Tax Words To Learn Right Now (As In Today)

As the saying goes, there are only two certainties in life: death and taxes. This saying dates all the way back to 1716, and the word tax is even older than that. But this year, there’s a special twist, making taxes feel a little less … certain. July is tax month, thanks to COVID-19.

Tax, meaning “a sum of money demanded by a government,” comes from the Latin taxare, meaning “censure, charge, tax with a fault,” and dates to around the 1200s.

For centuries, taxes have been a cause of dread for most people. So if you’ve got a sinking feeling in the pit of your stomach right about now, you’re not alone.

In most countries, the government essentially does your taxes for you. But in the United States, there is a unique system with its own vocabulary that residents and citizens have to navigate every year, between the beginning of January and April 15, which is Tax Day. The new deadline for 2020 is July 15.

The Internal Revenue Service, or IRS, is the agency in charge of processing tax returns, and they don’t mess around. To help make this process a little less dreadful, we’ve broken down some of the lingo you’re likely to come across if you file your taxes in the United States.

Form 1040

The key form needed to complete an annual tax return is the Form 1040, or 1040 for short. To this main document, additional forms, known as forms or schedules, may be added, depending on the situation.

If you have an easy tax return—say, if you only work one salaried job and don’t have itemized deductions (more on that in a second)—you might be able to file a Form 1040-EZ (the EZ stands for “easy”). If you have a more complicated return, you might have to use the typical Form 1040.

Every year, the IRS issues a new version of the Form 1040 for that year.

adjusted gross income (AGI)

One of the most important numbers on your Form 1040 is your adjusted gross income. Gross doesn’t mean “disgusting,” although that would be a good joke for the IRS. In business, gross means “the amount of salary or profit before deductions or expenses.” So, your gross income refers to how much money you made before taxes and other deductions.

The adjusted part is a little more complex. The IRS has a complicated system of allowances, exemptions, and credits, that we will get into in a minute. But, basically, there is a list of things that you’re allowed to deduct from your gross income before you even get into any of those other options.

For example, if you are a teacher, you can deduct up to $250 spent out-of-pocket on classroom expenses from your gross income. There are other adjustments available including health savings accounts (HSAs), self-employment health insurance premiums, and IRA deposits.

So, if you are a teacher who made $50,000/year before taxes. And you spent $250 on your classroom that year. Then you put $750 in your health savings account. Your AGI would be $50,000 – $250 – $750 = $49,000.

allowances

If you are allowed to do something in your daily life, you’re generally grateful for this little leeway. When it comes to taxes, allowances are also supposed to make your life easier (in theory).

If you work for an employer as a salaried worker, you had to fill out a Form W-4 when you joined the company. On the W-4, you note how many allowances you would like to take. This determines how much money your employer will withhold from your paychecks for taxes.

The more allowances, the less money they will withhold. The fewer allowances, the more money they will withhold. You have one allowance for yourself, which you can choose to use (although you do not have to). You also get allowances for a spouse and one for each child.

However, buyer beware! If you ask for too many allowances, you might end up stuck with a bill when you file your taxes because your employer did not withhold enough from your paycheck. You can change the number of allowances you have at any time—you just have to fill out at new form W-4 and give it to your employer.

deductions

Deduction means “to take away from or reduce,” which is exactly what deductions do to the amount of taxes you owe. The word might make you think of the way Detective Holmes solves mysteries, but it has less to do with logic and more to do with simple math.

There are two kinds of deductions that you can take, standard and itemized. These are different from the adjustments we mentioned earlier, because these deductions are taken from your adjusted gross income, not your gross income.

Standard deduction

Every year, the IRS sets amounts known as the standard deduction. There are different amounts of standard deductions depending on whether you file as single, married, or head of household.

Itemized deductions

If you are a real devil for the details and appreciate precision, you probably like itemized lists of things. Your best friend may think she has “makeup and stuff” in her purse, but you would be happy to give her an itemized list of all the items she has: two lipsticks, a lip balm, tissues, floss, and three peppermints.

Itemized deductions are also a list. But instead of a list of a purse’s contents, it’s a list of what you are deducting. There are many things that can be considered itemized deductions, and it changes every year. Some examples of things that can be itemized are medical and dental expenses and charitable contributions.

You have to pick either the standard or itemized deductions when you file your Form 1040. Typically, unless you donate a lot of money to charity, it is more beneficial to take the standard deduction. Your deductions are taken from your AGI.

tax-exempt

Certain assets or income are considered tax-exempt. Exempt means “to be free from obligation or duty.” If something is tax-exempt, you are free from the obligation or duty to pay taxes on it.

One common example of tax-exempt income is the interest earned on municipal bonds. Anything that is tax-exempt is yours to keep.

credits

In order to encourage certain behaviors, like investing in green energy, or to help out certain populations, the government will offer tax credits. While we think of credit as recognition for something, in bookkeeping, credit has a slightly different meaning: it’s the amount of money received. Basically, tax credits are like the government giving you a check. Hooray!

The most common credit people will receive is the earned income tax credit, also known as EIC or EITC. One of the biggest economic support programs in the United States, the EIC is a sliding scale credit. If you earn no money, you get no EIC. If you make some money, you will get an EIC based on how much you earned and how many dependents (like children) you have. If you make more than a certain amount, you will no longer get an EIC.

W-2 vs. W-4 vs. W-9

One of the things that makes filing your annual tax return so daunting is the confusing names of the forms, because they are so similar. Take, for example, the W-2, W-4, and W-9.

If you are a salaried employee, when you first started the job you filled out a W-4. That is where you note how many allowances you want.

At the end of the year, typically before the end of January, your employer will give you a W-2. On the W-2, you will find information about how much you were paid that year and how much was deducted for taxes. This information is critical for completing the Form 1040.

If you are a freelancer or contractor, like an Uber driver, you filled out a W-9 when you first began working with the company. You will not get a W-2 at the end of the year, but you might get a 1099. Not sure what that is? Read on.

1098 vs. 1099

A 1099 is a statement of income other than wages. There are different types of 1099 forms, but they include income like contractual earnings or rental property earnings. Unlike your W-2, you may or may not receive a 1099, although you can always request one.

A 1098 is a statement that you can use for itemized deductions if you choose to. A 1098 is a statement of how much money was paid on the interest for a mortgage loan. Similarly, 1098-E statements are specific to student loans. Because if it’s not one loan in our life, it’s another …

refund vs. liability

After you get all your paperwork together and fill out your Form 1040 and all the other schedules you may or may not need, you’re left with one of two numbers at the end: either a refund or a liability.

If you’re lucky, you will get a refund. When you pay more than you owe in taxes, you will get a refund, a word dating back to the 1400s that means “to give back.” This refund includes tax credits that you are eligible for.

If you didn’t pay enough in taxes over the year, you will have a liability. Liability is a slightly fancy word for “what you owe.” If you end up with a jaw-dropping amount of liability when you file your taxes, don’t fret. Contact the IRS. They will work with you to create a payment plan so you can pay off your liability.

With this tax lingo under your belt, you’ll be ready to tackle your US income tax return … or at least know enough to follow what your preparer is telling you. Happy filing!

 

If you’ve got money on the brain after all this (don’t we all?), you should read up on how to talk about it accurately. Do you know the difference between economic and economical?

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