Does filling out your return have you confused? Our tax glossary defines every tax term — and the tax rule it relates to — you ever needed to know.
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published 1 March 2014In Kiplinger’s A to Z tax glossary, you will find more than 100 tax terms defined in easy-to-understand language, along with the latest updates on the facts and figures you need to complete your tax return for 2013 and plan ahead for 2014 and beyond.
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401(k) plan
An employer-sponsored retirement savings plan that allows employees to divert part of their salary to a tax-deferred investment account. Salary put in the plan is not taxed until it is later withdrawn, presumably in retirement. Employers often match part or all of the employee's deposits. Penalties usually apply to withdrawals before age 55 if you leave your job or 59 ½ if you’re still on the job, although most plans allow employees to borrow limited amounts tax- and penalty-free from their accounts. For 2014, the limit for employees is $17,500 — plus an extra $5,500 for those age 50 and older by the end of the year. The maximum contribution limits will likely increase in the future with inflation. The same limits apply for 403(b) plans — used by public schools and non-profits, for example — and 457 plans (used by some local governments). See also Roth 401(k).
1040
The 1040 is the official income tax return form printed and distributed by the Internal Revenue Service. It was introduced in 1913, after the 16th Amendment to the Constitution, which authorized the income tax, was ratified. Today there are three versions of this tax form designed for increasingly complex returns: 1040-EZ, the 1040A and the full fledged 1040. You should use the simplest form that covers all the tax benefits you deserve.
Prior to 2011, the IRS automatically mailed forms to taxpayers of record who had filed on paper the previous year. To save money, however, the IRS no longer automatically mails the forms. You can download the copies you need or pick up forms at libraries, post offices or walk-in IRS offices around the country. You can also request that the IRS send you a form by calling 800-829-3676.
Above-the-line deduction
Certain expenses can be deducted to reduce taxable income even if you don’t itemize deductions. These money-saving write-offs, officially called adjustments to income, include: deductible contributions to traditional IRAs (individual retirement accounts), SIMPLE and Keogh plans, contributions to HSAs (health savings accounts), job-related moving expenses, any penalty paid on early withdrawal of savings, the deduction for 50% of the self-employment tax paid by self-employed taxpayers, alimony payments, interest on higher education loans and certain qualifying college costs, any jury duty pay forfeited to your employer and qualifying travel expenses for members of the Reserves and National Guard. They are called above-the-line deductions because they are subtracted before arriving at adjusted gross income. Exemptions and itemized deductions are subtracted from AGI to arrive at taxable income.
Accelerated depreciation
For most business property, except real estate, the law allows you to depreciate the cost at a rate faster than would be allowed under straight-line depreciation. For example, automobiles and computers are assumed to have a five-year life for tax purposes. With straight-line depreciation, you would be permitted to write off 20% of the cost each year; the accelerated method generally lets you deduct 20% of the business cost the first year, 32% the second, 19.2% the third, 11.52% in years four and five, and the remaining 5.8% in the sixth year. It takes six years to fully depreciate the property, thanks to the "midyear" convention, which, for simplicity, basically assumes that business assets are put into service in the middle of the year. Note: Special bonus depreciation rules enacted by Congress to stimulate business investment after the Great Recession expired at the end of 2013.
Acquisition indebtedness
This is the technical term that Congress uses for what most of us call home mortgage debt on which the interest is deductible. To qualify, the debt must be used to buy, build or substantially improve your principal residence or a second home and must be secured by the property. The interest paid on up to $1 million of acquisition indebtedness is deductible if you itemize deductions.
Active participation
The level of involvement that real estate owners must meet to qualify to deduct up to $25,000 of losses from rental real estate. Failure to pass this test could make such losses nondeductible under passive-loss rules.
Additional child tax credit
You may qualify for this credit if the regular child credit you deserve more than wipes out your tax liability. This additional credit can trigger a refund check from the IRS.
Adjusted basis
Your basis in property is the stepping-off point for determining gain or loss when you sell it. (This is sometimes referred to as cost basis or tax basis or, simply, basis.) The basis generally starts out as what you pay for the property, although special rules apply to assets you inherit or receive as a gift. The basis can be adjusted while you own property. When you buy rental property, for example, the basis begins at what you pay for the place, including certain buying expenses, and it is adjusted upward by the cost of permanent improvements. The basis is reduced by the amount of any depreciation you are allowed to deduct while you own the property. You use your adjusted basis to figure the gain or loss on the sale. When stock or mutual fund shares are involved, your adjusted basis is the cost of the shares, including any brokerage commissions or load fees minus any return of capital payouts.
Adjusted gross income (AGI)
This is your income from all taxable sources minus certain adjustments to income, and is the key to determining your eligibility for certain tax benefits. AGI is reduced by the value of personal and dependency exemptions and by either the standard deduction or the total of your itemized deductions. The resulting amount is your taxable income, the amount on which you income tax bill will be based. See Above-the-line deduction.
Adoption credit
This credit effectively refunds to you part of what you pay to adopt a qualifying child. For 2014, the credit can be as high as $13,190. An eligible child is generally one under age 18 or one who is physically or mentally incapable of caring for himself or herself. If you adopt a special-needs child, you can qualify for the full credit even if the adoption costs less than that. The right to the credit phases out on 2014 returns as AGI rises from $197,880 to $237,880.
Advocate
Alimony
Qualifying payments to an ex-spouse that can be deducted as adjustments to income regardless of whether you itemize. The recipient must include the payments in his or her taxable income.
Alternative minimum tax (AMT)
A special tax designed primarily to prevent the wealthy from using so many legal tax breaks that their regular tax bill is reduced to little or nothing. In recent years, it has hit more and more taxpayers who live in high-tax states, have many children or exercise incentive stock options. The AMT ignores certain tax benefits allowed by the regular rules and applies special rates — 26% and 28% — to a larger amount of income than is hit by the regular tax. The taxpayer pays either the AMT or the regular tax bill, whichever is higher.
Amended return
A revised tax return, filed on Form 1040X, to correct an error on a return filed during the previous three years. An amended return can result in owing extra tax or getting a refund, depending on the mistake you correct.
American Opportunity credit
This tax credit can effectively refund up to $2,500 of college bills paid for a qualifying student’s the first four years of higher education. The credit usually is claimed by the parent of the student. The American Opportunity credit phases out modified adjusted gross income rises between $80,000 and $90,000 on single returns and between $160,000 and $180,000 on joint returns.
Audit
As if you didn't know, this is a review of your tax return by the IRS, during which you are asked to prove that you have correctly reported your income and deductions. Only about 1% of all returns are audited each year and most audits are done by mail and involve specific issues, not the entire return. See 14 IRS Audit Red Flags to learn more about what the IRS is looking for.
Automobile, business use
The cost of driving your car on business can be deducted as a business or employee expense. You can deduct actual costs or, for 2014, 56 cents per mile, plus what you spend for parking and tolls.
Automobile, donating to charity
Strict rules control your charitable deduction of a donated vehicle. In most cases, your deduction is limited to the amount the charity gets for the car when it sells it. The charity should give you this information within 30 days of the sale. Without it, the maximum deduction you’ll be able to claim for the vehicle donation is $500.
Automobile, driving for charity
The cost of using your car while doing charitable work is deductible. You can deduct 14 cents per mile you drove while performing services for a charity. You can also deduct what you pay for parking and tolls.
Bargain sale to charity
Selling property to a charity for less than the property's actually worth. Depending on the circumstances, this could result in a tax deduction or extra taxable income.
Basis
Below-market-rate loans
If you make an interest-free or bargain-rate loan to a friend or relative — or anyone else — you may be required to include in your taxable income some of the interest the IRS believes you should have charged.
Blind
A person is considered legally blind for purposes of qualifying for a larger standard deduction if:
Bond premium
The amount over face value that you pay to buy a bond paying higher than current market rates. With taxable bonds, a portion of the premium can be deducted each year that you own the securities.
Burden of proof
The responsibility of the taxpayer to prove that his or her tax return is accurate, rather than the IRS having to provide convincing evidence that it is inaccurate. Although Congress has shifted the burden of proof to the IRS in certain tax disputes, don't throw away your records. The change will have no effect on the vast majority of taxpayers. The burden shifts only if a case gets to court — which happens very rarely — and then only if the taxpayer has complied with all record-keeping requirements and has cooperated with IRS requests for information. In almost all cases, then, the burden of proof remains on your shoulders.
Cancelled debt
Generally, when a debt is canceled or forgiven, the borrower who benefits is considered to have received taxable income equal to the amount of the canceled debt. There are exceptions. For example, some student loans contain agreements that debt will be forgiven if the borrower works for a certain period of time in a certain profession. And, for several years through 2013, up to $2 million of debt forgiven on a mortgage on a principal residence — in a foreclosure, for example, or short sale — could also be tax-free. (That break, enacted in the aftermath of the housing bust that accompanied the Great Recession, expired at the end of 2013 but may be reenacted for 2014 and later years. If your lender cancels debt on your principal residence, check for updates on this issue.) Also, forgiven debt is not taxable to the extent the borrower is insolvent (that is, whose liabilities exceed his or her assets) or when the debt is waived by a bankruptcy court. You should receive a 1099-C form showing the amount of any cancelled debt; be sure to check to see if you qualify for any exceptions before reporting the amount as taxable income.
Capital expenditure
The cost of a permanent improvement to property. Such expenses, such as adding central air conditioning or an addition to your home, increase the property's adjusted tax basis.
Capital gain
The profit from the sale of assets including stocks, mutual-fund shares and real estate. Gains from the sale of assets owned for 12 months or less are "short-term capital gains" and are taxed in your top tax bracket, just like salary. For most assets owned more than 12 months, profits are considered "long-term capital gains" and are taxed at preferential rates. Taxpayers who otherwise fall in the 10% or 15% bracket, for example, pay 0% on their long-term gains. Most other taxpayers pay 15%, but higher-income taxpayers can pay as much as 23.8%. The special rates for long-term gains do not, however, apply to all gains from investment real estate. To the extent that the gain results from depreciation (depreciation deductions reduce your basis in the property and therefore increase gain dollar for dollar upon sale), a 25% rate generally applies (unless you are in the 10% or 15% bracket, in which case that rate applies) to this "recaptured" depreciation. Also, long term-gains from the sale of collectibles are taxed at 28%. In both cases, higher-income taxpayers may also owe a 3.8% surtax on these gains.
Capital loss
The loss from the sale of assets such as stocks, bonds, mutual funds and real estate. Such losses are first used to offset capital gains and then up to $3,000 of excess losses can be deducted against other income, such as your salary and retirement plan distributions. Long- and short-term losses (distinguished by whether the property was held for more than one year or a shorter period of time) are first used to offset gains of a similar nature. Any excess first offsets the other kind of gain, then up to $3,000 of net loss can be deducted against other types of income each year.
Capital-loss carryover
Capital losses can be used to offset capital gains, and up to $3,000 of any excess loss can be deducted against other income, such as your salary. Losses not currently deductible because of the $3,000 limit can be carried over to future years.
Carryback losses
Firms can normally use net operating losses in the current year to reclaim taxes paid for the previous two years.
Casualty loss
Damage that results from a sudden or unusual event. After being reduced by $100, such personal losses are deductible to the extent that they exceed 10% of your adjusted gross income, if you itemize deductions.
Charitable contribution
A gift of cash or property to a qualified charity for which a tax deduction is allowed. A receipt is required as proof for any single contribution of $250 or more. You must also have either a receipt or a bank record (such as a cancelled check) to back up any donation of cash, regardless of the amount.
Charitable carryovers
Generally, your deduction for donations to charity in one year cannot exceed 50% of your adjusted gross income for that year (30% in the case of donations of appreciated assets and contributions to private foundations). You can carry over any excess for the following five tax years. The carryover expires, however, should you pass away before it is used up. Your heirs cannot claim it.
Charitable mileage
Child credit
This credit reduces your tax liability by $1,000 for each child under age 17 you claim as a dependent on your return. The right to this credit is phased out gradually as adjusted gross income rises over $110,000 on a joint return, $75,000 on an individual return or head of household return, and $55,000 if you're married filing separately. For each $1,000 (or part thereof) that your AGI exceeds the appropriate threshold, you lose $50 of credit.
Child- and dependent-care credit
Not to be confused with the child credit, this one offsets part of the cost of paying for care for a child under the age of 13 or disabled dependent while you work. The credit — which ranges from 20% to 35% of qualifying expenses depending on your income — can be applied to as much as $3,000 of qualifying expenses if you pay for the care of one qualifying child or up to $6,000 if you pay for the care of two or more.
Child support
Payments made under a divorce or separation agreement for the support of a child. The payments are neither deductible by the person who pays them nor considered taxable income to the person who receives the money.
College credits
Two tax credits help pay for higher education. The American Opportunity credit is worth up to $2,500 per student for each of the first four years of college. The credit usually is claimed by the parent of the student. The American Opportunity credit phases out income rises between $80,000 and $90,000 on single returns and between $160,000 and $180,000 on joint returns.
The Lifetime Learning credit can pick up where the American Opportunity credit ends, after the first four years of college. It can apply to tuition for graduate-level courses. It can also apply to any courses designed to acquire or approve job skills. So, it can apply to any post-high-school courses; you don’t have to be pursuing a degree or other credential. The credit is 20% of the first $10,000 of tuition, for a maximum of $2,000 per tax return. This credit phases out gradually as adjusted gross income rises between $50,000 and $60,000 for singles and between $100,000 and $120,000 for married couples. While you claim an American Opportunity credit for each qualifying student, you may claim only a single Lifetime Learning credit each year. There is no limit on the number of years you can claim this credit.
Combat pay
Pay received by members of the U.S. Armed Forces and support personnel in combat zones, including peace-keeping efforts. Military pay received by enlisted personnel serving in combat or designated peace-keeping efforts is tax-free. Officer pay is tax-free up to the maximum pay for enlisted personnel (plus imminent danger/hostile fire pay), an amount that increases each year. Although tax-free, combat pay may now be counted as compensation when determining whether the taxpayer can contribute to an IRA or Roth IRA.
Conservation easements
If you donate to a conservation group or a state or local government an easement to restrict development of your property, you can deduct the resulting decline in value of your property. Your deduction can offset up to 50% of your adjusted gross income. You can carry forward any excess for 15 years.
Constructive receipt
A concept of tax law that taxes income at the time you could have received it, even if you don't actually have it. A paycheck you could pick up in December is considered constructively received and taxed in that year, even if you don't get and cash the check until the following January. Also, interest paid on a savings account is considered constructively received and taxable in the year it is credited to your account, regardless of whether you withdraw the money.
Consumer interest
Coverdell education savings account
This was originally known as the education IRA, even though it had nothing to do with retirement. A Coverdell ESA allows you to put up to $2,000 a year in a special account that will be used to pay a student's school bills. There's no deduction for contributions, but if the money is used to pay qualifying expenses, withdrawals are tax free. The $2,000 cap is the limit on how much can be set aside for any student in one year, regardless of how many people contribute. In addition to being used for college expenses, ESA funds can also be spent for primary and high school bills. Even the cost of a computer is a qualifying expense. The $2,000 contribution limit phases out for single filers with adjusted gross incomes between $95,000 and $110,000. For joint filer, the phase-out zone is between $190,000 and $220,000.
Credit for qualified retirement savings contributions
Damages
If you receive a settlement in a personal injury damage lawsuit that includes money for future medical expenses, the amount is not taxable. But neither can you deduct those future medical expenses covered by the amount of the award allocated to medical care.
Deductions
Expenses you are permitted to subtract from your taxable income before figuring your tax bill. All taxpayers may claim a standard deduction amount — $12,400 for 2014 joint returns, for example, half that amount on individual returns. Higher amounts are allowed for those age 65 and older and the blind. If your qualifying expenses exceed your standard deduction, you may claim the higher amount by itemizing your deductions. Although no records are needed to back up your right to the standard deduction, you must maintain records of qualifying expenditures if you itemize. A restriction on itemized deductions applies for higher-income taxpayers (singles with AGI over $254,200 in 2014, for example, and married couples over $305,050).
Dependent
Someone you support and for whom you can claim a dependency exemption on your tax return. For each dependent you claim, the exemption knocks $3,950 off your taxable income in 2014. Each dependent under age 17 also qualifies his or her parent for a tax credit that's worth up to $1,000. A restriction on the value of exemptions applies for higher-income filers (singles with AGI over $254,200 in 2014, for example, and married couples over $305,050).
Depreciation
A deduction to reflect the gradual loss of value of business property as it wears out. The law assigns a tax life to various types of property, and your basis (cost) in such property is deducted over that period of time. See Accelerated Depreciation.
Direct transfer
A method to move funds from one individual retirement account (IRA) or Keogh plan to another or from a company plan to another company plan or an personal IRA. With a direct transfer, you order one sponsor to transfer the money directly to your new IRA; you do not take possession of the funds. There is no limit on the number of times you can move your money via direct transfer. However, if you take possession of the funds and personally deposit them in the new IRA, the switch is considered a rollover. You can use the rollover method only once each year for each IRA account you own. The direct transfer method must be used to move funds from a company retirement plan to an IRA, or else 20% of the money withdrawn from the company plan will be withheld for the IRS, even if no taxes are due because you are the one who is making the rollover to an IRA.
Earned income
Compensation, such as salary, commissions and tips, you receive for your personal services. This is distinguished from "unearned" income from investments such as interest, dividends and capital gains.
Earned income credit
If your 2014 adjusted gross income is below $52,497, you may be able to claim the earned income credit, which can wipe out your income tax bill and could give you a refund of part of the Social Security taxes you paid. The exact credit amount depends on your income level, as well as how many qualifying children you have. For single taxpayers with no qualifying children, for example, this credit disappears when income exceeds $14,590. For 2014, the maximum credit for a taxpayer with three qualifying children is $6,143; for a taxpayer with no qualifying children, it’s $496.
Education interest
Interest on college loans can be deducted as an adjustment to income, so you get a benefit even if you claim the standard deduction rather than itemizing deductions on your return. To qualify for the write-off, the debt had to be incurred to pay higher education expenses for you, your spouse or your dependent. Up to $2,500 of such interest can be deducted, but this tax-saver — like so many others — is phased out at higher income levels. The deduction phases out as income rises between $60,000 and $75,000 for single filers and $125,000 and $155,000 for joint filers.
Education IRA
Education savings account
Educator expenses
A special $250 deduction for kindergarten through 12th grade teachers for what they spend for classroom supplies. This break expired at the end of 2013, but there’s a good chance Congress will reenact it for 2014. (It has expired and been brought back to life several times in the past.) If you’re a teacher, be sure to check for updates when you work on your 2014 return … and, in the meantime, keep those receipts. This has been an "adjustment to income," which means you get this benefit even if you claim the standard deduction rather than itemizing.
Elderly or disabled credit
This credit is for low-income taxpayers age 65 or older at the end of 2010, or those who are retired on permanent and total disability. This is not an automatic credit for seniors; in fact, relatively few taxpayers qualify for it.
Electronic filing
The fastest way to get your tax return (or a request for an extension of time to file) to the IRS (and state revenue office). The majority of returns are now filed electronically, including tens of millions from home computers.
Energy credits
2013 was the last year you could claim a tax credit for installing energy-saving home improvements such as new doors, new windows, energy-efficient furnaces, heat pumps, hot water heaters, air conditioners, etc. Another credit is still available for more ambitious projects — like solar hot-water heating systems, geothermal heat pumps and, yes, even residential wind energy systems. Start generating your own power and Uncle Sam will rebate 30% of the full cost of your system … with no dollar cap.
Enrolled agent
A tax preparer who, by virtue of passing a tough IRS test or prior IRS work experience, can represent clients at IRS audits and appeals.
Estate tax
Very few estates are large enough to be hit by the federal estate tax. For 2014, for example, the tax applies only to estates larger than $5,340,000. When the tax applies, it is a flat 40% for amounts over that level. That $5-million-plus exemption is now “portable,” which means any part unneeded by the first spouse to die can go to the surviving spouse, protecting a total of $10,680,000 for a married couple. Even if one’s estate is not large enough to trigger a tax, an estate tax return must be filed to transfer the unused portion of the exemption to a widow or widower. Some states have estate taxes as well, with substantially lower exemptions. See States with the Scariest Death Taxes.
Estimated tax
If you have income that's not subject to withholding, such as investment or self-employment income or taxable retirement plan distributions, you may have to make quarterly payments of the estimated amount needed to cover your expected tax liability for the year. You can be penalized if estimated payments, combined with withholding from wages, don't come within $1,000 or 90% of the tax owed for the current year or 100% of the tax owed the previous year. Higher income taxpayers — individuals with adjusted gross incomes of more than $75,000 or married taxpayers with joint AGIs of more than $150,000 — are subject to a higher standard to avoid an underpayment penalty. Their quarterly estimated payments must equal at least 90% of the current year tax or 110% of previous year’s tax liability.
Excess Social Security tax withheld
If you hold more than one job during the year — either at the same time or successively — too much Social Security could be withheld from your pay. Each employer is required to withhold the full 7.65 percent tax from the first $117,000 of wages paid in 2014. But no taxpayer has to pay the full tax on more than the annual limits. If wages from two jobs pushes you over the limit, too much tax will be withheld. You get a credit for the excess when you file your tax return for the year.
Exemptions
You can claim a personal exemption for yourself. On joint returns, a personal exemption is claimed for each spouse. You also get an exemption for each dependent you claim on your return. Each exemption reduces taxable income by $3,950 in 2014. The value of exemptions is reduced for high-income taxpayers (singles with AGI over $254,200 in 2014, for example, and married couples over $305,050).
Expensing
Also known as the Section 179 deduction, expensing lets you deduct in full up to a certain amount worth of business expenditures that normally would be depreciated over a number of years. For 2014, the dollar limit is $25,000, and that amount is gradually phased out if you put more than $200,000 worth of assets into service during the year. In the past, the expensing rule was much more generous, and Congress may reinstate higher limits for 2014 and later years. Watch for updates on this issue.
Fellowships
FICA
The Federal Insurance Contribution Act tax that pays for Social Security and Medicare is split 50/50 between employers and employees. Each pays 7.65 on wages up to a certain amount (the annual wage base) and then 1.45 percent each for any additional wages (which is the Medicare portion of the tax). The full rate applies to the first $117,000 of wages in 2014.
Filing status
Your status determines the size of your standard deduction and the tax-rates that apply to your income. For tax purposes, you are considered single, married filing jointly, married filing separately, head of household or qualifying widow or widower.
Five-year averaging
This special tax-computation method for qualifying lump-sum distributions from company retirement plans is no longer available, but see the discussion of ten-year averaging.
Flexible spending account
Forgiven debt
Gift tax
To prevent people from avoiding the estate tax by giving their property away, the law includes a gift tax, too. You may give up to $14,000 yearly to as many people you want without worrying about this tax. Larger gifts are taxable, but a tax credit offsets the tax on the first $5,340,000 million of lifetime taxable gifts. Any part of the credit used to protect taxable gifts will not be available to reduce estate taxes. When the gift tax is owed, it is owed by the giver, not the recipient.
Gross income
All of your income from taxable sources, before subtracting any adjustments, deductions or exemptions.
Head of household
A filing status with lower tax rates for unmarried or some married persons considered unmarried (for purposes of this filing status) who pay more than half the cost of maintaining a home, generally, for themselves and a qualifying person, for more than half the tax year.
Health Savings Account
HSAs (health savings accounts) allow Americans under age 65 to make tax-deductible contributions to a special account tied to a high-deductible health insurance policy. Earnings inside the HSA are tax deferred (just like in an IRA). To be eligible to contribute to an HSA, you must have a qualified insurance policy, which, for 2014, is one that has a deductible of at least $1,250 for individuals or $2,500 for families. You can contribute up to $3,300 to an HSA in 2014 if you're single or up to $6,550 if you are married and have a family policy. (Those 55 and older by the end of the year can contribute — and deduct — an extra $1,000.)
Money from the HSA can be used tax- and penalty-free to pay the insurance policy deductible, co-payments and any other qualifying medical expenses. Money left in the account at the end of a year can be rolled over to the next year. The penalty for withdrawing HSA funds for non-qualifying purposes before age 65 has been doubled to 20% penalty. After you reach age 65, contributions to the HSA must cease, and non-qualifying withdrawals are taxed but not penalized.
Highly paid individuals
Special anti-discrimination rules can limit retirement plan contributions by highly paid individuals, generally defined as anyone making more than $115,000 in 2014 or who is a 5% owner of the company. If lower-paid employees do not contribute to a 401(k) plan in sufficient numbers, for example, higher-paids can have part of their contributions returned at year-end — in something called a corrective distribution — meaning it will be treated as taxable compensation.
Hobby-loss rule
One requirement for deducting business losses is that you show you are trying to make a profit. The law presumes you're in business for profit if you report a taxable profit for three years out of any five-year period (or two out of seven years if you're into breeding, showing or racing horses). Otherwise, your activity is assumed to be a hobby, unless you can prove otherwise. The distinction is important because if the expenses of a hobby exceed the income, the difference is considered a personal expense, not a tax-deductible loss.
Home office expenses
If you use part of your home regularly and exclusively as the principal place of your business or the place you meet with clients, patients or customers, you can qualify to deduct certain expenses that are otherwise nondeductible personal expenses. You may deduct a portion of your actual expenses (such as your utilities, homeowner's insurance premiums and depreciation, if you own your home, or part of your rent) or use a relatively no “safe harbor” rule that allows figuring the deduction by multiply the number of square in your home office by $5. This method limits the size of the home office to no more than 300 square feet at 300, capping the deduction at $1,500.
Home sale profit
Profit of up to $250,000 ($500,000 for married taxpayers filing jointly) is tax-free, if you owned and lived in the home for two of the five years leading up to the sale. This break can be used multiple times, but not more than once in any two year period. A surviving spouse is considered married (and eligible for a $500,000 exclusion) if a home is sold within two years of the death of his or her husband or wife.
Hope credit
Holding period
The period of time you own an asset for purposes of determining whether profit or loss on its sale is a short- or long-term capital gain or loss. Sales of assets owned one year or less produce short-term results. The sale of assets owned more than 12 months produces long-term results. The holding period begins on the day after you purchase an asset and ends on the day you sell it. If you buy on January 4, for example, your holding period begins January 5. If you sell the following January 4, you have owned the asset for exactly one year . and are stuck with short-term treatment. To be eligible for the gentler long-term tax treatment, you'd need to hold on until January 5, so that you have owned the asset for more than one year. See capital gain.
Home-equity loans
Debt secured by your principal residence or second home — such as a second mortgage or home-equity line of credit — that is not used to buy, build or substantially improve the property. Although interest on most loans is no longer deductible, interest on up to $100,000 of home-equity debt can be written off if you itemize deductions.
Household employee
If someone works in your home — as a child-care provider, for example, or housekeeper or gardener — as your employee (rather than as an independent contractor or an employee of a service company), you may be responsible for paying Social Security and Medicare taxes for the employee. This requirement is triggered in 2014 if you pay the employee $1,900 or more during the year. This is also sometimes called the "nanny tax." (If you pay an employee $1,000 or more in any calendar quarter, you must pay federal unemployment tax.)
Imported drugs
The cost of prescription drugs imported from Canada or any other foreign country is not deductible.
Imputed interest
Interest you are considered to have earned — and therefore owe tax on — if you make a below-market-rate loan. The term is also used to refer to the interest income you must report on taxable zero-coupon bonds. Although the bonds pay no interest until maturity, you must report and pay tax on the interest as it accrues.
Incentive stock option
An option that allows an employee to purchase stock of the employer below current market price. For regular income tax purposes, the "spread" or "bargain element" — the difference between the price paid and market value of the stock — is not taxed when the option is exercised. Rather, it is taxed when the stock is sold. For alternative minimum tax purposes, however, the spread is taxed in the year the option is exercised.
Indexing
An adjustment to prevent inflation from eroding certain tax benefits including standard deductions, exemption amounts, and the beginning and end of each tax bracket. These are automatically adjusted annually based on increases in the consumer price index (CPI).
Individual 401(k) plan
The 401(k) rules now allow a self-employed person with no employees (other than his or her spouse) to use a 401(k) plan to sock away — and deduct — far more for his or her retirement than in the past. For 2014, self-employed individuals can contribute a total of up to $52,000 to a solo 401(k), the sum of their elective deferrals and the business’s contribution. Those 50 and older can shelter an additional $5,500 in "catch-up" contributions.
Individual retirement account
A reference to an IRA without the moniker "Roth" in front of it is a reference to a traditional IRA, a tax-favored account designed to encourage saving for retirement. If your income is below a certain level or you are not covered by a retirement plan at work, deposits into a traditional IRA can be deducted. The maximum annual contribution for 2014 — deductible or not — is $5,500 or 100 percent of the compensation earned during the year, whichever is less. Those who are age 50 or older at the end of the year can add a $1,000 "catch-up" contribution, bringing their annual limit to $6,500. Also, a husband or wife can contribute part of his or her compensation to an IRA for a non-working spouse.
The tax on all earnings inside the IRA is postponed until you withdraw the funds. In most cases there is a penalty for withdrawing funds before you reach age 59 1/2. The right to deduct contributions phases out at higher income levels for those covered by a retirement plan at work. For single taxpayers covered by a company plan, the deduction phases out as income rises between $60,000 and $70,000 in 2014; for married couples filing joint returns, the deduction phases out as income rises between $96,000 and $116,000 in 2014. The phase out zone for deducting a spousal IRA contribution is between $181,000 and $191,000 of adjusted gross income. See Roth IRA.
Individual retirement arrangement
IRA payouts for first-time homebuyers
As a general rule, any withdrawal from traditional IRA before age 59 ½ or a withdrawal of earnings from a Roth IRA is hit with a 10% tax penalty. But the penalty is waived on up to $10,000 of traditional IRA funds or Roth earnings withdrawn to buy a first home for yourself, a child or grandchild, or your parents or grandparents.
IRA withdrawals for education
The typical 10% penalty for early (pre-age 59 ½) withdrawal from traditional IRAs is waived if the distributions is used to pay higher education expenses for yourself, your spouse, or a dependent. However, the payout is taxed as income to you. Similarly, if you withdraw earnings from a Roth prior to age 59 ½ to pay for qualifying educational expenses, the 10% penalty is waived.
Innocent-spouse rules
Tax rules designed to protect married taxpayers who file joint returns from being held responsible for taxes due to erroneous actions by their spouses — such as failing to report income or claiming unsubstantiated deductions. Basically, if you can show that you didn't know and didn't have reason to know about an error that resulted in the underpayment of tax on the joint return, you can be relieved of responsibility for that underpayment. You have two years from the time the IRS begins trying to collect the underpayment to petition for innocent-spouse relief.
Installment sale
With an installment sale, you agree to have the purchaser pay you over a number of years, and you report the profit on the sale as you receive the money instead of all at once in the year of the sale.
Investment interest
Interest paid on loans used for investment purposes, such as to buy stock on margin. You can deduct this interest on Schedule A if you itemize, up to the amount of investment income (not including capital gains or dividends that qualify for preferential tax rates) you report.
Itemized deductions
Job-hunting costs
The costs of looking for a new job in your same line of work are deductible. Qualifying expenses include the cost of want ads, employment-agency fees, printing and mailing resumes, and travel expenses such as transportation, lodging, and 50% of food, if your job hunting takes you away from home overnight. This write off is a “miscellaneous expense”, deductible to the extent that all your miscellaneous expenses exceed 2% of your adjusted gross income.
Job-related education
The cost of education that maintains or improves skills you use on the job, or that is required to maintain your job is deductible. Education that qualifies you for a new trade or business, such as law school, is not eligible for this deduction, but may be eligible for the American Opportunity or Lifetime Learning credit. This write off is a “miscellaneous expense”, deductible to the extent that all your miscellaneous expenses exceed 2% of your adjusted gross income.
Job-related move
Jury duty pay forfeited to employer
Jury fees you are required to turn over to your employer — in exchange for your salary continuing while you do your civic duty — are deductible. This will offset the jury fee income you are required to report if the money only passes through your hands.
Kiddie cards
A reference to the Social Security cards needed by any child you claim as a dependent on your tax return. The nine-digit identifying number shown on the card must be reported on the tax return of the parent who claims the child as a dependent. What if a child is born late in the year, and you haven't received a Social Security number by the time you're ready to file? The IRS says you must delay filing, even if it means getting an extension to file past the April 15 deadline. If you claim a dependent and fail to include the number, the exemption will be rejected and your tax bill hiked accordingly.
Kiddie tax
For 2014, this special tax imposes the parents' tax rate on investment income in excess of $2,000 earned by children under age 18 or full-time students under the age of 24. The first $1,000 of the child's 2014 income is tax free, the next $1,000 is taxed at his or her (presumably) low rate. After that, the parents’ rate applies.
Keogh Plan
Also known as an H.R. 10 plan, this is a retirement plan for the self-employed. As much as 20 percent of your net earnings from self-employment income (up to $52,000 in 2014) can be deposited in a Keogh, and contributions can be deducted. For taxpayers age 50 and older, the limit is $5,500 higher. There is no tax on the earnings until the money is withdrawn, and there are restrictions on tapping the account before age 59 ½.
Lifetime Learning Credit
Like-kind exchange
The tax-free exchange of similar assets, such as real estate for real estate. The tax on profit accrued on the first property is deferred until the subsequent property is sold.
Limited partnerships
Investments — in real estate and oil and gas, for example — that pass both profits and losses on to investors. By definition, limited partnerships are passive investments, subject to the passive-loss rules.
Listed property
"Listed property" is the term used for depreciable assets that Congress has put on a special list for special scrutiny by the IRS. Basically, this includes things Congress worries you might use for personal as well as business purposes — a car, computer, boat, airplane and photographic and video equipment. (If a computer or photographic or video equipment is used exclusively at your regular place of business, however, it is not considered listed property.) There are special restrictions on the depreciation of listed property if business use does not exceed 50%. And IRS can deny deductions if you can’t document the business usage of listed property.
Long-term care insurance premium
Premiums paid for long-term care insurance can be deducted as a medical expense. The maximum annual deduction is based on your age, ranging from $370 for those age 40 or younger in 2014 to $4,660 for those older than 70.
Long-term gain or loss
Lump-sum distribution
The payment within one year of the full amount of your interest in a pension or profit-sharing plan. To qualify as a lump-sum distribution — and potentially for favorable tax treatment — other requirements must be met.
Luxury-car rules
Special rules restrict the depreciation write offs businesses can claim on vehicles. Basically, Congress doesn’t want to be subsidizing opulent luxury cars when less expensive vehicles can adequately serve the purpose of getting workers from point A to point B. Regardless of how much you spent for a new business vehicle in 2014, for example, the maximum first year depreciation is generally limited to $3,160.
Margin interest
Marginal tax rate
The share of each extra dollar of income that will go to the IRS. It's not necessarily the same as the rate in your top tax bracket because, in many cases, rising income squeezes the value of tax breaks. The extra income is effectively taxed more harshly than advertised. Knowing your marginal rate tells you how much of each additional dollar you make will go to the IRS and how much you'll save for every dollar of deductions you claim.
Marital deduction
The deduction that allows any amount of property to go from one spouse to the other — via lifetime gifts or bequests — free of federal gift or estate taxes. Gifts or bequests to a spouse do not eat into the exemption that allows you to transfer up to $5,340,000 before having to pay the gift or estate tax.
Market discount
The difference between what you pay for a bond and its higher face value. The tax treatment varies depending on whether the bond is taxable or tax-free and whether you redeem it at maturity or sell it before that time.
Master limited partnerships
Similar to regular limited partnerships, but MLPs shares are traded on the major exchanges, making for a much more liquid investment. Although limited-partnership losses are considered passive, income from an MLP is considered investment income rather than passive income. That means passive losses can't be used to shelter MLP income.
Material participation
The test used to determine whether you are involved enough in a business to avoid the passive-loss rules. To be considered a material participant, you must be involved on a "regular, continuous and substantial basis." One way to pass the test is to participate in the business for more than 500 hours during the year.
Medicare tax
The portion of the Social Security tax — 1.45% for employees and 2.9% for self-employed taxpayers — that pays for Medicare. Although the part of the tax that pays for retirement benefits stops at $117,000 in 2014, the Medicare portion applies to all wages and self-employment income.
Midmonth convention
The rule that treats certain kinds of depreciable property, including real estate, as though it were placed in service in the middle of the month it was first used.
Midquarter convention
In general, business property is depreciated under a midyear rule that allows half a year's depreciation for the first year, whether you buy property in January or December. However, if you buy more than 40% of the business property you put into service for the year during the fourth quarter, the midquarter convention takes over. With it, you depreciate each piece of property as though it were placed into service in the middle of the calendar quarter in which it was purchased. You claim just six weeks' worth of depreciation for property put in service during the final quarter, for example.
Mileage rate
Mortgage interest
A term often used to refer to deductible interest paid on debt that qualifies as acquisition indebtedness or home-equity debt. Interest on up to $1 million of debt used to buy or build your principal residence or second home can be deducted; in addition, interest on up to $100,000 borrowing via a home-equity loan or line of credit can be deducted, regardless of how you use the money.
Moving expenses
Some of the costs of moving in connection with taking a new job are deductible. To qualify for the deduction, the new job must be at least 50 miles farther from your old home than your old job was. Deductible expenses include the cost of moving your household goods, as well as travel and lodging expenses for you and your family. If you moved to take your first job, the 50-mile test applies to the distance between your old home and your new job. You can take this deduction even if claim the standard deduction rather than itemizing deductions on your return.
Multiple-support agreement
An agreement under which two or more taxpayers, who together provide more than half the support for someone else, agree that one will claim that person as a dependent and the others will not.
Nanny tax
Net operating losses
Net operating losses from your business generally are carried back for two years (triggering a refund of taxes paid) unless you specifically elect to carry them forward to future tax years.
Net unrealized appreciation (NUA)
NUA comes into play if you take a total payout from a company retirement plan that includes appreciated stock of the company for which you work. Rather than make a tax-free rollover of the entire amount to an IRA, you can roll the employer stock into a taxable account and owe tax only on the stock's value when you acquired the shares. The net unrealized appreciation that accrued while the stock was inside the plan will not be taxed until you ultimately sell the stock. At that point, the profit can qualify for special long-term capital gain treatment. If you rolled the stock into an IRA, the tax would be delayed until you withdrew the money from the IRA, but all appreciation would be taxed as ordinary income when withdrawn, at your top tax rate.
Nonbusiness bad debt
A bad debt not connected with your trade or business. An uncollectible loan to a friend or a deposit to a contractor who becomes insolvent are examples. If your efforts to collect the debt are unsuccessful, a nonbusiness bad debt is deductible as a short-term capital loss in the year the debt becomes entirely worthless.
Noncash contributions
You can deduct as a charitable contribution the full fair-market value of assets that you have owned for more than a year before you donate them to charity. The deduction for assets owned one year or less is limited to your tax basis, which is generally what you paid for the property. If you give property with a total value of more than $500, you’ll need to file Form 8283 and give details about the assets, including a description of them and their individual values. If their value is more than $5,000, you generally will need to attach an appraisal, unless you give listed securities. Note that if you donate used clothing or household items such as furniture, appliances, linens, or electronics, you can’t deduct the value of the items unless they are in excellent or good condition.
Nonqualified stock options
Options to purchase company stock that are granted to employees as compensation but do not meet restrictions necessary to qualify as incentive stock options. (See Incentive stock option.) There is no tax consequence when the options are granted but when employees exercise the options to purchase stock, the "spread" or "bargain element" — the difference between purchase price and the stock's value — is taxed as additional compensation.
Out-of-pocket contributions
Expenses you incur while working for a charity — from the cost of driving your car (14 cents a mile, plus parking and tolls) to the cost of stamps for a charitable fundraiser — can be included in your charitable contribution deduction. Treat the cost as a cash contribution to the charity.
Original issue discount (OID)
The amount by which the face value of a bond exceeds its issue price. Part of the discount on taxable bonds must be reported as taxable interest income each year that you own the securities.
Passive-loss rules
Passive activities are investments in which you do not materially participate. Losses from such investments can be used only to offset income from similarly passive investments. Passive losses generally can't be deducted against other kinds of income, such as salary or income from interest, dividends or capital gains. Generally, all real estate and limited-partnership investments are considered passive activities, but there is an exception for real estate professionals and an exception for up to $25,000 of losses from rental real estate in which non-professionals actively participate. Losses you can't use because you have no passive income to offset can be carried over to future years.
Personal exemption
Personal interest
Basically, this is interest that doesn't qualify as mortgage, business, student loan or investment interest. Included is interest you pay on credit cards, car loans, life insurance loans and any other personal borrowing not secured by your home. Personal interest cannot be deducted.
Points
In connection with getting a home mortgage, each point is equal to 1% of the mortgage amount. Points paid on a mortgage to buy or improve your principal residence are generally fully deductible in the year you pay them. You get to deduct the points even if you convince the seller to pay them for you, as long as you paid enough cash at closing — as a down payment, for example — to cover the points. Points paid to refinance the mortgage on a principal home or to buy any other property must be deducted over the life of the loan.
Portability
The provision in the estate tax law that allows any part of the $5-million-plus estate tax exemption not used by the first spouse to die can go to the surviving spouse, effectively doubling the estate tax exemption for a married couple. Even if one’s estate is not large enough to trigger a tax, an estate tax return must be filed to transfer the unused portion of the exemption to a widow or widower.
Preference items
Tax breaks allowed under the regular income tax but not under the alternative minimum tax, including the deduction of state and local taxes and interest on home-equity loans. One that is becoming more and more important to more and more taxpayers is the "spread" between the exercise price and the value of stock purchased with incentive stock options. Although that amount is not taxed under the regular tax, it is a preference item subject to tax if you're hit by the AMT.
Prizes and awards
The value of a prize or award is generally taxable, so if you win the lotto, Uncle Sam is a winner, too. One exception is that certain non-cash employee awards — the proverbial gold watch, for example — can be tax-free.
Premature distribution
Withdrawals from a company retirement plan which are subject to a 10% penalty (in most cases) if you're under age 55 in the year you leave the job. "Early" withdrawals from a traditional IRA are generally subject to the 10% penalty if you're under age 59½.
Property taxes
Qualified plan
An employee benefit plan — such as a pension or profit-sharing plan — that meets IRS requirements designed to protect employees' interests.
Real estate taxes
Real estate taxes you pay are deductible. You can deduct state and local property taxes paid on any number of personal residences or other real property you own. There is no limit as there is with mortgage interest.
Recapture of depreciation
When you depreciate investment real estate, your tax basis declines. To the extent that profit when you sell is due to the reduced basis (rather than appreciation), the law recaptures part of the depreciation tax break by taxing that part of your profit at 25% . rather than the regular 0%, 15% or 20% rate for capital gains.
Reimbursement account
A fringe benefit, sometimes called a flexible spending account or salary reduction plan, that allows an employee to divert some of his or her salary to a special account that is used to reimburse the employee for medical or child-care expenses. Funds channeled through the account escape federal income, Social Security taxes and state income taxes.
Retirement saver's credit
This credit is worth as much as 50% of up to $2,000 contributed to an IRA, 401(k) or other retirement plan. It is designed to encourage lower-income workers to save for their retirement. For 2014, it’s worth 50% of up to $2,000 contributed if your AGI is less than $18,000 on a single return or $36,000 on a joint return. It gradually diminishes as income rises and disappears when income passes $30,000 on single returns and $60,000 on joint returns. Taxpayers under age 18 and those claimed as dependents on their parents' returns are not eligible, regardless of their income.
Rollover
The tax-free transfer of funds from one individual retirement account to another or from a company plan to an IRA. If you take possession of the funds, the money must be deposited in the new IRA within 60 days. Beware that when the rollover method is used to move money from a company plan to an IRA, 20% of the amount will be withheld for the IRS, even though the rollover is tax-free if the money is in the IRA within 60 days. To avoid this automatic withholding, use the direct transfer method to move money from a company plan to an IRA. See direct transfer. You can also use a rollover to move money from a medical savings account (MSA) to a health savings account (HSA).
Roth 401(k)
Employers are now allowed to add a Roth option to 401(k) plans to allow employees to invest after-tax money with the promise of tax-free withdrawals in retirement. With the regular 401(k), you invest pre-tax money but have to pay tax on all withdrawals in retirement. If your firm offers a matching contribution, it must go into the traditional 401(k), and you will be taxed on distributions from that part of the plan. The same dollar limits apply to Roth 401(k)s as to regular plans. The maximum contribution in 2014 is $17,500, plus a $5,500 catch-up contribution for workers age 50 and older. You can choose to divert part of your pay to each kind of account, but your combined contributions can’t exceed the limit.
Roth IRA
The back-loaded IRA is named after a chief supporter — the late Sen. William Roth of Delaware. It's called back-loaded because the tax benefits come at the end of the line. Contributions are not deductible, but all withdrawals are tax-free, as long as they come after you reach age 59½ and at least four calendar years after the year in which the account was opened. Contribution limits are the same as for traditional IRA: $5,500 in 2014, with an extra $1,000 catch-up contribution allowed for those age 50 and older. But there's a catch: If your income is too high, you can't contribute to a Roth. What's too high? In 2014, the right to use the Roth IRA phases out between $114,000 and $129,000 for single returns and $181,000 and $191,000 for joint returns. See more about these plans in our Roth IRA Special Report.
S corporation
Named after the subchapter of the tax law that authorizes it, an S corporation generally pays no tax because profits and losses are passed on and taxed to the shareholders.
Sales taxes
State and local sales taxes you pay may be deductible. But you must choose between deduction sales taxes or deducting city and state income taxes. If you live in a state that does not impose an income tax, claim the sales tax deduction. You don’t need to keep all your receipts, either. The IRS has a handy table with estimates based on your income, family size, and where you live. You can add to the table amount sales taxes paid on cars, boats, aircraft, and other big ticket items. Purchase of such items could lead some taxpayers in income-tax states to pay more sales tax than income tax. You can choose whichever deduction is most valuable to you.
Saver's credit
Salary reduction plan
Scholarships and fellowships
Scholarships and fellowships received by degree candidates to cover tuition, fees, books and supplies are generally tax-free. But amounts for room and board are taxable.
Section 179 deduction
SECA
The Self Employment Contributions Act tax that pays for Social Security and Medicare. While employees share this 15.3% tax with their employers (each pays half), self-employeds must pay the full tax themselves. For 2014, the rate is 15.3 percent on the first $117,000 of earnings and 2.9 percent on all amounts over that amount..
Self-employed health insurance premiums
Premiums paid by a self-employed person for medical insurance for yourself, your spouse, or dependents can be deductible, even if you don’t itemize deductions.
SEP
A simplified employee pension (SEP) is a tax-favored retirement plan for self-employed taxpayers. Contributions to the plan can be deducted. The maximum contribution for 2014 is the smaller of 20% of your net earnings from self-employment or $52,000.
Short sale
The sale of borrowed stock, usually with the hope that the stock price will fall. If it does, the investor profits by repaying the loan with shares purchased at the lower price. If the stock price increases, the investor loses and has to repay the loan with shares that cost more than those sold. As far as the IRS is concerned, the transaction doesn't count for tax purposes until the investor delivers stock to the lender to close the sale.
Short-term gains and losses
SIMPLE
The Savings Incentive Match Plan for Employees (SIMPLE) is a retirement plan that can be offered by firms with 100 or fewer employees. A key is that the employer generally must match employee contributions up to 3% or contribute 2% of pay for each employee, regardless of whether they contribute on their own. The rules are simpler than other tax-qualified retirement plans, and Congress hopes that this will encourage smaller employers to establish plans. For 2014, a self-employed person with no employees could open a SIMPLE and contribute up to $12,000 of self-employment earnings (plus a $2,500 catch-up contribution for those age 50 or older by the end of the year).
Social Security tax
Social Security Tax, excess withheld
If you hold more than one job during the year — either at the same time or successively — too much Social Security could be withheld from your pay. Each employer is required to withhold the full 7.65 percent tax from the first $117,000 of wages paid in 2014. But no taxpayer has to pay the full tax on more than the annual limits. If wages from two jobs pushes you over the limit, too much tax will be withheld. You get a credit for the excess when you file your tax return for the year.
Spousal IRA
Generally, to contribute to a traditional or Roth IRA, you must have earned income. But, a working spouse can contribute up to $5,500 of his or her earned income to an IRA for a non-working spouse. The limit is $6,500 if the account owner is age 50 or older by the end of the year.
Standard deduction
A no-questions-asked write-off that reduces taxable income, the amount of which varies depending on your filing status. For 2014, for example, the standard deduction is $12,400 on a joint return, $6,200 on a single return and $9,100 on a head of household return. Taxpayers age 65 and older or blind get larger standard deductions. Unlike taxpayers who itemize deductions, you need no records to prove you deserve this deduction. Even if you somehow made it through the year without incurring any deductible expenses, you may still claim the full standard deduction. About two-thirds of all taxpayers use the standard deduction rather than itemize.
Standard deduction for a dependent
If you can claim a child as your dependent on your tax return, the child may not claim a personal exemption on his or her tax return. But, if the child files a tax return, he or she still gets a standard deduction of between $1,000 and $6,200 in 2014, depending on how much money they earn and the source of that income.
Standard mileage rate
The deductible amount you can claim for each mile you use your car for business, charitable, job-related moving or medical purposes without having to keep track of the actual cost. For 2014, the standard rate for business travel is 56 cents per mile; for medically-related use of your car and job-related moving purposes, it's 23.5 cents a mile. For 2014 driving connected with a charity, it's 14 cents a mile. In any case, you add the cost of parking and tolls.
Stepped-up basis
The basis of inherited property is stepped up to its value on the date of death of the owner, or a slightly later date if chosen by the executor of a taxable estate. In other words, tax on any appreciation during his or her lifetime is forgiven. The heir uses the higher basis to figure his or her gain when the property is ultimately sold. If the value of property declined while it was owned by the decedent, the basis is stepped down to date of death value.
Student loan interest deduction
You can deduct up to $2,500 of interest on student loans used to pay for college or other post-high-school education expenses for yourself, your spouse or your dependents. This tax break is phased out for 2014 as income rises between $60,000 and $75,000 on single returns and between $125,000 and $155,000 on joint returns. You can claim this write-off whether or not you itemize deductions.
Taxable income
This can mean different things. It can refer to income that is taxable (such as wages, interest and dividends) rather than tax-exempt (such as the interest on municipal bonds). On tax returns, "taxable income" is your income after subtracting all adjustments, deductions and exemptions — that is, the amount on which your tax bill is computed.
Tax bracket
Each tax bracket encompasses a certain amount of income to be taxed at a set rate. The rates now run through seven brackets from 10% to 39.6%. You are said to be in the 25% bracket if your highest dollar of income falls in that bracket. Even if you're in the 25% bracket, part of your income is taxed at the 10% rate and some at 15%. Some of your income — such as the amounts protected by your personal and any dependent exemptions and your standard or itemized deductions — is not taxed at all.
Tax-exempt interest
Interest paid on bonds issued by states or municipalities that is tax-free for federal income tax purposes. Although you must report this income on your return, it is not taxed. Note that some interest that is exempt from the regular tax is taxed by the Alternative Minimum Tax.
Tax-free income
All sorts of income can be tax-free, including: auto rebates; car-pool receipts; casualty insurance proceeds; child-support payments; combat pay; damages in lawsuits for physical injury; disability payments, if you paid the premiums for the policy; dividends on a life insurance policy, up to the total of premiums paid; Education Savings Account withdrawals used for qualifying expenses; gifts; Health Savings Account withdrawals used for qualifying payments; inheritances; life insurance proceeds; municipal bond interest; policy officer survivor payments; profits from the sale of a home, up to $250,000 if you're single or $500,000 if you're married; Roth IRA and 401(k) withdrawals; scholarships and fellowship grants; Social Security benefits (between 15% and 100% are tax-free); state tax refunds; veterans benefits; and workers' compensation.
Taxpayer advocate
The official inside the IRS who is charged with helping individuals resolve their problems with the IRS, as well as identifying changes in IRS procedures that could make the agency more taxpayer-friendly. This official oversees IRS Problem Resolution Officers (PRO) around the country. You should go to a PRO, or ultimately the Advocate, if you are getting the run-around — or worse — from regular IRS channels. More on the Taxpayer Advocate Service
Tax preference item
Ten year averaging
Even though five-year averaging has been abolished, this special tax-computation method for lump-sum distributions from pension and profit-sharing plans is still available . but only to taxpayers born before January 2, 1936. If you qualify, it could save you a substantial amount.
Traditional IRA
Tuition credit
Unearned income
Income from investments, such as interest, dividends and capital gains. See Earned income.
Underpayment penalty
The penalty is the IRS's not-so-subtle reminder that taxes are due as income is earned, not just on April 15 of the following year. Basically, it works like interest on a loan, with the penalty rate applied to the amount of estimated tax due but unpaid by each of four payment dates during the year. The penalty rate is set by the IRS and can change each quarter. It was 3% at the beginning of 2014. There are several exceptions to the penalty. See estimated tax.
Vacation home
Special tax rules apply if you rent out a vacation home, and the rules differ depending on how much you use the home personally. While all rental income is to be reported, the deductibility of expenses can be limited if you engage in "too much" personal use — generally defined as using the home for more than 14 days during the year or more than 10% of the number of days it is rented for fair market rent.
Vested benefits
Benefits in a company retirement plan that are yours to keep if you leave the job. Your own contributions, to a 401(k), say, are immediately 100% vested. But employer contributions on your behalf can be vested gradually over a period of time, as a way to encourage you to stay with the employer. If you quit a job when just 50% of your benefits are vested, for example, you would forfeit half of the amount the employer has set aside for you. Employers can choose "cliff vesting," which gives you no rights to benefits until you have been in the plan for three years, after which you are 100% vested; or gradual vesting at a rate of 20% each year after the first year in the plan, so that you are 100% vested after six years.
Voluntary withholding
You can ask the Social Security Administration to withhold taxes from your social security benefits. This could make sense if withholding allows you to avoid making quarterly estimated tax payments. To request voluntary withholding, file form W-4V with Social Security. You can also ask a retirement plan sponsor to withhold from payouts from IRA distributions.
Wage base
The level of earnings to which the full Social Security and Medicare tax applies. For 2014, the full 15.30 percent tax (the combined rate paid by employers and employees) applies to the first $117,000 of wages or self-employment income and the 2.9 percent Medicare portion applies to all income over that level. (Employees pay half the tax — 7.65 percent up to the wage base limit and 1.45 percent after that — and their employers pay the other half. Self-employed taxpayers have to pay both halves, and get an income tax deduction for half of what they pay.)
Wash sale
The sale of stocks, bonds or mutual fund shares for a loss when, within 30 days before or after that sale, you buy the same or substantially identical securities. The law forbids the deduction of the loss.
Withholding
The amount held back from your wages each payday to pay your income and social security taxes for the year. The amount withheld is based on the size of your salary and the W-4 form you file with your employer.
Worthless security
If a stock you own becomes completely worthless during the year, you can claim a capital loss as though you sold the stock for $0 on December 31 of the year the stock became worthless.
