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Essential Tax Terms to Understand for First-Time Tax Filers

Essential Tax Terms to Understand for First-Time Tax Filers

We admit it, tax filing is not an easy task. It is intricate in itself, plus the instructions do not always come in handy. Filling out the forms is daunting especially for first-timers who are unaware of terms like Adjusted Gross Income, capital gains, exemptions and such. To help you get a better grip on tax terms we prepared this simple glossary of words that you will encounter time and again. We include only pertinent terms for now. But expect to see the list updated every now and then.

Adjusted Gross Income (AGI) – Is the intermediate taxable income of a taxpayer once s/he figured all his income throughout the year (including wages, salary, capital gains, dividends and interest) minus above-the-line deductions e.g health insurance premiums, alimony, IRA contribution, and student loan interests among others. Determining your AGI is the first step in figuring your federal income tax bill.

The simplified formula is thus: Taxpayer’s Total Income – Above the Line Deduction = AGI (The line)

Amortization – A process of allocating a cost over a period of time or paying off a debt e.g mortgage or loan with fixed payment schedule over a period of time.

Capital gain or loss –  The difference between the amount you paid for a capital asset and the amount you sold it for is either a capital gain when you profit, or loss when you did not even break even.

Filing status- This is determined to figure the rate of your income tax. There are five filing statuses: single, married filing a separate return, married filing jointly, head of household and qualifying widow(er)

Gross Income – Generally, the total amount of an individual’s earnings including alimony, dividends and interest, bonuses etc. without any deductions.

Salary – A fixed-amount compensation received by an employee. An employee who’s paid a salary earns a fixed amount regardless of the number of hours he rendered to work. The amount does not differ when he works under time or overtime.

Tax Exemption – Tax Exemption indirectly reduces the amount of your tax bill by deducting it from your AGI along with itemized or standard deductions. The amount is set by the IRS each year. You can claim a personal exemption for yourself, and in addition, your spouse and qualifying dependents also.

Tax Credits – Tax credit is a tax break that directly cuts the amount you owe to the IRS, unlike deductions and exemption that only deducts the taxable income. There are two types of tax credit: refundable credit which gives you a refund once the credit exceeds what you owe and nonrefundable credit which can only cut back the taxes you owe.

For instance, if Joe qualifies for a $500 credit and owes $1200 of tax, he will only pay $700. Explore more about tax credit here.

Tax Deductions (Above the line, Itemized, Standard) – Tax deduction is a tax break that indirectly cuts your tax bill by deducting an amount to your taxable income. It arises from certain expenses that are considered deductible. Above the line, the deduction is expenses that you deduct to your gross income to get AGI. Once you get your AGI, you can choose between itemized deduction and standard deduction whichever is bigger.

Itemized deductions or below the line deduction includes home mortgage interest, charitable contribution, property tax and real estate tax. On the other hand, the standard deduction is an amount set by the IRS per tax filing status.

Taxable Income – The final calculated income from which the amount of taxes you owe is calculated. This is the final figura after deducting deductions and exemptions from the AGI.

Wages – A compensation received by an employee measured by a pay rate per hour multiplied by the number of hours rendered. The amount of wages depends on the number of hours an employee worked.

Tax filing can be a complicated process especially for first-time tax filers, but by learning the most essential tax terms, mistakes can be avoided to save one from waste of effort and time.

Did you find this article informative? Find more relevant tax filing updates and information by visiting our blog.