TurboTax / Tax Calculators & Tips / All Tax Guides / General Tax Tips / 8 Tax Terms You Should Know

8 Tax Terms You Should Know

Updated for Tax Year 2015


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 & 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 & 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 $54.99*
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
  • Filing Deadline: IRS filing deadline for tax year 2015 is April 18, 2016 (except for residents of Massachusetts or Maine, where the IRS filing deadline for tax year 2015 is April 19, 2016).
  • Try for Free/Pay When You File: TurboTax online and mobile pricing is based on your tax situation and varies by product. Free 1040EZ/A + Free State offer only available with TurboTax Federal 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 expected 3/18/16. Special discount offers may not be valid for mobile in-app purchases.
  • 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 efiling state returns. E-file fees do not apply to New York state returns. Savings and price comparison based on anticipated price increase expected 3/18/16. Prices subject to change without notice.
  • Anytime, anywhere: Internet access required; standard message and data rates apply to download and use mobile app.
  • Fastest refund possible: Fastest tax refund with efile and direct deposit; tax refund timeframes 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 the TurboTax Home & Business/QuickBooks Self-Employed bundle offers.
  • About our TurboTax Product Experts: Customer service and product support vary by time of year.
  • About our credentialed tax experts: Live tax advice service is available via phone for your toughest tax questions; fees may apply. 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 2014 TurboTax products.
  • Most Popular: TurboTax Deluxe is our most popular product among TurboTax Online users with more complex tax situations.