24 Key Tax Terms That Confuse Everyone
Filing taxes can be confusing enough without needing to understand all of the different tax terms used. To help you understand some of the things you might hear when filing your tax return this year, GOBankingRates explains 24 tax terms that confuse most people.
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Above-the-Line Deduction
An above-the-line deduction allows you to decrease the taxes you owe. Examples of above-the-line deductions include student loan interest, health savings account (HSA) contributions, tuition and educator expenses.
“Think of tax deductions as tools to chip away at the chunk of your income that’s up for grabs by the taxman,” said Robin Snell, CFP, owner of Nested Financial & Tax Planning. “They’re like discounts you get before tallying up what you owe. Deductions lower the amount of your income that’s subject to tax, making it a smaller target for taxation.”
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Adjusted Gross Income
Adjusted gross income is your total annual income, including wages, interest, tips, dividends and capital gains, minus certain deductions. You can calculate your adjusted gross income by subtracting all allowable tax adjustments from your gross income. Allowable tax adjustments include moving expenses, student loan interest and retirement account contributions. Adjusted gross income is used to determine your eligibility for tax credits and deductions, tax liability and tax brackets.
“Think of adjusted gross income as the big picture of what you bring in before the taxman starts poking around,” Snell said. “It’s your total income, but with some things taken out, like certain deductions. AGI sets the stage for figuring out how much you owe Uncle Sam.”
Below-the-Line Deduction
A below-the-line deduction is an itemized deduction that you apply after you calculate your adjusted gross income. It reduces the amount of taxes that you owe. Interest (student loan, mortgage or investment), charitable donations and certain medical expenses are examples of below-the-line deductions.
“As a co-founder of a healthcare marketplace, I understand how tax terminology related to healthcare expenses can be confusing for many individuals,” said Akshaya Srivatsa, co-founder and CEO of Care Better. “Terms like medical expenses deduction, health savings accounts (HSAs) and flexible spending accounts (FSAs) can leave taxpayers scratching their heads.
“Transitioning to a simpler flat tax system could help clear up this confusion by simplifying the tax treatment of healthcare expenses. Under a flat tax system, individuals would have a clearer understanding of their tax liabilities and benefits related to healthcare expenses, as deductions and credits would be standardized.”
Capital Gains
Capital gains are money you earn from selling capital assets, including stocks, bonds and real estate. You must pay a capital gains tax on assets that resulted in profits. Most taxpayers have to pay a capital gains tax of 15%, but those in the top income bracket pay a 20% capital gains tax.
Capital Losses
If you sell an investment for less than you paid, you will have a capital loss. You can claim a capital loss of up to $3,000 on your taxes. Losses above this amount can be carried over to future tax years.
Child and Dependent Care Credit
The child and dependent care credit is a tax credit for taxpayers who pay for dependent care while working or looking for work. A dependent must be either a child under 13 or an adult unable to care for themselves. The IRS limits the child and dependent care credit to a maximum of $3,000 for one dependent or $6,000 for two or more dependents.
Child Tax Credit
The child tax credit is a financial stimulus payment to benefit families with children who qualify. For 2023 taxes (filed in 2024), the IRS has returned to its original credit limit of $2,000 per child instead of the previously increased credit during COVID-19.
Consumption Tax
A consumption tax is a tax on goods and services, like a sales tax or a tariff on imported goods.
Delinquent
Any unpaid taxes are considered delinquent. A delinquent taxpayer may have missed the deadline for filing tax returns or might not have paid the balance by the due date.
Earned Income Tax Credit
The earned income tax credit is a tax break that allows lower-income taxpayers with earnings from a job to reduce their tax bill. The federal earned income tax credit is refundable, so taxpayers can receive a deduction larger than the tax they owe, resulting in a refund in some cases.
Estimated Tax Payments
If you are a freelancer, independent contractor or business owner, you may have to pay estimated tax if you have earned income. These estimated tax payments are due quarterly on specific dates. Failure to make necessary estimated tax payments may result in a penalty.
Exemption
A tax exemption is a specific amount that reduces how much of your income is taxable. Your total exemption amount is subtracted from your adjusted gross income before the tax is calculated. Tax exemptions can be claimed by the taxpayer, a spouse or qualifying dependents.
Garnishment
Garnishment is a type of levy where a tax collection agency takes a portion of your wages if you have a tax debt.
Gift Tax
Gift tax is a tax you must pay if you have given money or property to someone in the past tax year without receiving payment or something of equal value in return. You can gift up to a certain amount without paying tax. For the 2023 tax year, that amount is $17,000.
Levy
A levy is a legal repossession of your property to satisfy a tax debt. The items being seized could include wages, savings or physical property.
Lien
A lien is a legal claim against property to secure payment of a tax debt
Nontaxable Income
Nontaxable income is income that you do not need to pay tax on. Nontaxable income includes things like child support payments, cash rebates and gifts.
Offer in Compromise
An offer in compromise is when a tax collection agency agrees to settle a debt for less than the amount owed if evidence shows that you won’t be able to pay it in full.
Principal Tax Liability
The amount of taxes owed, not including interest and penalties, is the principal tax liability.
Refundable Tax Credit
A refundable tax credit reduces a taxpayer’s liability. If the refundable tax credit amount is larger than the tax owed, the taxpayer may receive a refund. The federal earned income tax credit is an example of a refundable tax credit.
Tax Burden
The tax burden is the amount of money an individual or household spends on taxes as a proportion of their income.
Taxable Income
Taxable income is the wages you earn from your job, which are subject to tax. Taxable income is also the amount of your income that is subject to taxes once you have subtracted all deductions and exemptions.
Uniformity Clause
The uniformity clause is a clause in the federal Constitution and some state constitutions that requires equal collection of taxes. The purpose of the uniformity clause in the U.S. Constitution was to prevent Congress from imposing unequal taxation of one state over another.
Withholding
Withholding is when your employer holds back a portion of your earnings each pay period and sends that money directly to the government as partial payment of your income tax. You are credited for the amount paid when you file your return. The amount of your withholdings is determined by the number of allowances you claim on your W-4 form, as well as money for Social Security and Medicare.
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