In a Nutshell
Wrestling with tax terminology can feel like trying to talk a whole different language when you’re filing your own taxes. Knowing some common tax terms can help you feel more confident about the process.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.