7 Tax Terms Explained

By Tim Parker | February 22, 2012 AAA
7 Tax Terms Explained

It's tax season and that means the lingo is flying around and much of it goes right over some our heads. Much of the tax vocabulary is terms we should know as we attempt to manage our finances in a more tax friendly way throughout the entire year. For that reason, we've put together some of the terms that you should know as you complete your 2011 taxes.



SEE: Personal Income Tax Guide



AGI
Adjusted gross income (AGI) is the amount of money you made after you've factored in selected deductions, credits and certain business expenses. Your AGI does not include the standard or itemized deductions.

Let's assume that you made $50,000 last year, which includes your paycheck, interest payments and investment gains. You were able to gain $8,000 in allowable deductions making your AGI $42,000.

Tax Credit Vs. Deduction
You should be happy about a deduction and jumping for joy when you get a tax credit. A tax deduction reduces your taxable income. If you had a $1,000 deduction on that $50,000, your taxable income is now $49,000. That doesn't mean that you will receive the full $1,000 back. In fact, you'll receive much less than that.

A tax credit is applied directly towards your tax bill. If you owed $8,000 in taxes last year, a $1,000 credit would make your tax bill $7,000. Unlike the deduction, you get the full $1,000 back and in most cases, you get it even if you didn't owe any taxes.

Standard Deduction
Regardless of your tax status, the Internal Revenue Service (IRS) offers a standard deduction to all taxpayers. Instead of going through the process of deducting many small deductions, the IRS would rather offer you a set amount. That amount changes depending on your filing status and the rate of inflation. If you don't own a home, have no children and have few other tax altering events, you can probably claim the standard deduction each year.

If you itemize your deductions and the amount is larger than the standard deduction, you would elect to itemize on your taxes. You cannot claim the standard deduction and itemize. You would pick the higher of the two amounts. (For more, check out Why You Should Itemize Your Tax Deductions.)

Exemption
An exemption is anybody who relies on your income for basic needs. You can claim yourself, your spouse, children and any other dependents. Once you find your AGI, each exemption is applied to that number to calculate your taxable income.

Taxable Income
Taxable income is your final income once all of the deductions and credits are applied. This number is the figure used to calculate your final tax bill.

Withholding
In order to assure that you can pay your tax bill at the end of the year, the IRS requires employers to withhold a portion of your check. This money is placed on deposit with the IRS and once you complete your taxes, it is applied to your tax bill often leaving a refundable amount.

The Bottom Line
There are many other tax terms worth learning but these few will get you started. Visit the IRS website for even more valuable information as you become a more tax conscious citizen. (To learn more about taxes, see Next Season, File Taxes On Your Own.)

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