You might be surprised at how often tax terms come up in daily life. When you start a new job, you’ll encounter questions about withholding. If you’re a student applying for financial aid, you may need to provide details about your adjusted gross income. And if you’re buying or selling a home, you’ll likely hear the term capital gains. If these tax terms are unfamiliar, you might feel a bit out of the loop.
That’s why we’ve compiled a quick glossary to provide you with all the information you need before filing your tax return to help you feel well-informed and prepared the next time you come across these words.
Above-the-line deductions
Adjustments to income, commonly known as above-the-line deductions, are special deductions (quite literally) listed above the line where adjusted gross income (AGI) is calculated on IRS Form 1040. This placement is opposite of itemized deductions, which appear below the AGI line on tax forms. Above-the-line deductions are particularly valuable because they directly reduce your taxable income, which lowers your AGI and potentially qualifies you for additional tax benefits.
Above-the-line deductions include a variety of common expenses. For instance, contributions to retirement accounts like traditional IRAs, interest paid on student loans, and certain educator expenses can all be deducted. Unlike itemized deductions, which require you to forego the standard deduction, above-the-line deductions are available to all taxpayers. This means you can claim them regardless of whether you choose the standard deduction or itemize your deductions. Understanding and claiming these deductions can effectively reduce your tax liability and possibly help you qualify for more tax credits and benefits.
Adjusted gross income
When reviewing your tax return, you might notice a difference between your total income and your adjusted gross income (AGI). This difference is because AGI represents your total income after above-the-line deductions). Your AGI is typically used to determine eligibility for tax credits and deductions.
Amended return
Even with careful preparation, mistakes can happen on your tax return. The IRS allows you to correct such errors by filing an amended return. An amended tax return is a separate form used to correct inaccuracies on your original return, such as misreported income, credits, or deductions. To amend your federal return, you must file Form 1040-X and, if necessary, submit an amended state return as well.
Capital gains and losses
Capital gains tax is imposed on the profit from selling a capital asset, such as real estate, stocks, bonds, or collectibles. If you sell an asset for more than you paid for it, the difference is a capital gain, and if you sell it for less, it is a capital loss. These gains and losses must be reported on your tax return, with net capital losses deductible up to $3,000 per year.
Child and Dependent Care Credit
The Child and Dependent Care Credit is a federal tax credit designed to help parents offset the costs of child care. This credit allows you to claim up to 35% of qualifying expenses, with a maximum of $3,000 for one dependent and $6,000 for two or more. To be eligible, you must have incurred these expenses for the care of a child under 13 or a disabled dependent while you (and your spouse, if applicable) worked or looked for work.
The credit is nonrefundable, meaning it can reduce your tax bill but won’t result in a refund if you owe no taxes. Qualifying expenses include payments to daycare centers, babysitters, day camps, and after-school programs.
Child Tax Credit
The Child Tax Credit (CTC) is designed to support lower to middle-income households by providing a tax credit of up to $2,000 per qualifying child under the age of 17. Up to $1,600 can be refundable, known as the Additional Child Tax Credit (ACTC), meaning eligible taxpayers can receive this portion as a refund even if they do not owe any taxes. To qualify, the child must be a U.S. citizen, national, or resident alien with a valid Social Security number, related to the taxpayer, have lived with you for more than half of the tax year, and not have provided more than half of their own support.
Dependent
A dependent is an individual for whom you provide significant financial support. By claiming a dependent, you may be eligible for various tax credits and deductions, which can potentially reduce your tax liability and increase your refund. Generally, a dependent is either a qualifying child or a qualifying relative. To be considered a qualifying child, the individual must be under 19 years old (or 24 if a full-time student), related to you, live with you for more than half the year, and rely on you for more than half of their financial support.
Earned income
Earned income refers to the money you receive from working. This includes wages, salaries, tips, commissions, bonuses, and profit from self-employment. Essentially, the IRS considers any compensation received in exchange for providing labor or services earned income.
In contrast, unearned income is money received from sources other than labor and services. For example, interest from savings accounts, dividends from investments, rental income, unemployment benefits, and Social Security benefits are all forms of unearned income. The difference between earned income and unearned income is important for tax purposes because it impacts your eligibility for various tax credits and deductions, such as the Earned Income Tax Credit (EITC).
Earned Income Tax Credit (EITC)
The Earned Income Tax Credit (EITC) is a tax benefit designed to assist low-to-moderate income earners by reducing their tax liability and potentially increasing their tax refund. Eligibility for the EITC depends on several factors, including earned income, adjusted gross income (AGI), and the number of qualifying children. The maximum credit and income limits vary yearly. Significant life changes, such as a change in marital status or employment, can also affect your eligibility for the EITC.
To claim the EITC, you must have earned income from wages, salaries, or self-employment. Unearned income, such as interest, dividends, retirement income, and unemployment benefits, does not count towards the EITC.
Estimated tax payment
Estimated tax payments are periodic advance payments made to the IRS to cover your anticipated tax liability for the year. Estimated taxes are commonly paid by self-employed individuals, freelancers, and independent contractors, but they can also apply to you if you have significant income from dividends, interest, capital gains, or rental properties. If you expect to owe at least $1,000 in taxes, the IRS expects you to make quarterly estimated tax payments throughout the year. Estimated payments are due after each quarter throughout the year. Due dates fall in April, June, and September of the respective tax year, while fourth quarter payments are due January of the following year.
Filing status
Filing statuses are a classification used to determine how you file your tax return and calculate your tax liability. There are five main filing statuses: single, married filing jointly, married filing separately, head of household, and qualifying widow(er) with dependent child. Each status has its own set of rules and tax implications, which influence various aspects of your tax return, such as your standard deduction amount, eligibility for certain credits, and tax bracket.
Gross income
Gross income is the total amount you earn before any deductions or taxes are taken out. It includes all sources of income, such as wages, salaries, bonuses, tips, interest, dividends, rental income, business income, and alimony.
Itemized deductions
If you choose to forego the standard deduction, itemized deductions are specific expenses you can list on your tax return to reduce taxable income, potentially lowering the taxes you owe. Unlike the standard deduction, which is a fixed amount set by the IRS based on filing status, age, and other factors, itemized deductions allow individuals to claim certain qualifying expenses they incurred throughout the tax year. Common examples of itemized deductions include state and local taxes paid, mortgage interest, charitable contributions, and unreimbursed medical expenses.
Joint return
A joint return refers to the tax return filed by a married couple. A joint return combines you and your spouse’s incomes, deductions, credits, and liabilities. Married couples can choose to file jointly or separately. The joint status often results in lower tax rates and a larger standard deduction compared to filing separately. By filing jointly, both spouses assume equal responsibility for the accuracy of the information provided on the tax return and any taxes owed. Whether to file jointly or separately is unique to each taxpayer and depends on your specific tax situation.
Modified adjusted gross income
Modified adjusted gross income (MAGI) is a metric used to determine eligibility for specific tax benefits, credits, and exemptions. It begins with your adjusted gross income (AGI), which includes all taxable income sources minus certain adjustments like IRA contributions and student loan interest payments.
The MAGI helps to provide a more accurate representation of your finances. It determines your eligibility for tax breaks like deductions for Roth IRA contributions, certain tax credits, such as the Child Tax Credit and Adoption Tax Credit, and education credits, like the American Opportunity Tax Credit.
Nontaxable income
Nontaxable income refers to earnings that are not subject to federal income tax. This category includes various types of income the IRS does not tax, in turn, reducing your taxable income and potentially lowering your overall tax liability. Common examples of nontaxable income include certain Social Security benefits, child support payments, gifts and inheritances, and life insurance proceeds to name a few.
Personal exemptions
You might be familiar with personal exemptions, which were claimed on Form W-4 when you start a new job. In the past, taxpayers could claim personal exemptions for themselves, their spouses, and dependents, which would decrease their taxable income. However, starting with the 2018 tax year, the Tax Cuts and Jobs Act (TCJA) eliminated personal and dependent exemptions through 2025. They created a new tax process for taxpayers to calculate their W-4 withholding.
Self-employment income
Self-employment income is money earned from work or services performed as an independent contractor or sole proprietor rather than an employee. This type of income can come from various sources, such as freelance work, consulting services, gig economy jobs, or owning a small business.
One primary difference between independent contractors and employees is that contractors must make quarterly estimated payments towards their taxes throughout the year since an employer does not withhold them from a paycheck. Individuals who earn self-employment income are also responsible for accurately tracking their income and maintaining records of business expenses.
Self-employment tax
Self-employment tax is a mandatory tax on self-employment income. It serves as the self-employed individual’s equivalent of Social Security and Medicare taxes typically withheld from traditional employees’ paychecks. The self-employment tax rate combines both the employer and employee portions of these taxes, totaling to 15.3% of net earnings (as of 2023).
Standard deduction
The standard deduction is a fixed dollar amount that reduces the taxable income of taxpayers who do not itemize their deductions. The IRS provides the standard deduction option to simplify tax filing based on your filing status, such as single, married filing jointly, married filing separately, head of household, or qualifying widow(er) with dependent child.
You can choose between taking the standard deduction or itemizing deductions. The standard deduction amount is adjusted annually for inflation and aims to ensure that all taxpayers receive a basic deduction from their income before taxes are applied.
Tax exempt
Tax-exempt refers to income, investments, or organizations that are not taxed by federal, state, or local governments. Common examples of tax-exempt income include interest earned on municipal bonds, certain types of retirement account distributions (like Roth IRA withdrawals), and certain benefits received from employer-provided healthcare plans. Additionally, nonprofit organizations, churches, and charitable organizations recognized as tax-exempt by the IRS are not required to pay federal income tax.
Taxable income
Taxable income is the portion of your gross income subject to tax. You can calculate your taxable income by subtracting the standard or itemized deductions from your AGI. Common sources of taxable income include wages, salaries, tips, interest and dividends from investments, rental income, business profits, and certain retirement distributions.
The IRS uses your taxable income to determine the income tax amount you’re obligated to pay each tax year. By managing deductions and exemptions, you can reduce your taxable income and potentially lower your tax liability.
Withholding
If you work as an employee, you likely have a portion of your income withheld from your paycheck to cover federal, state, and local income taxes, and other mandatory deductions like Social Security and Medicare contributions. This amount is called a withholding. Employers withhold these amounts based on the information provided on your Form W-4, which includes your anticipated household income, dependents, and any other necessary adjustments.
If you have a change that impacts your household income, like getting married or divorced, starting a side hustle, or having children, it’s an excellent time to review and adjust your W-4 to avoid underpayment penalties and optimize your tax filing.
