It’s bad enough that the tax code is so complicated. It can seem overwhelming to understand. Changes are made at the last minute, sometimes as late as December 31rst, leaving you unsure of what you can actually count on when it comes time to filing. Then, there is the process of filing taxes which can be daunting especially if you do not understand the language of taxes. Just like every industry, there is an internal language that only those ‘in the know’ truly understand.
Here is a compiled list of essential tax terms that will help you navigate the tax filing season.
Withholdings are determined by the W-2 filed with your employer. This form gives you the opportunity to claim exemptions or allowances and determines the amount of taxes deducted from each check. Most filers believe you can only claim withholdings equal to the number in your household. Doing so could result in a smaller paycheck than necessary. Withholdings do not need to correlate with household size and can be adjusted based on home deductions, home ownership, or other factors that reduce tax liability. The purpose of withholdings is to make an educated guess on how much taxes to pay throughout the year so you don’t have a large tax bill when you file. When large refunds are received, you can safely increase withholdings, and give yourself an instant raise.
Filing Status is determined by your household structure. Tax rates are different depending on your household and filing status. Only married couples are allowed to choose filing status and there are strong tax incentives for those who choose the married jointly filing option, instead of married filing separately. The latter option is mostly used by couples in the process of a divorce that has not been finalized. Other filing statuses include single filers, single parents with children, filer as head of household, and widowers with dependent children can get similar benefits to couples filing a joint return.
Tax Exemptions are given for the number of people you support in the household. For example, if you are married with two children, your taxes would show that you have four exemptions. This number is important as it establishes the standard deduction and personal exemptions for your tax return. The dollar amount of your tax exemptions lowers your AGI and taxable income.
AGI or Adjusted Gross Income is the benchmark for income. This is the calculation most commonly used to determine the income of applicants on many forms including loans, income sensitive scholarships, or financial aid forms. The AGI is the industry standard for determining qualification’s based on income. The AGI is calculated by adding all sources of taxable income and then subtracting a few qualifying deductions available without itemizing. Some of the most popular reductions to income include student loan interest, IRA contributions, and the self-employment tax for business owners. These items directly reduce income to produce your AGI.
Tax Deductions are available for businesses and individuals. Business deductions are completed on a separate form and reduce income reported on your taxes. Business deductions directly impact your AGI. A few select individual deductions are taken upfront and reduce AGI. The remainder is taken after the AGI is established and only reduce taxable income without impacting income being reported on credit applications. Personal filers may select the greater of the standard deduction and the itemized deductions.
Standard Deduction may be taken without itemizing. This deduction is based on age, filing status, and the size of your household. The claim offers a fixed amount that reduces your AGI to determine taxable income. You are not required to track any expenses or keep any receipts for this deduction making it the most popular deduction for tax filers. The standard deduction for a married couple filing jointly is $12,600. Single filers get a personal deduction of $6300.
Itemized Deductions reduce the AGI and are reported on the Schedule A. In order to benefit from home interest, charitable contributions, medical deductions and other tax reducing expenses, you must itemize. These deductions are taken before establishing taxable income.
Taxable Income is used in two different ways. First, it is the amount of income reported before establishing the AGI. Second, it is the final amount that is used to calculate the amount of taxed you owe.
Reported taxable income includes W-2 or 1099 income from your employer and interest paid on a savings account from the bank. These are taxed as ordinary income. Other forms of income you might not think of include business income, gambling winnings, jury duty pay, IRA distributions, alimony, and unemployment. Not all income is taxable. Social security, life insurance proceeds, and child support are often not taxed. Capital gains or investment income is taxed at a lower rate than other forms of earned income.
Taxable income is also considered the final calculation on your return that determines the amount of tax you will owe. From that number, tax credits and payments made throughout the year reduce the amount you need to pay at tax time, and can result in a refund being issued.
Tax Credits directly reduce your tax bill and are subtracted from the taxes you owe rather than from income, making them more valuable than deductions. In some cases, you can benefit from a tax credit which will trigger a refund, even if you do not owe any taxes. Other times the tax credit might fully offset your tax liability. Tax credits are available for some educational costs, child care expense, and retirement savings. Low to moderate income families are able to take advantage of the earned income credit (EIC) which can be used even if you do not have children.
Progressive Tax System means the tax rate is not the same across your income. It is paid in tiers. Tax rates start at 10% on the low end and go to 39.6% on the high end. Incomes below your standard deduction and personal exemption do not require taxes to be filed. When income rises above the first tier of $9,225, the rate becomes staggered. For example, all taxpayers pay a 10% tax on the first $9,225 of taxable income. The rate then jumps to 15%. However, the 15% is only taxed on amounts above the $9,225 up to the next tax bracket, which has a threshold of $37,450. This makes calculating taxes more difficult and reduces the amount owed for those in higher tax brackets.
The language of taxes can be difficult to comprehend. Knowing the most common terms used on your tax forms and understanding the technical language, will help you make better decisions when it comes time to filing your taxes.
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If you are burdened with high amounts of credit card debt and are struggling to make your payments, or you’re just not seeing your balances go down, call Timberline Financial today for a free financial analysis.
Our team of highly skilled professionals will evaluate your current situation to see if you may qualify for one of our debt relief programs. You don’t have to struggle with high-interest credit card debt any longer.
Call (855) 250-8329 or get in touch with us by sending a message through our website https://timberlinefinancial.com.