14 Tax Definitions You Should Know

You’ll encounter some specific tax terms in the forms you fill out when filing your tax return. Although books, YouTube videos, and software programs can help you sort through the details, a helpful first step is to prime yourself with basic terms and definitions.

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 file your taxes with confidence.

Need more guidance? Read our Taxes 101 guide to help make tax season less stressful.

An above-the-line deduction allows you to decrease the amount of taxes you owe. Some examples include student loan interest, health savings account (HSA) contributions, educator expenses, and tuition.

When filing your taxes, complete Schedule 1 to claim above-the-line deductions and attach it to your tax return.

Adjusted gross income (AGI) is your total annual income, 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. The IRS uses AGI to determine eligibility for tax credits and deductions, tax liability, and tax brackets.

A below-the-line deduction can also reduce the amount you owe in taxes. Some examples of below-the-line deductions include interest (mortgage, student loan, or investment), charitable donations, and certain medical expenses.

Below-the-line deductions are usually referred to as itemized deductions because they apply after you’ve calculated your AGI.

Capital gains are money you earn from selling capital assets, like stocks, bonds, real estate, and other items you sell for more than you originally paid. If you sold an asset resulting in profit this year, you’d have to pay a capital gains tax of 15% for most taxpayers and 20% for those in the top bracket.¹

On occasion, you might sell capital assets at a loss. In this case, you can claim a loss of up to $3,000 on your taxes¹ – but only if your losses exceed your gains within a given year. Capital losses can also carry over for use in future tax years.

A charitable contribution is an itemized deduction you can claim for potential tax breaks. Charitable contributions can result in an itemized tax deduction when you donate to a qualifying non-profit organization, charity, or private foundation. These gifts are made as cash, real estate, clothing, appreciated securities, and other assets.

Refer to the Tax Exempt Organization Search to figure out if the organization you contributed to qualifies for income tax deduction purposes.

You can claim the child and dependent care credit if you pay for dependent care while you work (or while looking for work). Dependents must fall into one of the following categories:

• A child under 13
• An adult-dependent who is unable to care for themselves

The IRS limits the credit to a maximum of $3,000 for one dependent or $6,000 for two or more dependents.²

The child tax credit is a financial stimulus payment made to benefit families with children who qualify. For 2023 taxes (filed in 2024), the IRS has returned to its original credit limit of $2,000 per child;³ in recent years, the IRS had previously increased the credit as a form of COVID relief.

Cost basis refers to the initial cost of an asset before any appreciation or depreciation occurs. For example, if you purchase a stock for $100, the cost basis of that stock is $100, regardless of its current value.

A dependent is a child, relative, or someone else who relies on you financially. 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 double-check the guidelines before claiming anyone as a dependent on your tax forms.

The earned income tax credit, or EITC, is a refundable tax credit designed for low-to-moderate earners. The earning threshold to qualify for the EITC is $59,187 or less.⁴

The exact amount of the EITC will differ between each taxpayer as it also considers investment income and foreign income.

You may need to pay quarterly estimated taxes if you are a freelancer, independent contractor, or business owner. These payments are due on the following dates:⁵

• April 15, 2023, for income earned between January 1 and March 31, 2023
• June 15, 2023, for income earned between April 1 and May 31, 2023
• September 15, 2023, for income earned between June 1 and Aug. 31, 2023
• January 17, 2024, for income earned between September 1 and December 31, 2023

Failure to make estimated tax payments may result in a penalty. Learn more about what happens if you file taxes late.

Tax exemptions are specific amounts that reduce how much of your income is 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.

Federal income tax is the money the federal government collects applied to all earnings made by each U.S. citizen. The IRS administers the national income taxation system.

In addition to federal income tax, most states collect annual tax on your earnings or income. In some states, you may also pay county, city, and even school district taxes.

Your filing status determines which tax forms you’ll fill out and is a significant factor when calculating your taxable income.

The filing status options are:

• Single
• Married filing jointly
• Married filing separately
• Head of household
• Qualifying widow or widower with a dependent child

The IRS offers a filing status tool to help you determine your appropriate filing status. Single, married filing jointly, and head of household are the most common statuses.⁶

The IRS also makes it easy to choose the correct filing status when you use the IRS e-file, which is one of the fastest ways to get your refund.

If you give money or property to someone without receiving payment or something of equal value, you may be subject to gift tax—even if you don’t intend it to be a gift.

You can gift up to a specific value without paying tax; for the 2023 tax year, that amount is $17,000.⁷

There are some exceptions to gift tax, including the following:

• Educational expenses for a third party
• Medical expenses for a third party
• Gifts to a spouse
• Gifts or donations to a political organization

Certain types of income are considered nontaxable. These include the following:

• Cash rebates
• Child support payments
• Gifts

Unlike the wages you earn from your job, you will not need to pay tax on this income.

Independent contractors, freelancers, and sole proprietors earn “self-employment income.” This term applies to any income you make from providing a service to a customer.

The term “taxable income” could refer to one of two things:

• The wages you earn from your job, which are subject to tax (unlike nontaxable income from child support payments or interest paid on bonds).
• The amount of your income that’s subject to taxes once you’ve subtracted all deductions and exemptions.

Your tax bracket determines the rate at which your income will be taxed. It’s calculated based on your filing status and how much you earn, ranging from 10% to 37%.

A tax credit is a dollar-for-dollar reduction of the amount you owe. After calculating your tax return, you can use credits to reduce the amount 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.

Tax deductions, or tax write-offs, are expenses the IRS allows you to subtract from your AGI to arrive at your taxable income. You’ll owe less in taxes by reducing your taxable income through deductions.

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 contributing to an individual retirement account (IRA) or 401(k).
• 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 your deductions, 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.

Not sure what you can deduct? Discover some of the most best tax deductions to ensure you’re not missing out.

Tax liability refers to the amount of money you owe in taxes to federal, state, and local governments. 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 great! This means you (or your business) don’t owe any money to the federal, state, or local government. If you’ve overpaid, you’ll receive a tax refund.

A tax return is a document you fill out and file with the IRS annually, reporting your income, expenses, and other important tax information. This is how you receive a refund for overpaying taxes throughout the year. If you’ve underpaid, your tax return is how the IRS can tell you owe them money.

Missed the deadline? Find out whether you should file a tax extension.

Your employer withholds a portion of your earnings each pay period and sends it directly to the government as partial payment of your income tax. This is called tax withholding. These 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.

You may owe money at tax if you claim too many allowances. If you significantly underpay your taxes during the year, you may get penalized when you file your tax return.

To ensure your withholdings are correct, learn how to read a pay stub.

Knowing some basic tax terminology is the first step toward saving money on your taxes and filing them correctly. When you know common tax definitions and how they apply to your situation, you can avoid making errors on your tax return and find more deductions to maximize your refund. Be sure to choose direct deposit when you e-file to get your refund faster!

Once you have a handle on your taxes, learn how to file your taxes online.