8 Tax Terms You Should Know

Updated for Tax Year 2017


OVERVIEW

With the proper use of tax deductions and exemptions, you can be sure that you're only paying the amount of tax that you legally owe.


The American tax system is based on the concept of voluntary compliance. That means, as an individual taxpayer, you are responsible for reporting and paying your own income tax. With the proper use of deductions and exemptions, you can be sure that you’re only paying the amount of tax that you legally owe.

Adjusted gross income and taxable income

Your adjusted gross income (AGI) is a modified version of the total income you receive from all sources, such as wages, salaries, dividends and capital gains. To calculate your AGI, you're allowed to subtract various deductions from your total income, including IRA contributions, alimony, moving costs and certain business expenses. AGI is important, because it can affect things like how much you can claim for your itemized deductions, says Arthur Mendoza, M.B.A. and Principal of Hermosa Beach, CA-based Copia Solutions. Most states also base taxation amounts on your AGI, rather than your total income.

At the end of the day, Mendoza says, "taxable income is the most relevant number on your tax return." That's because the amount of tax you owe is based on your taxable income, as opposed to any other figure. "Deductions, exemptions, anything that can lower your adjusted gross income ultimately trickles down to your taxable income," Mendoza says. This can mean lower taxes or a bigger refund.

Standard deduction, itemized deduction and exemptions

"Proper use of deductions and exemptions are two important ways taxpayers can lower the amount they owe," according to Mendoza. The two main types of deductions are itemized deductions and the standard deduction. The standard deduction is the same for all taxpayers and is set by the IRS. The amount varies depending on your filing status, and it is also regularly adjusted for inflation. You subtract your standard deduction directly from your adjusted gross income.

If you do not wish to use the standard deduction, you can claim itemized deductions. Doing so takes additional time, but that extra effort can result in big tax savings, especially if you have big deductions like mortgage interest. If the total amount of your itemized deductions exceeds the standard deduction, you're usually better off itemizing. Common itemized deductions include the following:

  • mortgage interest
  • excess medical expenses
  • charitable contributions
  • casualty losses
  • non-reimbursed employee expenses
  • state, local and property taxes

After you subtract your deductions from your adjusted gross income, the IRS allows you to lower your AGI even further through the use of exemptions. "Exemptions work just like deductions, but they represent a different type of expense," says Mendoza. You're granted one exemption for every member of your household. This includes yourself, your spouse, and any dependents, such as younger children or any family member who relies on you for support. Unlike deductions, the value of each exemption is the same regardless of your filing status. As with the standard deduction, the amount you can deduct for each exemption can vary from year to year.

Credits

Mendoza notes that tax credits are often even more effective than deductions at lowering your taxes. “Credits are a dollar-for-dollar offset to the amount of tax you owe," he says, "rather than a reduction of your taxable income."

For example, if you owe $1,000 in taxes but qualify for a $600 tax credit, the tax you owe drops to $400. If that $600 was a deduction, you might save as little as $60, because it just reduces the amount of your income that can be taxed. Some credits, such as the earned income credit, are "refundable," meaning if the credit is larger than the total tax you owe, you receive a refund from the government.

Filing status

Your filing status determines which tax brackets apply to your return. Filing status options are:

  • single
  • head of household
  • married filing jointly
  • married filing separately
  • qualifying widow(er) with dependent child

You can only select a status that applies to your situation, although in some cases you may have multiple options. For example, if you are married, you can choose to file separately or jointly, although Mendoza states that "in most cases, filing jointly offers the best tax option for married couples."

Withholding

Withholding is the process by which you pay your taxes directly to the IRS as you earn your income. Your employer can set up your paycheck so that a certain amount of tax is withheld every period. If you don't make withholding payments, the IRS might assess a penalty when you file your tax return, since the U.S. uses a "pay-as-you-go" method.

If you over-withhold your taxes, you'll end up with a refund. Tempting as it may be to over-withhold and get a large refund, Mendoza says that's not a financially sound policy. "If the IRS is writing you a check every year, you've been extending the government an interest-free loan. Instead of having the IRS hold your money all year," Mendoza says, "at the very least, you could keep that money in a savings or investment account and earn interest on it. At the end of the tax year, you could withdraw that money—with interest—and have the 'rush' of getting an even bigger 'refund' check."

Get every deduction you deserve

TurboTax Deluxe searches more than 350 tax deductions and credits so you get your maximum refund, guaranteed.

For only $59.99$39.99*
Start for Free

Looking for more information?

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.


Security is built into everything we do
Here's how
* Important Offer Details and Disclosures
  • TURBOTAX ONLINE/MOBILE

  • Try for Free/Pay When You File: TurboTax online and mobile pricing is based on your tax situation and varies by product. Absolute Zero $0 federal (forms 1040EZ/1040A) + $0 state limited time offer only available with TurboTax Free Edition; offer may change or end at any time without notice. Actual prices are determined at the time of print or e-file and are subject to change without notice. Savings and price comparisons based on anticipated price increase. Special discount offers may not be valid for mobile in-app purchases.
  • QuickBooks Self-Employed Offer with TurboTax Self-Employed: To receive your complimentary subscription to QuickBooks Self-Employed through 4/30/19, you must pay for your 2017 TurboTax Self-Employed return by 4/17/18 and sign-in and access your QuickBooks Self-Employed account via mobile app or at https://selfemployed.intuit.com/turbotax at least twice by 7/15/18. You will have the option of renewing your QuickBooks Self-Employed subscription by 4/30/19 for another year at the then-current subscription rate. You may cancel your subscription at any time from within the QuickBooks Self-Employed billing section. See QuickBooks.com for price comparison. Offer not valid for existing QuickBooks Self-Employed subscribers already on a payment plan.
  • Pays for itself (TurboTax Self-Employed): Estimates based on deductible business expenses calculated at the self-employment tax income rate (15%) for tax year 2017. Actual results will vary based on your tax situation.
  • Anytime, anywhere: Internet access required; standard data rates apply to download and use mobile app.
  • Fastest refund possible: Fastest tax refund with e-file and direct deposit; tax refund time frames will vary.
  • Pay for TurboTax out of your federal refund: A $X.XX Refund Processing Service fee applies to this payment method. Prices are subject to change without notice.
  • TurboTax Help and Support: Access to a TurboTax specialist is included with TurboTax Deluxe, Premier, Self-Employed and TurboTax Live; not included with Free Edition (but is available as an upgrade). TurboTax specialists are available to provide general customer help and support using the TurboTax product. SmartLook on-screen help is available on a PC, laptop or the TurboTax mobile app. Service, area of expertise, experience levels, wait times, hours of operation and availability vary, and are subject to restriction and change without notice.
  • Tax Advice, Expert Review and TurboTax Live: Access to tax advice and Expert Review (the ability to have a Tax Expert review and/or sign your tax return) is included with TurboTax Live or as an upgrade from another version, and available through October 15, 2018. These services are provided only by credentialed CPAs, EAs or tax attorneys. State tax advice is free. Some tax topics or situations may not be included as part of this service, which shall be determined in the tax expert’s sole discretion. In the event your return is reviewed by a tax expert and requires a significant level of tax advice or actual preparation, the tax expert may be required to sign your return as the preparer at which point they will assume primary responsibility for the preparation of your return. Expert Review [and TurboTax Live] not available on the TurboTax mobile app or when using a web browser on your mobile phone. On-screen help is available on a PC, laptop or the TurboTax mobile app. Service, area of expertise, experience levels, wait times, hours of operation and availability vary, and are subject to restriction and change without notice.
  • Tax Return Access and My Docs features: Included with TurboTax Deluxe, Premier, Self-Employed, TurboTax Live or with PLUS benefits. Access to all tax-related documents we have on file for you is available through 10/31/2019. Terms and conditions may vary and are subject to change without notice.
  • #1 best-selling tax software: Based on aggregated sales data for all tax year 2016 TurboTax products.
  • Most Popular: TurboTax Deluxe is our most popular product among TurboTax Online users with more complex tax situations.
  • CompleteCheck: Covered under the TurboTax accurate calculations and maximum refund guarantees.
  • #1 rated online tax prep provider: Based on independent comparison of the best online tax software by TopTenReviews.com March 13, 2017.
  • Get tips based on your tax and credit data to help get you to where you want to be: Tax and credit data accessed upon your consent.
  • TURBOTAX CD/DOWNLOAD SOFTWARE

  • TurboTax CD/Download products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees apply for e-filing state returns. E-file fees do not apply to New York state returns. Savings and price comparison based on anticipated price increase. Prices subject to change without notice.
  • Fastest refund possible: Fastest tax refund with e-file and direct deposit; tax refund time frames will vary.
  • Pay for TurboTax out of your federal refund: A $X.XX Refund Processing Service fee applies to this payment method. Prices are subject to change without notice. This benefit is available with TurboTax Federal products except TurboTax Business.
  • About our TurboTax Product Experts: Customer service and product support vary by time of year.
  • About our credentialed tax experts: Live tax advice via phone is included with Premier and Home & Business; fees apply for Basic and Deluxe customers. State tax advice is free. Service, experience levels, hours of operation and availability vary, and are subject to restriction and change without notice. Not available for TurboTax Business customers.
  • #1 best-selling tax software: Based on aggregated sales data for all tax year 2016 TurboTax products.
  • Data Import: Imports financial data from participating companies; may require a free Intuit online account. Quicken and QuickBooks import not available with TurboTax installed on a Mac. Imports from Quicken (2016 and higher) and QuickBooks Desktop (2012 and higher); both Windows only. Quicken import not available for TurboTax Business. Quicken products provided by Quicken Inc., Quicken import subject to change.