You’ll encounter a lot of confusing tax terminology in all the forms you have to fill out when filing your tax return. Although books, YouTube videos, and software programs can help you sort through the madness, a good first step is to prime yourself with basic terms and definitions so you don’t get stressed out.
We’ve rounded up the most commonly used (and confusing) tax terms – and spelled out what they mean for you. Learn the basic meaning of these words to become a more educated tax filer this season.
1. Withholding
Withholding is the portion of your paycheck that your employer takes out and sends directly to the government each pay period as partial payment of your income tax. These withheld taxes are deposited in an Internal Revenue Service (IRS) account, and you are credited for the amount when you file your return.
Your withholding amount is determined by the number of allowances you claim on your W-4 form. Other withholdings from your paycheck go to Social Security and Medicare.
If you claim too many allowances, you may owe money at tax time, and if you significantly underpay your taxes during the year, you may get hit with a penalty when you file your tax return.
To ensure your withholdings are correct, review the breakdown of your paycheck.
2. Filing status
Your filing status determines which tax forms you’ll fill out and is a major factor when calculating your taxable income. Whether you’re single and ready to mingle or joined in matrimony, your relationship status determines how you file and if you’re entitled to any tax breaks.
The filing status options are:
- Single
- Married filing jointly
- Married filing separately
- Head of household
- Qualifying widow or widower with dependent child
The IRS offers a handy tool to help you determine your appropriate filing status. Single, married filing jointly, and head of household are the most common statuses. The IRS also makes it easy to choose the correct filing status when you use the IRS e-file, which also happens to be one of the fastest ways to get your refund.
3. Dependent
A dependent is a child, relative, or other individual who relies on you, the taxpayer, for financial support. Dependents are claimed as a tax exemption on your federal income tax return. There are rules and qualifications for who is considered a dependent, so make sure you double-check the guidelines before claiming anyone as a dependent on your tax forms.
4. Adjusted gross income
Adjusted gross income (AGI) is your total income over the course of one year, including wages, tips, interest, dividends, and capital gains, minus certain deductions. To calculate AGI, subtract all allowable tax adjustments, like retirement account contributions, moving expenses, and student loan interest, from your gross income. This number is most important because the IRS uses your AGI to calculate if you qualify for other tax credits and deductions, figure out your tax liability, and determine your tax bracket.
5. Capital gains
A capital gain is one type of earning that counts toward your gross income. It’s money you earn from selling capital assets, such as stocks, bonds, real estate, and other material items that you sell for more than you originally paid. If you sold an asset resulting in profit this year, you’ll have to pay a capital gains tax, which is 15% for most taxpayers and 20% for those who are in the top bracket.
Note: There are exclusions for capital gains taxes, especially for homeowners who sell a house after living in it for several years.
6. Tax deductions
Tax deductions, also called tax write-offs, are expenses the IRS allows you to subtract from your AGI to arrive at your taxable income. By reducing your taxable income through deductions, you’ll owe less money in taxes.
When calculating your taxable income, there are three different types of deductions to consider:
- Above-the-line deductions. These are immediately subtracted from your gross income. An example would be a contribution to a retirement account.
- Itemized deductions. Itemized deductions include certain medical expenses, charitable contributions, mortgage interest, and more. An itemized deduction requires taxpayers to keep track of each possible tax-reducing expense throughout the year and is usually limited to a certain percentage of one’s adjusted gross income.
- Standard deduction. If you choose not to itemize, you usually qualify to take a standard deduction. The amount of the standard deduction is based on your filing status, age, and whether or not you’re claimed as a dependent on someone else’s tax return.
7. Charitable contribution
A charitable contribution is a type of itemized deduction you can claim for potential tax breaks. When it comes to charitable giving, acting as your best friend’s wingman unfortunately isn’t going to save you any money at tax time.
However, charitable contributions can earn you an itemized tax deduction when you donate to a qualifying non-profit organization, charity, or private foundation. These gifts are commonly made in the form of cash, but can also include real estate, clothing, appreciated securities, and other assets.
To determine if the organization that you have contributed to qualifies for income tax deduction purposes, refer to the Tax Exempt Organization Search.
8. Exemption
Tax exemptions are specific amounts that reduce how much of your income is actually taxable. Tax exemptions can be claimed for yourself, a spouse, or qualifying dependents. The total of your exemption is subtracted from your AGI before the tax is calculated on your remaining taxable income.
Again, generally, you can claim one exemption for yourself and one for your spouse. You can also claim one exemption for each dependent. And no, although you and your spouse may think differently, they are never considered your dependent.
9. Taxable income
10. Tax credit
A tax credit is a dollar-for-dollar reduction of the amount you owe. After you calculate your tax return, you can use credits to reduce the amount that you owe to the IRS. Tax credits are better than tax deductions because they directly impact the amount of money you have to pay back, rather than reducing the amount of taxed income.
In some cases, if your credit exceeds how much you owe, you get the difference back as a refund; these are called “refundable tax credits.” Not every tax credit is refundable, however.
The Earned Income Tax Credit (EITC) is a well-known credit used to decrease taxes for low-income families. The credit amount is determined by your income and number of children.
11. Tax return
A tax return is a document you fill out and file with the IRS every year reporting your income, expenses, and other important tax information. This is how you receive a refund for the overpayment of taxes throughout the year.
12. Federal and state income tax
Federal income tax is the money collected by the federal government that’s applied to all earnings made by each citizen in the U.S. The IRS administers the federal income taxation system.
In addition to federal income tax, most states collect their own income tax on your earnings or income each year. In some states, you may also pay county, city, and even school district taxes.
13. Tax liability
Tax liability refers to the amount of money you owe in taxes to federal, state, and local governments. In general, the more income you earn, the greater your tax liability. Things like tax credits and deductions can help lower your tax liability.
If you have no tax liability in a given year, that’s a good thing! This means you (or your business) don’t owe any money to the federal, state, or local government.
14. Child Tax Credit
The Child Tax Credit is a financial stimulus payment made to benefit families with children who qualify. For 2022 taxes (filed in 2023), the IRS has returned to its original credit limit of $2,000 per child; in recent years, the IRS had increased the credit as a form of COVID relief.
