Finance101 guide: Tax terms you should know
It’s that time again — employers are due to send out W-2s and 1099s by January 31! That means you can start filing your taxes for 2018 and possibly get a return.
Before you do, familiarize yourself with some important — and notoriously confusing — tax terminology. The following guide from Finance101 might help whether you’re filing for the first time, need a refresher or want to inform your accountant of deductions you might qualify for.
Basic tax terms
People that are single — and some married couples — will file tax forms with only their income and asset information. More benefits are available to married couples filing jointly, but some choose not to for various reasons. For example, some spouses don’t want to be jointly responsible for taxes they file.
The Balance says: “You might prefer this arrangement if your income is $20,000 while your spouse earns six figures. Filing jointly would put you on the hook for paying some significant taxes resulting from his far superior income.”
Only those that are married can file their taxes together. That means a couple will use both spouses’ income and tax information. The IRS recommends married couples to file together, as they can claim more deductions than those filing separately. For instance, for the 2018 tax year (for which you’ll be filing by April 15) joint filers’ standard deduction is $24,000 while those filing separately will claim only $12,000 (see below for more information on standard deduction).
Like standard deductions, itemized deductions will reduce your taxable income but through a different process. Instead of claiming one standard deduction across the board, you’d itemize deductions like home mortgage interest, investment interest expenses, and medical expenses. Sometimes it makes more sense just to claim the standard deduction as it might be more than itemized deductions, says H&R Block.
To reduce taxable income, taxpayers can either claim itemized deductions or just one standard deduction, says H&R Block. If you’re claiming a standard deduction, you’ll be subtracting a fixed dollar amount from your taxable income before figuring out what you owe for taxes. As we mentioned above, the standard deduction for 2018’s tax year is $12,000 for individuals and $24,000 for filing jointly.
Also called the Internal Revenue Code, this is a federal document detailing all tax rules that individuals, joint filers, businesses, and more must adhere to when filing taxes. The tax code is altered when Congress writes tax laws but it’s the Internal Revenue Service (IRS) that implements the rules, says Investopedia.
The tax code is thousands of pages long, but the IRS website and various other online resources provide simplified versions for the public to refer to.
Like deductions, you’ll be subtracting these to potentially lower the amount you owe from taxes. However, these will be subtracted from the amount of tax that you owe, not your taxable income. Credits are available for the following: family and dependents, income and savings, homeowners, health care, and education. Research the various credits available on the IRS website to see if you apply.
Tax Cuts and Jobs Act (TCJA)
TCJA is a 2017 tax bill that changed a few parts of the tax code for the tax year 2018 and beyond. Some signature changes were increased standard deductions, increased family tax credits, elimination of personal exemptions, and repealing of the individual mandate formerly required by the Affordable Care Act (ACA).
This tax reform bill was mainly touted by Republicans and the current Administration. The Congressional Budget Office’s analysis of the bill estimated businesses and corporations would receive more benefits but trillions in national debt may be added over some years.
Tax deductions are amounts you can subtract from your taxable income before you figure out taxes owed. There are several deductions you can potentially use: work-related deductions, itemized deductions, education deductions, health care deductions, and investment-related deductions.
Specific deductions in each of these categories are listed on the IRS website. It’s a good idea to see if any of these deductions apply to your situation before filing taxes. If you’re using an accountant, it’s not a bad idea to advise them of any deductions you think are applicable to your tax situation.
Tax rate & tax bracket
A tax rate is at which a person — or corporation — is taxed at. What bracket the individual fits into is based on their income. As of tax year 2019, there are seven tax rates a taxpayer can fit into — 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. There’s also a zero rate.
Each tax year they might get adjusted for inflation. e.g. those that make less than $9,525 will be taxed at 10 percent for tax year 2018. In tax year 2019, however, those making $9,700 or less will be taxed at 10 percent.
You’ll pay taxes to the federal government every paycheck unless you’re a contractor (then, you’d pay taxes to the federal government only when you’re filing by Tax Day). Tax withholding is the amount your employer takes from your paycheck and sends to the IRS in your name.
Home-related tax terms
Home equity line of credit (HELOC)
You might have used or plan to use this type of loan if you’re a homeowner. With a HELOC, a lender will lend the maximum amount using the loan recipients’ home as collateral. The TCJA has affected a lot of deductions, including HELOC.
Whether or not you’ll be able to deduct HELOC under the TCJA is dependent on several factors, Forbes reports. Basically, you can’t deduct it from 2018 to 2025 but there are some exceptions. You can determine if you qualify for any of these exceptions by referring to this IRS guideline.
Mortgage interest deduction
With the implementation of the TCJA, buying a home between December 14, 2017 and 2026 will allow you to deduct the interest on up to $750,000 in mortgage debt. People that bought their homes before December 14, 2017 can deduct up to $1 million in debt.
Inheritance-related tax terms
The estate tax
Your estate refers to the assets that you’ll transfer to a beneficiary upon your death. The estate tax is the tax upon these assets, says the IRS. After determining your gross estate (everything in your estate before taxes), you may be able to apply deductions to your “taxable estate.” These deductions might be debts like mortgages, estate administrative expenses, and property.
This is a tax on the “transfer of property by one individual to another while receiving nothing, or less than full value, in return,” says the IRS. This transfer can be taxed whether it was intended as a gift or not.
Healthcare-related tax terms
Health flexible spending arrangement (FSA)
Through some employees’ work, they’re able to contribute a little bit of their salary each pay period to an FSA. This money can be used to pay for services that aren’t covered by their health insurance plans. It’s especially useful if you have a big expense, like eyeglasses or contacts, because you can save up money for them using an FSA. Other things, like copays, may be paid for using FSAs.
The IRS may change how much money one can contribute to an FSA each year. For example, the cap for contributions during tax year 2018 was $2,650 and for 2019 it’s changed to $2,700.
Money in an FSA usually comes from a pre-tax payroll deduction.
Health Savings Account (HSA)
HSAs are similar to FSAs except that they have to be used in conjunction with an HSA-qualified high deductible health plan (HDHP) and they have different caps. For 2018, for example, the cap was $3,450 for individuals. See page 400 in this IRS bulletin for more.
Like FSA, money in HSAs usually comes from a pre-tax payroll deduction.
When the Affordable Care Act was passed in 2010, all Americans were required to have at least the most basic form of healthcare or pay a tax penalty. This responsibility was called the “individual mandate.”
The TCJA eliminated the individual mandate, a move that some experts say will increase the Affordable Care Act plan deductibles and diminish the risk pool (groups of policyholders). A large risk pool is good because it ensures there will be enough money to cover individuals who get sick.
If you did not purchase health insurance in 2018, you will be paying the penalty for 2018 taxes, but not 2019 onward.
Children-related tax terms
If you’ve adopted a child, you could use the adoption credit to lower your taxes for expenses the IRS considers “eligible.” Some of these include adoption fees, court and attorney costs, traveling expenses, and other expenses related to the legal adoption of an eligible child.
A child that’s eligible for the adoption credit is one that’s under 18 and a U.S. citizen or is unable to care for themselves (someone with a mental or physical disability that prevents them from caring for themselves, for instance).
Child Tax Credit
Parents might be able to claim this credit to reduce the amount of taxes owed. However, both parent and child must meet seven requirements: 1) the child must be under 17, 2) the child must be yours (this includes foster and stepchildren), 3) the child must provide less than half of (or none of) the money used for their support, 4) the child must be claimed as the parent’s dependent on taxes, 5) the child must be a U.S. citizen, 6) the child must have lived with you for more than half the tax year, and 7) your modified adjusted gross income (MAGI) must be above a certain amount.
Also known as “Tax on a Child’s Investment and Other Unearned Income.” If a child has unearned income, like interest or dividends that total more than $2,100, that money could be subject to taxation. For more details on if you must pay this tax or are exempt from it, see the IRS’ section on Kiddie Tax.
Income-related tax terms
Alternative Minimum Tax exemption (AMT)
Just like the name suggests, this is an alternative to the standard deductions and itemized deductions.
In the rare case that you’re using the AMT, you might want to look elsewhere for guidance. The IRS retired its AMT assistant due to “declining use and the significant increase in the AMT exemption amount provided by recent legislation.”
Earned Income Credit (EITC, EIC)
This is a credit that working people in the low to mid-income bracket might be able to qualify for to lower taxes owed. The qualifying income levels might change each year. For 2017, your gross income must be less than $15,010 if filing individually and $20,600 for married couples filing jointly. Those that have children will be able to qualify with higher levels of income.
You can see if you qualify for EIC for 2018’s tax year by using the IRS’ EIC assistant.
Foreign Earned Income Exclusion
You might be able to avoid federal taxation on money you’ve made abroad if you are able to apply for this exclusion. The IRS says: “You may qualify to exclude from income up to an amount of your foreign earnings that is adjusted annually for inflation.” Certain foreign housing amounts and values of meals and lodging provided by an employer might also be able to be excluded.
If you’re not sure whether or not you can exclude foreign earned income, refer to the IRS’ Interactive Tax Assistant.
Business-related tax terms
Section 199A deduction
The TCJA created a new 20 percent deduction for pass-through businesses. Otherwise known as the section 199A deduction, you can find out more about whether or not you qualify on the IRS’ website.
A pass-through business is one of the following: a sole proprietorship, a partnership, a limited liability company (LLC), or an S corporation. They’re considered pass-through for federal taxation purposes, says LegalZoom.
Miscellaneous tax terms
Alimony payment deduction
TCJA eliminated this deduction for most with post-December 31, 2018 divorces. Ex-spouses paying alimony will no longer be able to deduct these from taxable income. On the other side of alimony payments, recipients aren’t required to include payments in their taxable income.
For those unfamiliar with alimony payments: This is a sum of money paid to one ex-spouse for support. Not all divorced couples will be required to pay alimony payments, only if this is determined during divorce arrangements.
Lifetime Learning Credit
You can claim this credit on your taxes if you, a spouse or a dependent, is enrolled at an eligible school to help alleviate some of the costs associated with school and taxes. The IRS says this credit is worth up to $2,000 per tax return.
It’s important to note that this has been eliminated by the TCJA so taxpayers can’t claim this for tax year 2018 onward.
The personal exemption was a specific amount of deduction that you could claim for yourself and dependents. There were a few requirements to this, however. For example, you couldn’t use this deduction if someone else can claim you as a dependent.
Are you familiar with all the tax changes for tax year 2019? See Finance101’s article on what you can expect in the coming year.