This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma.

Audits, collections, tax levies and liens: These terms can strike fear in the hearts of taxpayers everywhere.

You may fear that making a mistake on your tax return will have dire consequences. But the IRS strives for fairness when it comes to taxes. Its Taxpayer Bill of Rights outlines your rights as a taxpayer and how the IRS conducts audits, hears appeals, collects taxes and issues refunds.

Let’s look at the Taxpayer Bill of Rights and some of the most common situations in which you may need to understand and apply your rights as a taxpayer.

What is the Taxpayer Bill of Rights?

The IRS first adopted a bill of 10 fundamental taxpayer rights in 2014. A year later, Congress placed those rights into the Internal Revenue Code, the foundation of federal tax law. Since then, the IRS has worked to inform taxpayers about the Taxpayers Bill of Rights and continually shares the rights internally with its employees.

You can read the full list of taxpayer rights here, but let’s cover each briefly.

1. The Right to be Informed — Ignorance of the law may not get you off the hook if you run afoul of tax laws. But having access to information about what you need to do to comply with tax laws could help keep you out of trouble. This right is intended to ensure you have the information you need to be a law-abiding taxpayer, as well as information pertaining to IRS decisions and outcomes about your tax account.

2. The Right to Quality Service — It may seem like customer service isn’t what it used to be in a lot of industries, but this right requires that IRS employees treat you with courtesy, promptness and professionalism. This means they must speak with you in a way you can understand and be reasonable about when and where they contact you. For example, they shouldn’t call you before 8 a.m. or after 9 p.m., or contact you at work if they know your employer doesn’t allow personal calls.

3. The Right to Pay No More than the Correct Amount of Tax — As a responsible taxpayer, you may be willing to pay your fair share, but not more than that. This right says you shouldn’t have to pay more than what you actually owe. For example, if the IRS decides you owe additional tax, you can challenge their assessment in Tax Court without paying the added tax first. However, be aware that time limits apply, and you’ll need to file a petition to have your case heard in tax court within those limits.

4. The Right to Challenge the IRS Position and be Heard — If the IRS takes action against you, or informs you it’s intending to act, you have the right to object and to argue your case with documentation that supports your side of the disagreement. The IRS has to consider your objection — as long as you were timely in making it — promptly and fairly, and explain in writing if it decides you still owe more tax.

5. The Right to Appeal an IRS Decision in an Independent Forum — Your right to challenge an IRS decision extends outside the service. This right ensures you can also appeal an IRS decision to an independent IRS Office of Appeals outside the IRS office that first reviewed your case. For certain situations, the IRS Office of Appeals has the full authority to settle your case, plus you can challenge an IRS decision in court.

6. The Right to Finality — This right ensures that you know and understand how much time you have for challenging an IRS position in addition to understanding the timeline for an IRS audit.

7. The Right to Privacy — This right requires the IRS to be as unobtrusive as possible when conducting an inquiry, examination or enforcement. Further, the IRS must follow due process, including search and seizure protections. This means the IRS can’t seize certain personal items (like clothing or undelivered mail) or take your home without first getting court approval and showing it has no other way of collecting the tax you owe.

8. The Right to Confidentiality — Unless you or the law authorize it to do so, the IRS can’t share your tax information with third parties. This right also applies to your interaction with tax return preparers, who could face criminal fines and prison if they disclose or use your information improperly for any purpose other than for tax preparation unless authorized by the taxpayer or by law. Plus this right makes confidential the communications between you and any tax professional authorized to practice before the IRS if you’ve hired one to represent you.

9. The Right to Retain Representation — Just as you have the right to be represented by an attorney when dealing with law enforcement, you have the right to have someone (for example, an attorney, CPA or enrolled agent) represent you in dealings with the IRS. If you can’t afford to pay someone, the IRS must make you aware that you might be able to get help from a Low Income Taxpayer Clinic. And if you do pay for someone to represent you in a disagreement with the IRS, and you win in court, you might be able to recover some of the costs.

10. The Right to a Fair and Just Tax System — This right basically ensures you’re not just a number — or a tax bill — when you’re dealing with the IRS. This means the IRS must consider your entire life circumstances, including factors like your ability to pay or provide information in a timely manner, your mental and physical health, and any economic hardships you face. It also provides the added security of knowing your tax preparer may be subject to penalties if they take a unreasonable or reckless position that results in underreporting your tax on your tax return. Plus this right prohibits the IRS from seizing all your wages if you owe a tax debt; they must leave you enough to cover basic living expenses.

What is the Taxpayer Advocate Service?

The Taxpayer Advocate Service is an independent organization within the IRS. The TAS helps taxpayers resolve tax problems with the IRS, and ensures they’re treated fairly and know and understand their rights. You can learn more about the TAS at taxpayeradvocate.irs.gov.

What is the income limit for a Low Income Taxpayer Clinic?

Because they’re intended to help low-income taxpayers who have a tax issue with the IRS, Low Income Taxpayer Clinics have ceilings for income and dispute amounts. Generally, dispute amounts must be less than $50,000.

Income ceilings range from $30,350 for a single person in the 48 contiguous states, Puerto Rico and the District of Columbia, to $105,950 for a family of eight in those locations. Ceilings for Alaska and Hawaii are higher. You can check the IRS Income Eligibility Guidelines to learn more.

Common tax rights questions

Now that we’ve reviewed your rights as a taxpayer, let’s look at some common tax scenarios and how your rights could apply in each situation.

What are your rights when you can’t pay your taxes?

The Taxpayer Bill of Rights includes the right to have your financial situation taken into account, such as your ability to pay (Right No. 10). So if you know you’re going to owe more in taxes than you can pay by Tax Day, explore your options.

It’s best to be proactive. Contact the IRS right away and look into getting more time to pay or arranging monthly payment installments. In the case of severe financial hardship, the IRS may consider an offer in compromise, which could reduce the amount you owe.

However, be aware that when you can’t pay your taxes on time, you could face interest charges on the unpaid amount plus penalties and fees, even if you’ve made other payment arrangements, like monthly installments.

And if you suspect you’ll have some trouble paying any taxes you might owe, be sure to file your return on time, even if you’re not making a payment — the IRS could also ding you for filing a late return in addition to not paying on time.

Can the IRS seize your property without due process?

If you owe a tax debt, the IRS does have the ability to legally seize your property to satisfy the debt. They can garnish your wages, take money from your bank account or other financial account, and seize and sell any real estate, vehicles or other personal property you own. This is done through a tax levy, either a one-time or continuous levy.

However, a levy doesn’t just fall on you out of the blue. Plus you have protections under the Taxpayer Bill of Rights that apply when you’re facing a tax levy.

The IRS must follow an established process to collect taxes you owe, and it will start by sending you a bill. Per Right No. 1, the bill will clearly state how much you owe. If you don’t respond to IRS notices informing you of your tax debt and requesting you to pay or make payment arrangements, or you refuse to pay the tax, then the IRS can issue a levy.

Before seizing money from your wages or bank account, the IRS should send you a Final Notice of Intent to Levy and Notice of Your Right to a Hearing at least 30 days before they take action. On that notice, the IRS will give you a window of time in which you can request a Collection Due Process hearing with the IRS Office of Appeals (Right No. 5). Using your hearing, you can challenge the levy or seek a compromise or payment plan with the IRS to halt or release the levy.

What the IRS cannot do is issue a levy without first going through the collection process that gives you notice and informs you of your right to a hearing. If this happens, you may be able to have the levy released and any proceeds returned to you. There’s a time limit though — requests for return of levy proceeds have to be made within nine months of the levy start date.

The best course of action, however, is to address any adjustments or debts with the IRS before it comes to risking a levy. Always make sure to keep the IRS up to date with your current address so that you never miss important notices.

What are your rights when you’re in collections with the IRS?

If you’re in the process of collections, you have the right to challenge the IRS and be heard (Right No. 4). There are several options to explore before your situation escalates.

If you don’t agree with the tax bill or notice you received, begin communicating with the IRS as soon as possible, and take action to minimize any fees or penalties. The notice you got should include information for how to pay and how to challenge or provide more information. Of course, we know from Taxpayer Right No. 9 that you’re entitled to representation from a tax attorney, enrolled agent or certified public accountant (or advice from the Low Income Taxpayer Clinic). If you can’t pay the amount requested, then you may have options for installments, delayed payment or even a compromise.

What are your rights when there’s a tax lien against your home?

Unlike a tax levy, a federal tax lien doesn’t seize your property. A tax lien is a legal claim against the property (real estate, personal property or financial assets) that you must satisfy if you sell it.

Like a levy, a lien only occurs after a set process. Typically, when you owe unpaid taxes, the IRS will send you a bill. If you don’t pay the bill in full and on time, or fail to make payment arrangements, the IRS can place a tax lien on your property, usually filing a Notice of Federal Tax Lien in the public record when it does so. You’ll typically receive a notice five days after the filing, notifying you of your right to a Collection Due Process hearing with the IRS Office of Appeals.

When you’re facing a tax lien, your immediate rights as a taxpayer include the following:

• The right to request a Collection Due Process hearing to have your stance heard and even ask for an audit reconsideration (Rights No. 4 and 5).
• You also have the right to hire and involve an attorney, enrolled agent, certified public accountant or a representative from the Low Income Taxpayer Clinic (Right No. 9).
• You also may have the option to get a Notice of a Federal Tax Lien removed from your credit history if you satisfy some of the requirements.
• You have the right to have your ability to pay considered and explore other options, including to pay in installments or seek a compromise with the IRS to settle your bill (Rights No. 3 and 10).
  

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Bottom line

The Taxpayer Bill of Rights ensures U.S. taxpayers aren’t powerless when dealing with the IRS. That said, the IRS does have the ability to require you to pay your taxes — if you’re able — and if you don’t pay, to hit you with fines, penalties and fees, or even seize your property and sell it.

To get the most benefit from your rights as a taxpayer, it’s important to always be proactive and responsive when dealing with the IRS. Showing the IRS you’re willing to work with them may encourage the agency and its representatives to be more willing to work with you toward resolving any tax issues you may have.

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.

This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma. It has been updated for the 2020 tax year.

For many Americans, higher education is a path to a better lifestyle, and plenty of parents envision their little ones attending college one day. But how will they pay for it?

The average undergraduate student attending a four-year public institution in their home state will pay $10,560 for the 2020–2021 academic year, according to College Board data. That high price tag helps explain the total amount of student loan debt outstanding in the U.S. — $1.51 trillion at the end of 2019, the Federal Reserve reports.

Yet in the face of those staggering numbers, “only 58% of parents with children under the age of 18 are saving for college,” says Paul Curley, the director of College Savings Research for Strategic Insight, an asset-management data services company. “And that percentage needs to go higher.”

Instead of relying on financial aid, consider starting a qualified tuition plan, commonly known as a 529 plan, for your new baby. It could help ensure you have funds available to pay for their college education down the road. Qualified tuition plans come in two general types: college savings plans, which only states can offer, and prepaid tuition plans, offered by states and qualified educational institutions.

Investing in your child’s education with a 529 college savings plan has its advantages, which may also include some tax benefits. Plus changes to the tax code added elementary and secondary school costs to the list of education-related expenses you can pay with money from a 529 college savings plan.

• What is a 529 college savings plan?
• Tax considerations for 529 college savings plans
• Opening a 529 college savings plan
• When to start a 529 college savings plan

What is a 529 college savings plan?

Sponsored by states, 529 college savings plans are tax-advantaged investment accounts that allow you to invest money toward your child’s education. Generally, you can choose to invest your 529 college savings plan contributions in investment options like mutual funds, exchange-traded fund portfolios or bank products.

As state-sponsored plans, some 529 college savings plans may have residency requirements. So your state’s 529 plan rules may require you use the funds at a college or university within the state that sponsored the plan. Or you may be required to live in the sponsoring state in order to open the account. Though not all 529 college savings plans have these stipulations, so be sure to do your research.

Tax considerations for 529 college savings plans

The benefits

Among the biggest advantages of 529 college savings plans are the tax benefits associated with them.

While you pay taxes on the money you contribute to these plans, you aren’t taxed on any gains from your 529 investments provided you use withdrawals for qualified education expenses. Plus in many states, you can claim contributions as a tax deduction or credit on your state income taxes.

When you take money out of the plan to pay for qualified education expenses, you don’t pay taxes on those withdrawals. You can generally use withdrawals for qualified expenses at any college or university, and may even be able to use the money for overseas studies.

529 plan rule caveats to be aware of

Keep in mind, if you withdraw money from a 529 college savings plan to pay for non-qualified higher education expenses, you may pay a 10% federal tax penalty on the earnings plus regular state and federal income tax on that withdrawal.

Investigate whether your state offers tax benefits for 529 plans, because many states only offer tax credits or deductions for state residents in addition to waiving certain fees. It’s worth noting that some states will allow residents to deduct contributions even if they invest in another state’s plan.

What education expenses can I pay for with a 529 college savings plan?

Qualified education expenses at eligible institutions can include the following:

• School tuition
• Room and board (if enrolled at least half-time and included in the cost of attendance)
• Fees
• Books and supplies
• Equipment the school requires students to have
• Computers and internet service
• Computer peripherals (such as printers)
• Education software

Contribution limits for 529 college savings plans

There are technically no specific contribution limits set by the IRS for 529 plans, unlike IRAs or other investment vehicles. However, the IRS does stipulate that “Contributions cannot exceed the amount necessary to provide for the qualified education expenses of the beneficiary.”

Also, if your contributions, plus any other gifts, to a particular beneficiary are more than $15,000 in a year, starting in 2018, you could trigger gift taxes.

Some states will set limits, so it’s best to check if the plan you choose has established limits. If it does, and you suspect your child’s education expenses will exceed the plan limits, you may consider opening a second college savings plan in another state to make up the difference. Just be sure the amount you save in both plans doesn’t exceed the amount you actually need for qualified education expenses.

Impact of tax reform on 529 college savings plans

The tax reform law adopted in December 2017 expanded how families can use 529 college savings plans.

Starting in 2018, you can use plan funds to cover up to $10,000 of qualified education expenses for each child you have in kindergarten through 12th grade at a public, private or religious school. The withdrawals you make won’t be subject to federal taxes, but they may be subject to state taxes or penalties, depending on the state you live in.

Opening a 529 college savings plan

Start by doing some comparison shopping of different states’ options, especially checking what tax benefits your own state offers.

Consider establishing your plan directly with the state, known as a direct-sold plan, rather than through an advisor or broker, due to the fees brokers charge. You may find that direct-sold plans for your state have lower fees. Additionally, your state may waive fees for state residents, those who keep high balances, those who opt for paperless statements or those who make regular contributions. Check to see what your state offers.

With state-sponsored 529 college savings plans, the state usually selects one administrator. Typically, the administrator is a large well-known brokerage, like Vanguard or Fidelity, that will manage your investments.

Once you’ve chosen a 529 college savings plan, you’ll need your child’s Social Security number and birthdate to open the account. You may have to pay an enrollment or application fee when you set up via a direct-sold plan or a plan with a broker. You may also be required to make an initial contribution.

What’s more, there may be other fees associated with your 529 college savings plan, including for the following:

• Account maintenance
• Program management
• Asset management

Once you begin contributing, you can select your risk profile and begin seeing return on your investments while watching them grow tax-free. Once your child nears college-age, you can opt for a less-risky portfolio. Many plans adjust your portfolio automatically based on age to reduce volatility. If you are looking for someone to help guide your investments, it may be worth going through an advisor and facing the extra management fees.

When to start a 529 college savings plan

You can open a college savings plan at any time. Keep in mind, however, the younger your child is when you open the account, the more time your investment will have in which to grow before you begin making withdrawals for college expenses.

Just like saving for retirement, the magic of compound interest makes putting aside money early on very advantageous. For example, just putting aside $200 a month for 18 years can amount to more than $97,000 given an interest rate of 8% — assuming, of course, that your investments gain rather than lose.

Bottom line

Opening a 529 college savings plan for your baby can be a great way to save toward their eventual college education costs. The money you put in a 529 plan can grow tax-free — whereas you might have to pay tax on gains from other types of investments. Plus if you use the money for qualified education expenses at qualified educational institutions, you may avoid taxes on the withdrawals.

And thanks to changes in the tax code, it’s now possible to put 529 college savings plan funds toward elementary and secondary school expenses.

Keep in mind that, as with any investment, gains are not guaranteed. So your investment could lose money.

However, Curley emphasizes the importance of automating your investment contributions to help you successfully save.

“Consider automatically saving with a 529 college savings plan through payroll deduction or from your bank account, which is what 36% of account holders did last year,” he says. “That way, automatic money going in can help you get to where you want to go regardless of market returns.”

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.

W-2, 1040-EZ, HSA, AMT — these aren’t the crop of new car models.

These labels and acronyms are important tax terms that you’ll come across repeatedly throughout your life as a taxpayer. Whether you’re filing your own taxes or paying someone else to do it for you, knowing the meaning of common tax terms can help you take charge of your tax obligations.

While the following list of common tax terms is by no means comprehensive, it’s a good starting point to learn about tax terms you might encounter as you file your own taxes.

1040

This is the form you’ll use for filing your federal income tax return every year. There are several versions of Form 1040 as well as three accompanying schedules you may also need to file.

Adjusted gross income

Income is all the money that you receive in a year, whether you earn it or otherwise. Gross income is all your income from every source (wages, home sale, investment income, gambling winnings, gifts, etc.) added together. Adjusted gross income, or AGI, is what you get when you subtract allowable tax adjustments (retirement account contributions, student loan interest, etc.) from your gross income. AGI affects your eligibility for certain tax credits, like the earned income credit, and helps determine how much tax you should pay.

After-tax

You may hear this term paired with the words “income” or “contributions.” Basically, it refers to money you have left over after payroll taxes have been deducted from your income. When you use this remaining money to invest in a retirement account, it’s an after-tax contribution.
This means you already paid taxes on the money contributed to your retirement account or money used to pay for a benefit.

Alternative minimum tax

The alternative minimum tax, often called AMT, is intended to help ensure high-income individuals with access to tax benefits that can significantly reduce their taxes still pay a minimum amount of federal income tax. Generally, you’ll have to pay the AMT if your taxable income plus certain adjustments exceeds your AMT exemption amount. IRS Form 6251 can help you determine whether you must pay AMT, and how much you should pay.

Amended return

If you discover that you made a mistake after filing your tax return, you can submit an amended (corrected) return to the IRS using Form 1040-X. The IRS says you don’t have to submit a 1040-X to correct math errors (the agency will take care of those). Keep in mind, you must file your amended return within three years of the original filing or within two years after the date you paid the tax, whichever is later, if you want to use it. To learn more, check out the instructions for the 1040X.

Business expenses

If you run a business or are self-employed, the costs you incur to run your business are business expenses. Some necessary and ordinary business expenses are tax deductible.

Child and dependent care credit

If you paid for childcare or caregiving services for a qualifying individual in your care so that you can work or find work, you may qualify for this tax credit. You must meet the AGI qualifications. The credit will be a percentage of caregiving expenses as determined by your AGI.

Credit

A credit is a dollar-for-dollar reduction in the amount of tax you pay. For example, if you qualify for a $1,000 tax credit and owe $5,000 in taxes, that credit will reduce your tax burden to $4,000. Some credits are refundable, meaning you get money back even if the credit is more than the tax you owe. So if you still have that $1,000 tax credit but you only owe $500 in taxes, you’ll get $500 back from the IRS. Nonrefundable credits only refund your money up to the amount you owe.

Dependent

A dependent is a child, relative or individual whom a taxpayer can claim on their federal income tax return to receive a dependency exemption. Rules apply to who qualifies as a dependent. You must also meet certain criteria in order to count someone as a dependent on your taxes.

Earned income

Earned income is taxable income you make from an employer that you work for, or from a business or farm you run. Sometimes disability benefits count as earned.

Earned income credit

If you have a low or moderate income, you may qualify for this credit. The Earned Income Credit, also known as the earned income tax credit, is a refundable credit that lowers your tax bill. In some cases, claiming it may result in a refund even if you didn’t owe any taxes. To claim it, you must meet specific criteria and file a federal income tax return, regardless of whether you owe taxes or aren’t otherwise required to file.

Eligible

Eligibility means you or your situation meet a required set of criteria to claim a certain status, deduction, exemption, credit, etc.

Estimated tax payment

For self-employed taxpayers that earn above a certain threshold, you may need to pay quarterly estimated taxes to the IRS. These quarterly payments typically cover self-employment tax. You may also owe estimated tax payments throughout the year if you receive income in the form of interest, dividends, alimony, capital gains, prizes or awards.

Exemption

A tax exemption is a set amount that reduces your taxable income, which helps reduce the amount you owe in taxes. Tax reform did away with personal exemptions beginning with 2018 tax returns.

Filing status

The federal tax return has five different filing statuses: single, married filing jointly, head of household, married filing separately, and qualified widow(er) with dependent child. Single, married filing jointly, and head of household are the most common statuses. Your filing status depends on multiple criteria and is used to determine what forms, filing requirements, credits, deductions, exemptions and tax rates you’re subject to.

Gross income

Gross income is all the income you’ve received throughout the year that is not exempt from taxes. Gross income is used to determine your tax rate and benefits that you may qualify for.

Health savings account

A health savings account, or HSA, is a tax-exempt account used to pay for qualified medical and healthcare expenses. To qualify for an HSA, you must be covered under a high-deductible health plan, have no other health coverage, not be enrolled in Medicare and not be claimed as a dependent on someone else’s tax return. The contributions you or your employer make to an HSA are tax deductible, even if you don’t itemize. The money in your account grows tax free, and distributions may also be tax free if you use the money to pay for qualified medical expenses. Check out IRS Publication 969 to learn more about HSAs.

Independent contractor

An independent contractor is a class of worker. Generally, you’re an independent contractor if the person or company paying you to do work only has the right to direct the result of the work and not how you will do it. Income earned as an independent contractor is subject to self-employment taxes.

IRA

An IRA is an individual retirement account, also sometimes called an individual retirement arrangement. IRAs are tax-advantaged ways to save for retirement. There are two types, each with distinct benefits. Contributions to a traditional IRA are generally tax-deductible. This reduces your current tax burden, but you’ll have to pay taxes on the money when you withdraw it. With a Roth IRA, you pay taxes at the time you make contributions, which generally means you can withdraw the money tax-free in retirement. To compare the types of IRAs, check out this IRS chart.

Interest income

Interest income refers to any interest you earn from savings accounts, certificates of deposits, bonds, money market accounts or deposited insurance dividends. This income is typically subject to taxes but not always.

Investment income

Investment income is any income you’ve received in the form of dividends, interest, capital gains from the sale of property or assets, or certain other types of payments.

Itemized deductions

On a federal tax return, taxpayers can take either the standard deduction or itemized deductions. Your standard deduction depends on your income, age and filing status. Itemized deductions are a set of expenses you’ve incurred throughout the year like medical costs, local taxes, real estate taxes, charitable contributions and more. These deductions lower the amount of income you pay taxes on.

Joint return

A joint return is for taxpayers who have elected the status of “married filing jointly,” thus combining their income, credits, deductions and any other benefits for tax purposes.

Modified adjusted gross income

Modified adjusted gross income is a calculation of your gross income minus certain deductions (student loan interest, foreign housing, etc.) used to determine your eligibility for tax benefits or additional taxes.

Net investment income

Net investment income includes the gains or profits made from investing in stocks, bonds, funds or other investment vehicles.

Nonrefundable credit

See the entry on credits.

Nontaxable income

Most forms of income are subject to taxes, but some are not. Examples of income that are usually nontaxable include child support payments, inheritances and welfare benefits.

Pre-tax

Pre-tax usually refers to any deductions taken from your individual paycheck before payroll taxes have been applied. This means the money used to pay for that benefit or for a contribution was not subject to income tax.

Qualified plan

A qualified plan refers to any accounts or services with tax benefits meeting a certain criteria. Examples include, but are not limited to, traditional IRAs, 401(k)s, and 403(b)s.

Refundable credit

See “credits” above.

Roth IRA

See “IRA” definition above.

Self-employment income

Self-employment income includes income earned from a self-run business or as an independent contractor. Other types of income reported to the IRS using Forms 1099-MISC and 1099-K often count toward self-employment income. Income from dividends or interest usually does not count as self-employment income.

Self-employment tax

When you work for an employer, they generally will calculate your Social Security and Medicare taxes, which are called payroll taxes, and deduct them from your wages. When you’re self-employed, you must do this for yourself. Self-employment taxes are contributions to Social Security and Medicare that you must make based on a percentage of your self-employment income.

Standard deduction

The standard deduction is a deduction you can take instead of itemizing all your deductions. The standard deduction will reduce the amount of your income subject to taxes. Your standard deduction depends on your filing status, age and other factors. If you choose to itemize deductions, you can’t also take the standard deduction. You must pick one or the other.

Tax exempt

This term means that the indicated income, contributions, or assets are not subject to taxes.

Taxable income

Taxable income is the income you received in past tax year which is eligible for income tax. Taxable income often includes employee compensation, rental income and self-employment profit.

Tax withholding

As you receive paychecks from an employer as an employee, income tax and other contributions to Social Security and Medicare are withheld from your paycheck. This is what is often referred to as tax withholding.

W-2

You’ll get a W-2 if you received $600 or more from an employer as an employee. Employers are also required to furnish a W-2 if they withheld any income, social security, or Medicate taxes from your paycheck(s), regardless of whether you earned $600 or more. The W-2 shows how much the employer paid you and how much they withheld for income tax, Social Security tax and Medicare tax. Employers must furnish W-2s to employees by Jan. 31 at the absolute latest.

W-4

The W-4 is the form that helps your employer determine your withholding status. This form requires you to share your filing status, number of dependents, and answer other questions relevant to your tax withholding. Generally, people fill out W-4s when they start a new job, but the IRS recommends you complete a new one when changes occur in your life situation, such as getting married, getting divorced or having a baby.

Bottom line

It’s possible to encounter hundreds of tax terms throughout your taxpaying lifetime. Knowing a few of the more common ones can help make filing your own taxes easier. If you come across a term you don’t know or understand, navigate to the IRS website and plug the term into the search field at the top of the page. You’ll find a wealth of tax information on the site.

This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma. Portions of this article have been updated for the 2020 tax year.

You may know claiming tax deductions and tax credits can help lower the amount of tax you owe, but do you know the difference between the two?

While the end result of deductions and credits may be the same — you pay less in taxes — they work in different ways. Understanding the differences between tax deductions and tax credits can help ensure you stay organized, in control of your taxes, and ready to pay just the right amount when you file your income tax return.

• What is a tax deduction?
• What is a tax credit?
• What is the difference in how each works?
• What are the benefits of tax deductions?
• What are the benefits of tax credits?
• What are some common tax deductions and tax credits you might be eligible for?
• How to claim tax deductions and tax credits
• The forms you’ll need to claim deductions and credits
• Is there a maximum I can take for deductions and for credits?
• Beware these caveats

What is a tax deduction?

A deduction reduces the amount of income you pay taxes on, which means you could pay less in taxes. You subtract deductions from your income before calculating how much taxes you owe. How much a deduction saves you depends on your income tax bracket.

To calculate how much a deduction could reduce your taxes, you multiply the amount of the deduction by your marginal tax rate. For example, if a deduction is worth $5,000 and you are in the 10% tax bracket (the lowest), the deduction would reduce your taxes by $500.

A deduction’s value to you is tied to your tax rate. So if you’re paying a higher tax rate, you can reap more of a deduction’s benefit. The lower your tax rate, the less benefit a deduction will have for you. Imagine that you take a $5,000 deduction, but you’re in the 35% tax bracket — the second highest. Now you’re saving $1,750 in taxes.

What is a tax credit?

On the other hand, a credit is a dollar-for-dollar reduction in the amount of tax you owe. For example, if you qualify for a $1,000 tax credit of some kind and owe $5,000 in taxes, that credit will reduce your tax burden to $4,000.

What is the difference in how each works?

The big difference between tax deductions vs. tax credits is that deductions chip away at the income you’ll pay taxes on, which then reduces your taxes, while credits directly reduce the amount of taxes you owe.

Some tax credits like the earned income tax credit may even increase your refund, or provide you with a refund even if you didn’t owe any taxes. These are known as “refundable” tax credits. Tax credits are always refundable or nonrefundable.

Nonrefundable tax credits can’t increase your tax refund — they can only reduce the amount you owe in taxes. Imagine you get a $1,000 nonrefundable tax credit, but you only owe $500 in taxes. You won’t have to pay any taxes, but you also won’t get the remaining $500 from the credit back as a refund.

What are the benefits of tax deductions?

Tax deductions are designed to offset the amount of income you’ll pay taxes on by writing off expenses like tuition and healthcare, contributions to retirement, and any self-employed or capital gains losses you faced. Claiming a deduction ensures you don’t pay taxes on certain income you’ve already spent, invested or lost.

What are the benefits of tax credits?

In addition to reducing the amount you pay in taxes or increasing a refund, some tax credits can be claimed even if you have no tax liability. That means that if you don’t owe any taxes but qualify for $1,000 in refundable tax credits, you can get these credits as a $1,000 refund.

What are some common tax deductions and tax credits you might be eligible for?

Of course, Congress has the ability to change or eliminate deductions and credits, so it’s important to confirm a specific credit or deduction is still available before you try to claim it. You can do this by either by looking it up on the IRS website, consulting a tax professional or using a tax prep service.

Here are some common deductions and credits to be aware of.

Common deductions

• The standard deduction — Instead of itemizing deductions, many taxpayers claim a standard deduction because it can be simpler than itemizing all of their deductions individually. How much you can deduct using the standard deduction mostly depends on your filing status and age. For 2020, the standard deductions are $25,100 for people married filing jointly, $18,800 for those filing as head of household, and $12,500 for single and married, filing separately.
• Student loan interest — If you pay interest on a qualified student loan, you may be eligible to deduct up to $2,500. You don’t have to itemize deductions to take the student loan interest deduction.
• Medical and dental expenses — Qualified medical and dental costs are tax deductible as long as they exceed a set percentage of your adjusted gross income.
• State and local income tax — You may be allowed to deduct state, local and foreign income taxes.
• Property taxes — If you pay taxes for property like land, cars or boats, that tax may be deductible.
• Mortgage interest — If you pay mortgage insurance premiums, interest on a mortgage or points, they may be deductible.
• Retirement contributions — Contributions to a traditional 401(k) or a traditional IRA are often eligible for deductions.
• Contributions to a health savings account — If you have a high-deductible health plan and contribute to an HSA in conjunction with that plan, your HSA contributions are generally tax deductible.

Common credits

• Earned income tax credit — If you are working and earn a low to moderate income, you could be eligible to claim the EITC, sometimes known as the EIC. This is a refundable tax credit. But be aware that claiming this credit could delay any tax refund you’re owed. That’s because federal law requires the IRS to hold the refunds of anyone who claims this credit until mid-February.
• Lifetime learning credit — Depending on your modified gross income, you may be able to get a credit for up to $2,000 for qualified tuition and education-related expenses for yourself, a spouse or dependent.
• Saver’s tax credit — This credit helps individuals who meet adjusted gross income requirements save for retirement. For 2020, the qualifying AGI is $66,000 for people who are married filing jointly, $49,500 for head-of-household filers and $33,000 for all other filing statuses.
• Residential energy-efficient property credit — As a homeowner, if you’ve invested in making your home more energy efficient, then you may be able to deduct those investments.

Can I take a personal exemption for my 2020 federal income taxes?

You can’t take any personal exemptions for your 2020 taxes. The Tax Cuts and Jobs Act of 2017 suspended personal exemptions for tax years after Dec. 31, 2017, and before Dec. 31, 2025.

How to claim tax deductions and tax credits 

When you’re ready, it’s best to add up all the itemized deductions you might be able claim. From there, compare whether taking the standard deduction or itemizing your deductions provides the biggest reduction.

After applying all your deductions, you arrive at your taxable income and apply any credits you’re eligible for. This is the typical process for whittling down your tax bill to make sure you’re taking advantage of all deductions and credits you’re entitled to.

The forms you’ll need to claim deductions and credits

For deductions, you can claim the standard deduction on your Form 1040. But if you’re looking to itemize your deductions, you’ll need to fill out a Form 1040 and Schedule A.

For claiming credits, you must use Form 1040. For those claiming the earned income tax credit, you’ll need to fill out Schedule EIC if you’re planning on listing qualifying dependents.

Is there a maximum I can take for deductions and for credits?

For tax years between 2018 and Dec. 31, 2025, there is no overall limit on itemized deductions. The Tax Cuts and Jobs Act of 2017 repealed previous limitations that applied to upper-income taxpayers.

But individual limitations remain on certain deductions, such as medical and dental expenses.

When claiming the EITC or claiming dependent credits, you’re capped at certain maximums. For example, you’re limited to a $3,618 credit for one qualifying child in 2020. For credits like the foreign tax credit, the amount you’re eligible for is a fraction comprising the tax paid to non-U.S. tax entities divided by the total amount owed the IRS and entities abroad.

Beware these caveats

A drawback of claiming the EITC is that it can sometimes delay your refund. The IRS now holds EITC recipient refunds until at least February 15 before distributing.

Also, if you’re married but filing separate returns, and you want to itemize deductions, your spouse will also have to itemize. Likewise, if either of you want to use the standard deduction, the other must do the same as well.

Also for itemizing, you must have well-documented records to claim certain deductions, which is generally more work to prepare than simply claiming the standard deduction. For example, if you’re claiming business use of your car, you often need proof in the form of a mileage log delineating business and personal use.

Bottom line

They work in different ways, but both tax deductions and tax credits can help reduce the amount of taxes you pay. Understanding the difference and how each works can help ensure you maximize the value of every deduction or credit you’re eligible for. Plus, doing your homework before filing can help you identify every opportunity to use a tax deduction or credit to save you money.

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.

This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma. It has been updated for the 2019 tax year.

Most Americans get their income from multiple sources, according to a Federal Reserve study.

These sources include traditional W-2 earnings, self-employment ventures, investment dividends, retirement income, unemployment and much more. With so many taxpayers receiving multiple types of income, it’s no surprise that calculating taxable income can get complicated.

Let’s look at the types of income the IRS defines as taxable, what income could be excluded from taxes, and some common questions you might have about taxable income.

• What is ‘taxable income’?
• What types of income must you pay taxes on?
• What types of income are not taxed?
• How does taxable income affect how much tax I owe?
• How does taxable income affect my refund?
• How can I reduce my taxable income without losing money?
• Frequently asked questions about income

What is ‘taxable income’?

The IRS says income can be in the form of money, property or services you receive in the tax year. The two basic types of income are earned and unearned income.

Earned income includes money you receive from an employer in exchange for your work or money you make working for yourself. Unearned income includes money you didn’t directly work for, such as interest and dividends, Social Security payments, alimony, etc.

To arrive at your taxable income, you’ll first need to calculate your adjusted gross income, or AGI. Your AGI is basically all your taxable earned income less any income adjustments you’re eligible to take before you get into itemizing deductions.

You report your total income on Form 1040, including things like W-2 income, taxable interest and ordinary dividends. Schedule 1 allows you to report other types of income, such as alimony you received, unemployment income or business income. Schedule 1 also lists adjustments to income such as contributions to health savings accounts, contributions to a traditional IRA, interest paid on student loans, alimony you paid and more. For more information on how to calculate adjusted gross income, visit the IRS website for Form 1040.

What types of income must you pay taxes on?

The IRS counts the following common income sources as taxable income:

• Wages, salaries, tips and other taxable employee pay
• Union strike benefits
• Long-term disability benefits received prior to minimum retirement age
• Net self-employment or freelance earnings under certain circumstances
• Jury duty fees you earned
• Security deposits and rental property income
• Awards, prizes, gambling, lottery and contest winnings
• Back pay from labor discrimination lawsuits
• Unemployment benefits
• Capital gains (there’s an exception for the selling of a property that’s your primary residence)
• Severance pay from a previous job
• Alimony from an ex-spouse
• Interest or dividends from investments
• Royalties and license payments
• Canceled debts (but there are key exceptions for those declaring bankruptcy)

What types of income are not taxed?

You don’t have to pay taxes on all income, though. This category generally includes …

• Workers’ compensation benefits
• Child support payments
• Life insurance proceeds unless the policy was turned over to you for a price
• Disability benefits (if you contributed to the premiums from your salary)
• Social Security benefits (depending on your filing status and other income)
• Capital gains on the sale of your primary home (up to certain thresholds)
• Money received as a gift or other inherited assets (the exception here is, if you’ve earned money as a result of that gift, you owe taxes on those earnings)
• Canceled debts intended as a gift to you
• Scholarships or fellowship grants
• Foster care payments
• Federal income tax refund
• Money rolled over from one retirement account to another via trustee-to-trustee transfer

For full instructions on what constitutes taxable and non-taxable income, see IRS Publication 525.

How does taxable income affect how much tax I owe?

Your taxable income determines your tax bracket, which in turn influences your income tax rate and the amount of tax you owe. Federal income tax is progressive, which means that income tax rates increase as a person earns more income.

Lower taxable income can mean you’re in a lower tax bracket with a corresponding tax rate — and your tax liability will likely be lower.

How does taxable income affect my refund?

You probably noticed that a portion of your paycheck goes toward federal taxes. Or, if you’re self-employed, then you’ve (hopefully) been paying quarterly taxes throughout the year.

If you paid more federal income tax than you owed based on your taxable income, you may receive a refund. The more tax you overpaid, the bigger your refund.

How can I reduce my taxable income without losing money?

You can lower your taxable income — and possibly increase any tax refund you’re owed — in two basic ways.

First, you can lower your AGI by subtracting as many adjustments as you’re legally entitled to. Second, tally up all your allowable credits, deductions and exemptions to determine whether you’ll save more by itemizing deductions or taking the standard deduction. Generally, you want to use whichever option saves you more.

Take note here: Some adjustments (often referred to as “above-the-line-deductions”) may lower your overall AGI, but also will limit the deductions or credits you can take for “below-the-line” deductions. For example, if you had a lot of deductible medical expenses during the tax year, then you’re only allowed to deduct the amount of your total medical expenses that exceed a certain percentage of your AGI on your itemized Schedule A.

Here are some strategies for lowering your taxable income.

• Max out your retirement contributions — Contributions to 401(k)s and traditional IRAs may be tax deductible. You generally don’t pay taxes on the income you’re allowed to contribute to these retirement plans, and you don’t get taxed on their earnings. But you’ll pay taxes later when you take money out of these accounts.
• Charitable donations — You may deduct charitable contributions made to, or for the use of, a cause or charity as long as that organization is a registered charity under Section 501 (c)(3).
• Defer your year-end bonus — If you’re expecting a holiday bonus, ask your employer to give it to you in the next year so you don’t owe additional taxes on that income.
• Tidy up your investment accounts — If investments in your portfolio have lost money and you sell them, you could claim those losses and offset any capital gains you report.

Frequently asked questions about income

Are Social Security benefits taxable income?

In some situations, Social Security income may be subject to federal income tax. You may have to pay taxes on Social Security benefits if …

• Your federal income tax filing status is single and your combined income (AGI plus non-taxable interest) between $25,000 and $34,000 in the tax year. Or, you file jointly and have combined income of $32,000 to $44,000. In these cases, you could have to pay income tax on up to half of your benefits.
• You file as an individual and earn more than $34,000 in combined income, or you filed jointly and have combined income of more than $44,000. You could have to pay income tax on up to 85% of your Social Security benefits.

Are disability insurance payments taxable income?

They could be. You could have to pay income tax on disability benefits if your employer paid a portion of the disability insurance policy premium.

If you and your employer share the cost of the premiums, you’ll need to report the amount of disability income that you get based on your employer’s payments. That portion could be subject to income tax.

Are my unemployment benefits taxable?

Yes, the IRS considers income from unemployment benefits taxable in most cases. Typically you can elect to have federal income tax automatically deducted from your unemployment payments at the time you enroll.

A late relative left me some money. Is it taxable income?

You generally don’t have to pay income taxes on inherited money. That money is taxed before you receive it from the person or estate bequeathing the money. But if you invest it or create earnings using that money, you’ll have to pay tax on those earnings.

Also keep in mind that the deceased person’s estate may have to pay the federal estate tax if the amount of the estate exceeds a certain threshold. For 2019, that threshold is $11.4 million. Note that some states have estate or inheritance taxes (or both) that may also apply.

I received a monetary gift. Is that taxable income?

Similar to the above answer, a monetary gift from a friend or family member is typically non-taxable.

I won some money in Vegas. Is that taxable income?

Yes, gambling winnings do count toward your taxable income, and you must report them on your Form 1040.

My company pays a bonus, tuition reimbursement and some other awesome benefits. Are those taxable income?

The IRS considers bonuses and fringe benefits such as use of a business vehicle to be taxable income. As long as the tuition reimbursement meets the criteria for the Education Working Condition Fringe Benefit Exclusion, the tuition reimbursement is not taxed until it exceeds $5,250.

Bottom line

Having multiple types of income can mean more money, which most people would consider a good thing. But more tax complexity can accompany having more sources of income.

You can take charge of your taxes by understanding what the IRS considers taxable income, what it doesn’t count as taxable, and how taxable income gets calculated.

Relevant sources: Report on the Economic Well-being of U.S. Households in 2016, Board of Governors, Federal Reserve System | IRS Publication 525: Taxable and Nontaxable Income | IRS: What is Earned Income? | IRS: About Form 1040-EZ, Income Tax Return for Single and Joint Filers with No Dependents | IRS Form 1040 | IRS Publication 527: Residential Rental Property | IRS Topic No. 431: Canceled Debt – Is it Taxable or Not? | IRS Publication 523: Selling Your Home | IRS 1040 Instructions | IRS Publication 4491: VITA/TCE Training Guide | IRS: 401(k) Plans | IRS: Retirement Topics – IRA Contribution Limits | Social Security Administration: Benefits Planner – Income Taxes and Your Social Security Benefit | IRS: FAQ – Life Insurance & Disability Insurance Proceeds | IRS: Estate Tax | IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits

The holidays are all about family, friends and food. Thinking about your income taxes? Not so much.

But setting aside time to get organized around your taxes now may help you get ahead at tax time next year. Plus, key tax milestones — such as when the IRS opens up for federal tax returns (it’ll be sometime mid- to later January) and the deadline to file your federal tax return (generally April 15) — will arrive before the ink is dry on your New Year’s resolutions.

Here are some simple tips to make the most of the season — the tax season, that is — before the ball drops on 2020.

1. Review your withholding.
2. Prioritize charitable deductions.
3. Guard against tax fraud.
4. Open an FSA. 
5. Gather paperwork now.
6. Pad your retirement savings.

1. Review your withholding.

For W-2 workers, it’s a good time to review your paycheck withholding — the amount of federal income taxes taken out of your pay by your employer(s). If it’s too much you may get a refund; too little, you could have taxes due. The IRS has a useful calculator to see how much you should be withholding. Some people love getting a refund at tax time — and we get it — but there can be better ways to save. Consider adjusting your W-4 so less taxes are taken from your paycheck but immediately divert the difference into an interest-bearing savings account. These accounts don’t pay as much interest as they used to, but it’s better than nothing — and now you’ve added to your nest egg.

2. Prioritize charitable deductions.

You have until Dec. 31 this year to claim charitable deductions for the tax year. But whether you’re donating to Goodwill or local disaster relief, you need to document your contributions, whether that’s in cash, a check or some other type of gift. It’s also important to note that you can only deduct charitable contributions if you itemize your deductions vs. taking the standard deduction. If you are unsure if an organization is tax exempt, you can find out with this IRS status check.

3. Guard against tax fraud.

Many people don’t realize tax returns are a magnet for identity theft. In an August 2017 news release, the IRS reported stopping 19 million suspicious returns from 2011 to October 2014. That’s why it’s wise to file your taxes as early as possible and to regularly check your credit reports for accuracy and any potential fraudulent activity.

4. Open an FSA. 

Flexible Spending Arrangements (FSAs) can help you save money on health care, but you have to select an FSA during open enrollment periods for your health plan, which can start before the end of the year (check with your employer for exact dates). With these accounts you (or your employer) can set aside up to $2,750 to be used for health-related expenses. The amount you contribute is not subject to federal income tax, Social Security tax or Medicare tax. If you already have an FSA, consider using up your remaining amount before the end of the year. Unspent amounts could be forfeited but it depends on options your employer gives. You might have a grace period or you may carry over up to $500.

5. Gather paperwork now.

Getting your tax receipts organized well in advance of tax day is smart for everyone, but it’s especially critical for the self-employed. Learn more about what you can or cannot deduct when it comes to business expenses with this IRS guide to deducting business expenses.

6. Pad your retirement savings.

As the year rounds out, there is still time to bump up contributions to your 401(k) and/or IRA account. If you’re under 50, you can contribute up to $19,500 to your 401(k) for the year ending Dec. 31, 2020. If you’re 50 or older, you can contribute up to $26,000. For a traditional Individual Retirement Account (IRA) or Roth IRA you can contribute up to $7,000 if you’re 50 or older. Technically, you have until the April tax filing day to add to an IRA and have it “count,” but make sure you indicate the year you want the contribution to be applied to when depositing.

Bottom line

Thinking about these tax moves now can help set you and your family up for a better year ahead. And consider this: Peace of mind when it comes to your taxes might be the best holiday gift of all!

This offer is no longer available on our site: Wells Fargo Secured Card

The Wells Fargo Secured Card is no longer available. For another option, check out the Discover it® Secured Credit Card.

Updated October 24, 2023

This date may not reflect recent changes in individual terms.

Editorial Note: Intuit Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our third-party advertisers don’t review, approve or endorse our editorial content. Information about financial products not offered on Credit Karma is collected independently. Our content is accurate to the best of our knowledge when posted.

Written by: Laura Zulliger

There are two noteworthy benefits with the Wells Fargo Secured Card.

You can get a higher credit limit with this card compared with some other secured cards.

With the Wells Fargo Secured Card, the amount you put down as a deposit determines what your credit limit is, and you can put down up to $10,000. This makes this card appealing for those who have the money to make a large security deposit to secure a high credit limit.

The other benefit of this Wells Fargo card is that you can apply even if you’re a nonpermanent resident.

What is a secured card?

For people with low credit or no credit, secured credit cards are a good way to build credit.

With a traditional unsecured credit card, you can begin using the card as soon as you get it. But with a secured card, you need to make a deposit first.

This is a form of collateral the credit card company takes to make sure that in case you can’t pay back what you borrow it at least has your deposit.

There are a host of secured credit cards available. As with any credit card, determining which one is best for you depends on many factors, which include how much you earn, how much you spend and how good you are at paying off your balance every month.

Here are more details on the pros and cons of the Wells Fargo Secured Card.

The rundown: Everything we like about the Wells Fargo Secured Card

Given the full range of secured credit cards out there, the Wells Fargo Secured Card has some distinguishable benefits that make it a good option for some.

Whether you’re new to the country or starting to build credit, this card could be worth your while. Here are its biggest benefits.

Great for temporary U.S. residents

Many secured cards require you to be a U.S. citizen or permanent resident. The good news is you can qualify for this card even if you’re not a citizen or permanent resident.

In other words, “non-resident aliens” or those on temporary visas may apply. But be aware: You can’t upgrade to a Wells Fargo unsecured card unless you’re a U.S. citizen or permanent resident with a valid Social Security number.

High available credit limit

This card allows for a deposit of up to $10,000 to establish your available credit limit. While you’re only required to put down a minimum of $300 for the security deposit (as collateral for using the card), you have the option to deposit up to $10,000 when you get started.

For those hoping to build their credit quickly, this is a great feature because your credit scores are in large part based on how much available credit you use (also known as your credit utilization). If you’re financially able to deposit more than $300, then it could be worth increasing your available credit limit.

This will help you borrow just a small amount of the total limit available to you. But it’s worth pointing out that after your initial security deposit you can only increase your deposit (and thus your credit limit) in $100 increments up to $10,000.

Clear path to transition to an unsecured credit card

After some time paying off your balance in full and regularly, Wells Fargo may upgrade you to an unsecured card. At this point, you can get your security deposit back.

Reports to the three major credit bureaus

Rest assured that Wells Fargo regularly reports your account activity to Equifax, Experian and TransUnion, so all that hard work you’re doing to build credit is noticed.

Perks like cellphone protection

This card also comes with the neat perk of cellphone protection. If your phone is severely damaged or stolen, you have protection of up to $600. It’s worth noting that you do have to pay a $25 fee to make a claim and are limited to two claims per year.

Heads up: What you should consider before applying for the Wells Fargo Secured Card

While this card has a lot of great features, it does have some drawbacks that could be dealbreakers for some. Here are some key things to be aware of.

$25 annual fee

Wells Fargo charges a $25 annual fee for this card. Given that many other secured cards don’t have any annual fees, this could be a nonstarter for some folks.

Overdraft fees that are on the higher side

Wells Fargo charges a $12.50 penalty for overdraft protection of $50 or less. That penalty ratchets up to $20 if the overdraft amount is over $50. If you’re prone to overdrawing your account, this could be costly for you in the long run.

High late payment penalty

If you pay your statement late, you’ll get hit with a penalty fee of up to $37. If you know that keeping on top of payments would be a struggle for you, this may be a big drawback.

3% foreign transaction fee

The card comes with a 3% transaction fee on all foreign purchases. With that in mind, this is not a great card to pack on an overseas trip.

Do the math: How to get the most out of the Wells Fargo Secured Card

If you’re trying to build credit with the Wells Fargo Secured Card, you may want to consider depositing the highest amount you can afford for the card’s initial security deposit. Why? Because the main benefit of this card is its high credit limit of up to $10,000.

The amount you put down for a security deposit will determine your credit limit. This high credit limit helps you spend a smaller portion of your total available credit (a factor referred to as credit utilization), which can have a positive impact on your credit scores.

But make sure you don’t deposit so much that you put yourself in financial stress. And, of course, make sure you’re only spending as much as you can regularly pay off. That’s the best way to take advantage of this Wells Fargo Secured Card.

Bottom line: Is the Wells Fargo Secured Card right for you?

The Wells Fargo Secured Card has some undeniable benefits for those looking to build their credit.

If the $25 annual fee isn’t a problem for you and you have the savings or funds to put down a large security deposit, this card could be a good option for building credit. Of course, building is contingent on regular, on-time payments of your balance.

But on the flipside, if you’re strapped for cash or don’t have much in savings, the fees and penalties with this card may outweigh its benefits.

For example, if you’re prone to overdrawing your account and late payments, you could easily waste nearly $140 with just two overdraft incidents and two late payments, as well as the annual fee.

If you need to establish or build credit but don’t have a lot of income for financial cushioning, then there are probably better cards on the market for you.

But if you’re coming to the U.S. as a nonresident or noncitizen looking to build credit, this card is worth your consideration.