What does adjusted gross income mean? What are itemized deductions or exemptions? Here are 11 important tax terms you should be aware of during tax season.
The U.S. tax code spans over 74,000 pages, which can be quite overwhelming. However, there are numerous resources like books and software to assist you when tax time approaches.
Even if you're not filing your taxes on your own, understanding some key concepts is beneficial. Here's a brief overview of 11 essential tax terms that everyone should know.
Adjusted gross income: This is your total earnings minus any eligible deductions, crucial for determining your tax liability. It influences your tax bracket and how much you can put into tax-deferred retirement accounts.
Basis: This refers to the value of an asset, which is important for calculating gain or loss upon sale. For example, if you sold stocks bought years ago, knowing the original amount you paid is necessary to assess your profit or loss for tax purposes.
Capital gains: This is the profit you earn when selling a capital asset, like stocks or real estate. A profit from sales incurs a capital gains tax, typically 15% for most taxpayers and 20% for those in the highest bracket.
Defined benefit plan: Commonly known as a traditional pension, this retirement plan offers a guaranteed monthly payment upon retirement, based on factors like salary, age, and years of service with the employer.
Defined contribution plan: More prevalent today, this plan involves contributions from both employees and employers. The account's value fluctuates based on contributions and investment performance. Examples include 401(k) plans, 403(b) plans, and profit-sharing plans.
Dependent: A dependent is someone other than yourself or your spouse whom you can claim for tax exemptions. To qualify, they must be either your qualifying child or qualifying relative.
Exempt from withholding: This indicates you're not subject to federal income tax withholding from your paycheck. You must meet specific income and dependency criteria to qualify, although this doesn't exempt you from other tax withholdings like Social Security.
Exemption: This is the amount you can claim for yourself, your spouse, and qualified dependents at tax time. The total exemption amount is deducted from your adjusted gross income before calculating your taxable income.
Itemized deduction: These deductions, which can be claimed on Schedule A (Form 1040), cover medical expenses, home mortgage interest, charitable donations, and more. They are deducted from adjusted gross income to determine taxable income, but cannot be claimed if you opt for the standard deduction.
Standard deduction: Taxpayers who do not itemize deductions can claim a standard deduction. For 2024, the standard deduction amounts are:
- $29,200 – Married Filing Jointly or Qualifying Surviving Spouse
- $21,900 – Head of Household
- $14,600 – Single or Married Filing Separately
Tax credit: This directly reduces the amount of tax you owe. Tax credits can be claimed for various expenses, including child care, education costs, and earned income for lower-income taxpayers.
