year.
What’s the difference between the child tax credit and a dependent exemption?
An exemption will directly reduce your income. A credit will reduce your tax liability.
A dependent exemption is the income you can exclude from taxable income for each of your dependents. In 2019, you can exclude $4,200 for each dependent.
The child tax credit:
Is a credit that offsets the tax you owe dollar for dollar
Is available if you have a child younger than age 17 at the end of the year
Can reduce your tax by as much as $1,000, (2003 – 2019, through the Working Families Tax Relief Act) for each qualifying child
You can only claim the child tax credit if you claim the child as a dependent.
If you meet the requirements, you can claim an exemption for a dependent on your return and the child tax credit for that dependent.
Dependent Exemption
A dependent exemption applies to your children and other qualifying relatives whom you support. By IRS definition, you can’t claim a personal exemption for children or other relatives. Unlike personal exemptions, which are limited to a maximum of two, there is no limit on the number of dependent exemptions you can claim. If you claim someone as your dependent, however, that person can’t claim a personal exemption on her own tax return, nor can anyone else claim her as a dependent.
To claim exemptions for your dependents, you need their Social Security numbers, but they must also qualify on certain bases, such as their relationship to you, where they reside, who provides their financial support, and their age. Children who were born, were adopted or died during the tax year count as dependents for the entire year.
Personal Exemption
The personal exemption was a federal income tax break up until 2017. The Tax Cuts and Jobs Act of 2017 eliminated the personal exemption for tax years 2018 to 2025. The exemption was earmarked for a subsistence level of income, which was untaxed and gave an exemption for each person the taxpayer-supported. The taxpayer could claim the personal exemption for themselves, their spouse, and qualifying dependents.
The personal exemption was figured by counting up all eligible family members and multiplying by a per-exemption dollar amount as claimed by the filing status. A single filer could claim one personal exemption for themselves. Head of household filers got themselves and could claim each dependent. Those filing jointly received credit for themselves, their spouse, and each qualified dependent.
Finally, married filing separately taxpayers could claim themselves, dependents and spouse, as long as the spouse had zero gross income and was not claimed as a dependent by any other taxpayer. To claim an exemption for a dependent, they must be a qualifying child or a qualifying relative.
American Opportunity and Lifetime Learning Credits
The American Opportunity Credit has a maximum of $2,500 per student. It’s calculated as 100% of the first $2,000 of qualifying tuition and fees, plus 25% of the next $2,000 of qualifying tuition and fees.
The Lifetime Learning Credit has a maximum of $2,000 per return. It’s 20% of qualifying tuition and fees up to $10,000.
Your education credits might be limited if:
Your modified adjusted gross income (AGI) is $68,000 or more – or $136,000 for married filing jointly. If your income increases above this amount, the education credits will decrease.The credits are phased out completely if your modified AGI is $90,000 or more – or $180,000 if married filing jointly.
The tax you owe is less than the total of your American Opportunity and Lifetime Learning Credits after subtracting one of these:
Foreign tax credit
Child and dependent care credit
Credit for the elderly and disabled
No education credits are allowed if:
You’re married filing separately.
Your income is $90,000 or more – or $180,000 for joint returns.
Someone else is claiming you as a dependent.
Most taxpayers can receive 40% of the American Opportunity Credit as a refundable credit. However, if you’re age 24 or under at the end of the year and certain conditions apply, you can’t claim the refundable part of the credit on your return. Your credit is recalculated and only the nonrefundable credit can be used.
