Tax Glossary | MD Horton Bookkeeping & Tax

A

Named for the Achieving a Better Life Experience Act of 2014, an ABLE account is a tax-advantaged savings plan for a person with a qualifying disability. People with qualifying disabilities may set up these accounts for themselves, or the account may be established by the person's designated agent, a relative or someone else authorized by the IRS or Social Security Administration. The disabled individual must be the sole beneficiary of the account. Anyone may make after-tax contributions to an ABLE account, as long as the total of all contributions does not exceed the annual contribution limit. Generally, ABLE accounts can grow in value tax-free, and beneficiaries may receive tax-free distributions throughout their lives, as long as the funds are used for qualified disability-related expenses.

Accrual accounting is one of two major bookkeeping methods (the other being the cash method) that businesses may use for tax purposes. With accrual accounting, a business reports income when it is earned, regardless of when payments are actually received (technically, constructively received). Similarly, expenses are recorded when they are incurred, regardless of the date of payment. The IRS allows many small businesses to choose between accrual and cash accounting, or to use a combination of the two (hybrid accounting). However, businesses in some industries, along with those with sales above a specified threshold, must use accrual bookkeeping methods.

People are considered to actively participate in rental activities if they make significant business or rental management decisions, such as approving expenditures and projects, or overseeing rental terms and new tenant selection. The IRS guidelines for active participation are not as strict as the business material participation standards. Those who actively participate in rental operations may qualify for an exception to the passive activity loss rule, such as the special $25,000 allowance.

The actual expense method is one of two methods that businesses and self-employed people may use to calculate and deduct expenses related to business vehicle use. To use this method, tally up all relevant vehicle expenses, such as fuel and maintenance costs, auto loan interest, and parking fees and tolls. For a vehicle used for both business and personal purposes, prorate all expenses based on the vehicle's business use percentage (measure by mileage). Alternatively, vehicle expense deductions may be calculated by using the standard mileage rate. Note that enterprises that operate a fleet of five or more vehicles generally must report actual expenses instead of using the standard rate.

People whose earned income for a year exceeds a threshold set by the IRS must pay the Additional Medicare Tax. This tax is assessed on top of the standard Medicare tax component of FICA taxes. The income threshold depends on a person's filing status. In most cases, an employer automatically withholds Additional Medicare Tax from an employee's pay once the employee's earnings for the year cross the threshold. However, people with multiple jobs or self-employment income may need to figure their Additional Medicare Tax on their tax returns, and may need to make quarterly estimated tax payments.

This term can play a key role in calculating capital gains and losses. If you purchase investment property, then your cost basis in the property is typically the amount you paid for it, including commissions and fees. For gifted or inherited property, or property acquired in a trade, your initial basis might be based on the original owner's basis, or on fair market values (FMVs) at the time of the transfer. Certain activities may subsequently decrease your basis, like claiming depreciation deductions for property used in a trade or business. Meanwhile, making substantial improvements to property may increase your basis. Taking all of these factors into account enables you to calculate your adjusted basis, which in turn must be used to figure a capital gain or loss.

An Adoption Taxpayer Identification Number (ATIN) is a temporary, 9-digit ID that the IRS issues for a child in the process of being adopted. Sometimes, a child is placed in a home before the adoption process is finalized, and the adoptive parents cannot immediately obtain a Social Security Number (SSN) for the child. In these circumstances, the adoptive parents may obtain an ATIN, which enables them to claim the child as a dependent and/or qualifying child for certain tax benefits. Adoptive parents may apply for an ATIN by filing Form W-7A.

Many people who qualify for the Premium Tax Credit (PTC) under the Affordable Care Act (ACA) may choose to receive the credit as an adjustment to their health insurance premiums. This adjustment, called the Advance Premium Tax Credit (APTC), can significantly reduce the cost of healthcare coverage for an individual or family. If you receive the APTC, you will need to reconcile your monthly APTC premium reductions with your total PTC for the year when you file your tax return. To avoid issues with incorrect APTC amounts, inform the Health Insurance Marketplace where you purchased your coverage of any changes in your income, family size or other circumstances that may affect your PTC.

The Affordable Care Act (ACA) created the official Health Insurance Marketplace, where individuals and families can purchase private health insurance. Those who obtain coverage through the marketplace and have incomes below specified limits may qualify for the Premium Tax Credit (PTC), which is a refundable credit. Eligible people may choose to receive this credit as a reduction in their monthly health insurance premiums, known as the Advance Premium Tax Credit (APTC). The ACA also established minimum standards for health insurance coverage, and increased the number of Americans who qualify for free or very low-cost coverage through the Medicaid Expansion.

Various federal tax benefits, such as the Child Tax Credit (CTC), are only available to people with a qualifying child they can claim as a dependent. The IRS uses a number of tests to determine whether someone is your qualifying child. Age tests set a maximum age for qualifying children, which may depend on whether the child is a full-time student. Note that various IRS programs have their own age tests, so your qualifying child for one tax deduction or tax credit may not meet the test for another tax benefit.

In most cases, employees who receive tips must report those tips to their employers, as well as to the IRS on their tax returns. If you work in a food or beverage establishment and the tips you report add up to less than a percentage of gross revenue specified by the IRS, then your employer may assign additional tips to you, called allocated tips. Generally, you must report the full amount of allocated tips assigned to you on your tax return. However, if you have records proving that your actual tips were less than the amount allocated by your employer, then you can qualify for an exception to this rule. Note that only tips reported by your employer on a year-end income statement like Form W-2 qualify for the "No Tax on Tips" deduction.

The IRS offers the American Opportunity Tax Credit (AOTC) for qualifying students for their first four years of higher (post-secondary) education. This partially refundable tax credit for tuition and required school fees may be claimed by either the student or another person (such as a parent) who claims the student as a dependent. To qualify, the student must be pursuing a degree or other recognized credential. In addition, the person taking the credit must have a modified adjusted gross income (MAGI) below the limit set by the IRS. In order to claim the AOTC on your tax return, you will need to obtain IRS Form 1098-T (Tuition Statement) from a qualifying higher education institution.

The annual gift exclusion allows people to give away a certain amount of money or property each year without having gift and estate tax reporting or payment obligations. Gifts below the annual exclusion threshold do not count toward the donor's lifetime exclusion. Importantly, the annual exclusion applies to the amount given away per beneficiary, and there is no limit on the number of beneficiaries a person may make gifts to during a given year. Note that gifts in excess of the annual exclusion amount generally must be reported to the IRS, but do not necessarily get taxed. In most cases, gifts only become taxable events once the donor has exceeded the lifetime exclusion.

An Archer MSA (named for a congressman who wrote key parts of the legislation) works much the same way as a health savings account (HSA). For that reason, once HSAs came into common use, Congress voted not to allow people to start new Archer MSAs. However, those who already had Archer MSAs could continue contributing to and using their accounts. If you have an Archer MSA and a high-deductible health plan (HDHP), then you or your employer can make pre-tax contributions to the account. However, unlike with an HSA, an employee and employer cannot both contribute to an Archer MSA during the same year. You can withdraw Archer MSA funds tax-free, as long as you use them for qualified medical expenses.

In many cases, people who engage in business activities and other self-employment pursuits can use business losses to offset other income, reducing their tax liability. However, the IRS limits losses that may be claimed in relation to a passive activity that generates business or rental income. Under the at-risk rule, you cannot claim a passive active loss greater than the amount of investment for which you are personally at risk. In other words, the loss you claim must be no more than the maximum amount of money you stand to lose in the event of a business failure. Also see passive activity rule.

B

To determine whether you had a capital gain or loss from the sale of property like a home, stocks, artwork, musical instruments or virtual currency, you need to know your basis in the property. Basis is essentially a measure of your total investment. If you purchase or build property, then your basis is typically the purchase price or building cost, including fees and commissions. If you trade for property, then your basis may be the fair market value (FMV) of either the property you give up or the property you receive. In these scenarios, your basis may be called cost basis. For inherited or gifted property, your initial basis may be determined by its FMV, the previous owner's basis or other factors. Some activities, such as making improvements to a building or claiming depreciation deductions, can increase or decrease your basis in an asset. In these cases, you may need to determine your adjusted basis.

These terms usually refer to the act of passing property along to heirs, or otherwise giving it away as instructed in a deceased person's will. For example, if Armon's last will dictates that $200,000 of his assets are to be given to the local library upon his death, then Armon has bequeathed this money to the library. Similarly, if Armon's son and daughter receive his house as an inheritance, then Armon bequeathed the home to them. In both cases, the transferred property is called a bequeathal or bequest. Bequests in excess of the donor's lifetime exclusion may be subject to gift and estate tax.

Generally, U.S. citizens and residents must report and pay tax on their foreign income in U.S. dollars. In some cases, however, foreign income cannot be readily converted into U.S. dollars due to laws or other restrictions imposed by a foreign government. The IRS calls this non-convertible income blocked income. In most cases, people may choose to either report and pay tax on blocked income, or defer reporting and paying tax on the income until it is unblocked. If you choose to defer paying tax on blocked income, then you generally must submit an information return called a Report of Deferrable Foreign Income, to explain the situation to the IRS.

The book value of capital property is the theoretical remaining value of the asset, as indicated by depreciation deductions. Generally, book value is equal to the owner's basis minus those deductions. For example, suppose that you purchase business equipment at a total cost of $15,000. You claim a $2,600 depreciation deduction for the equipment in each of the first three years after putting it in service, for a total of $2,600 X 3 = $7,800 in deductions. After those three years, the book value of the equipment would generally be $15,000 - $7,800 = $7,200. At the end of the recovery period for an asset, its book value should equal its salvage value.

A business entity (or business structure) is a legal framework for the ownership of an enterprise. The type of entity established affects not only how a business is taxed, but also how well the owners' personal assets are protected from a business failure or legal action against the company. The most commonly used business entities are sole proprietorships, partnerships, limited liability partnerships (LLPs), limited liability companies (LLCs), S corporations, C corporations and nonprofit organizations. Setting up a business entity other than a sole proprietorship often requires the assistance of both a tax professional and a business attorney.

People with business income, including sole proprietors, independent contractors, self-employed freelancers and many gig economy workers, may generally deduct business expenses on their tax returns. These deductions reduce tax liability by lowering the net profit of a person or business. IRS rules state that in order to be deductible, an expense must be "ordinary and necessary" to conduct a trade or business. There is no precise definition of these terms, but the basic ideas are:

Ordinary: Broadly, this term means that the expense is common within a particular trade or industry. For example, purchasing sheet metal would be ordinary for a welder, but not for a freelance writer. The more unusual an expenditure is within your field, the better prepared you should be to show how it contributes to your ability to earn income.
Necessary: To qualify as "necessary," a business expense does not have to be absolutely indispensable. However, it does need to have a clear connection to the ongoing success of your business or self-employment activities.

For tax purposes, this term refers to income not only from formal business ownership, but also from a broad range of self-employment activities. These activities may include freelancing, gig economy work, or work as an independent contractor or artist. Note that if you accept goods, property or services as forms of payment in the course of your business activities, you generally must include the fair market value (FMV) of those payments in your business income. Business income may be subject to both income tax and self-employment tax. People with significant business income may need to make quarterly estimated tax payments to avoid tax penalties.

C

A capital business asset, or capital business property, is any capital asset that is either held by a business entity (like an LLC or corporation), or used by an individual for business purposes. Common examples of capital business property include financial assets, intangible assets like intellectual property, and fixed assets like buildings, machinery, furniture and computers. Selling capital business property may result in a capital gain or loss, and possibly the need to report a depreciation recapture. Also see Capital Business Expense.

The IRS divides business expenses into two main categories: operating (or ordinary) expenses and capital expenses. The category of capital expenses includes costs associated with acquiring capital business assets, including not only purchase prices but also required taxes, commissions and fees. Under standard IRS rules, a capital expense cannot be deducted all at once. Instead, the cost usually must be recovered gradually, through depreciation deductions. However, some capital assets may qualify for bonus depreciation, or for a one-time Section 179 Expense deduction.

The sale of real estate, stocks, antiques, musical instruments, mutual funds, virtual currency, artwork, capital business property or other long-term investment assets may result in a capital gain or capital loss. The amount of gain or loss is the difference between your basis or adjusted basis in the property, and the amount realized in the sale (the selling price minus necessary expenses). If the amount realized is greater than your basis, then you generally must report a capital gain, which may be subject to capital gains tax. If your basis is greater than the amount realized, then you may have a capital loss that can be used to offset capital gains or other income, reducing your tax liability. Capital gains and losses are classified as either short-term or long-term:

Short-term capital gain or loss: This classification generally applies to a gain or loss from the sale of property held for a year or less.
Long-term capital gain or loss: This classification generally applies to a gain or loss resulting from the sale of property held for more than a year.

The IRS and many states assess capital gains tax on income derived from the sale of investment or business property. The rules for capital gains tax may differ significantly from the tax rules for other income. To determine whether you owe capital gains tax, first calculate your net capital gain or net capital loss for the year. The tax rate that applies to a net gain will depend on your adjusted gross income (AGI), and on how long you held the property in question. Also see short-term capital gain or loss and long-term capital gain or loss under Capital Gain or Capital Loss, and Capital Gains Tax Rate.

Cash accounting is one of two major bookkeeping techniques that businesses may use for tax purposes (the other being accrual accounting). With cash accounting, a business or self-employed person reports income when it is constructively received, regardless of the date of the underlying transaction. Similarly, most expenses are recorded when they are paid, regardless when they are incurred. Many businesses that generally qualify to use cash accounting for tax purposes must use accrual methods for a few specific situations, such as inventory accounting. In such cases, the IRS may allow hybrid accounting, which involves using accrual bookkeeping for limited purposes, and cash accounting for all other transactions.

People who itemize deductions may claim a tax deduction for contributions they make to qualifying nonprofit charities. The maximum allowed deduction for charitable donations is typically based on a percentage of a person's adjusted gross income (AGI). Contributions in excess of the deduction limit may generally be carried over to the next tax year. People who use the standard deduction may qualify to claim an above-the-line deduction for a very limited amount of cash donations. Corporations may also deduct charitable contributions, up to an annual limit based on the company's taxable income.

Members of the U.S. Armed Forces who serve in a designated combat zone may typically exclude military pay from their taxable income. However, eligible military personnel may instead elect to include combat pay in their reported income for the purpose of qualifying for the Earned Income Tax Credit. In general, a combat zone is any area that (1) the President of the United States designates by Executive Order as an area in which U.S. forces are engaged in combat; (2) the Department of Defense has certified for combat zone tax benefits; or (3) has been established by statute as a Qualified Hazardous Duty Area where service members receive imminent danger pay.

Cost basis generally refers to a person's or company's initial investment in a capital asset. In most cases, cost basis is the total amount paid to acquire the property, including any required taxes, fees or commissions. However, your cost basis for a particular asset could also be based on the fair market value (FMV) of the property when you took possession of it, the former owner's basis, or the FMV of any goods, services or property that you exchanged for it. Cost basis plays a critical role in calculating a capital gain or capital loss. Also see Adjusted Basis.

A Coverdell ESA is a tax-advantaged account created for the purpose of paying the qualified education expenses of a designated beneficiary. Qualified education expenses typically include tuition and school fees, along with certain other required purchases like books and supplies. Individuals may make after-tax contributions to an ESA if their adjusted gross income (AGI) is below a specified limit, while trusts and corporations may generally contribute to ESAs regardless of their income. The beneficiary of an ESA may subsequently take tax-free withdrawals from the account to pay qualified education expenses. Overall, a Coverdell ESA works similarly to a qualified tuition program plan, also called a Section 529 plan.

D

IRS rules sometimes require people or businesses to report exactly when a particular transaction occurred. For example, if a transaction is conducted in a foreign currency, then the conversion to U.S. dollars should be based on the exchange rate on the date when the transaction occurs. For individuals, the official date of a transaction is typically either the date when they make a payment, or the date when they constructively receive income. For a business, the correct transaction date for tax purposes may depend on whether the business uses cash accounting or accrual accounting.

In general, a person is your dependent if you provide significant financial support for that person (usually more than half of the person's total support), and the person meets several other dependency tests. Having one or more dependents may make you eligible for tax benefits like the Child Tax Credit (CTC), Earned Income Credit (EITC) or Credit for Other Dependents. If you are unmarried, having dependents may also qualify you to use Head of Household or Qualifying Surviving Spouse as your filing status.

For tax purposes, depreciation is the process of claiming tax deductions for a capital expense over a series of years. It is the most common example of capitalization of an expense. Depreciation usually involves deducting a portion of the cost of an asset each year throughout a specified depreciation period. However, businesses and self-employed people can sometimes shorten the timeline through the use of bonus depreciation or Section 179 deductions. The two most common methods of calculating depreciation deductions are the straight-line method and the modified accelerated cost recovery system (MACRS). In some cases, the IRS allows alternative depreciation techniques, such as the units of production method. Also see Amortization.

Also called a recovery period, a depreciation period is the number of years required to deduct the total depreciable cost of property through annual depreciation deductions. For example, if IRS rules require a business to deduct the cost of new machinery gradually over the course of six years, then the machinery has a 6-year depreciation period. Depending on the date an asset is put into service and the depreciation method used, the asset's depreciation period may differ slightly from its useful life.

The process of depreciation is based on the assumption that a capital asset will lose value over time, ultimately retaining only a nominal salvage value or no value at all. The theoretical remaining value of an asset at any point during the depreciation process is known as its book value. However, the true residual value of property may be significantly higher than its book value. If you sell or exchange a depreciated asset for more than its book value (or more than its salvage value after the depreciation period ends), then you may need to report that gain as a depreciation recapture. A depreciation recapture may be taxed as ordinary income, rather than at capital gains tax rates.

The IRS offers a variety of tax relief programs for people and businesses affected by disasters like storms, floods, earthquakes and wildfires. These programs are usually available only in areas covered by major disaster declarations signed by the President. Relief measures may include tax filing and/or payment extensions, special tax deductions, and waivers of tax penalties and IRS interest. People who lose vital records in a disaster may also request free transcripts of their past tax returns from the IRS.

A person's domicile is the state where they maintain a legal, permanent residence. Note that your domicile might not be the same as the state where you currently reside. For example, if you have a permanent home in Tennessee but live for two years in a rented home in Delaware to complete a work contract, your domicile would generally still be Tennessee. If you regularly use homes in multiple states, then the IRS and state governments will apply a variety of tests to determine which state is your domicile.

This term most often refers to property that a person uses for both personal and business purposes. Common examples include vehicles, computers and cell phones used by independent contractors, freelancers, and sole proprietors. When deducting business expenses related to dual-use property, you generally must prorate each expense based on your percentage of business use. For example, if you use your computer for business purposes 40% of the time, then you may claim at most 40% of costs related to the computer (such as repairs and software updates) as business expenses.

E

In general, a person who withdraws funds from a traditional IRA before reaching 59 1/2 years of age may need to pay an early withdrawal penalty, also called the additional tax penalty. Other qualified retirement plans may also have penalties for early withdrawals. Exceptions exist for certain withdrawals taken due to financial hardship, and for loans taken from the retirement account that are repaid within a short time. A withdrawal from a Roth IRA before age 59 1/2 may or may not be subject to an early withdrawal penalty, depending on the reason for the withdrawal, the amount withdrawn and how long the withdrawn funds have been in the account. Also see Qualifying Reason for Roth IRA Withdrawal and Roth IRA Early Withdrawal Rules.

People with modest incomes may qualify for the Earned Income Tax Credit (EITC or EIC), which is a refundable tax credit. Generally, to claim this credit, you must have an adjusted gross income (AGI) below the limit set by the IRS for your filing status and number of qualifying children, and have some earned income for the tax year. The rules for the EITC also include a limit on unearned income. Because the EITC is fully refundable, you can receive the credit as an IRS refund even if you owe no tax and did not have tax withheld from your pay. However, you must file a tax return to claim the credit.

A person's effective tax rate is the percent of their income that they actually pay in tax. This percentage typically differs from the person's marginal tax rate (also called nominal tax rate). For example, suppose that Jamal's gross income for a year was $67,780, but he qualified for tax deductions totaling $22,860. His taxable income was therefore $67,780 - $22,860 = $44,920, and his resulting tax liability was $8,700. Based on that year's tax brackets, Jamal's marginal tax rate was 22%. Yet his effective tax rate was only $8,700 ÷ $67,780 = 0.128 = 12.8%.

E-filing is the process of transmitting forms and documents to the IRS or other U.S. Treasury departments over the internet. Electronically filing a federal tax return generally results in faster processing and a shorter wait time to receive a tax refund than mailing a paper return. Because tax forms contain a great deal of sensitive information, it is critical to use a secure, IRS-approved platform for e-filing. If you use public wifi, also use a VPN to encrypt the information on your tax documents.

Whether workers are classified as employees or independent contractors has major tax impacts for both the workers and those who hire them. An employer must generally withhold income tax and the employee share of FICA taxes from each employee's pay, and also pay unemployment tax and the employer share of FICA taxes. By contrast, hirers generally do not need to withhold or pay taxes related to payments to independent contractors. Instead, independent contractors usually pay self-employment tax on their net earnings. The primary factor that the IRS examines to determine whether a worker should be classified as an employee or independent contractor is how much control the hirer exerts over when, where and how the worker must complete tasks.

The IRS enforces a "pay as you go" rule for taxes, meaning that people and businesses generally must make regular payments throughout the year. Employees usually meet this requirement through paycheck withholding. On the other hand, if a significant portion of your income derives from sources not subject to withholding, such as dividends, interest, rents, or self-employment earnings, then you may need to make quarterly estimated tax payments. In most cases, the total of your withholding and estimated tax payments for a given year must be at least 90% of your tax for that year, or 100% of your tax from the previous year, whichever is less. (The standard shifts to 110% of the previous year's tax at higher income levels.) Note that different rules may apply to income from farming or fishing.

F

Sometimes called the Foreign Bank Accounts Report (hence, FBAR), this form must be submitted annually by many Americans with foreign financial holdings. In general, you must file an FBAR if you have a financial interest in and/or control over foreign financial accounts with a total value above a threshold set by Congress. Note that the FBAR is not an IRS form and therefore cannot be filed with a tax return. Instead, FBARs must be filed with the Financial Crimes Enforcement Network (FinCEN). Electronic filing is required in most cases. Many people required to file an FBAR must also provide information about their foreign accounts on their tax returns, most often on Schedule B, and sometimes on Form 8938 as well.

Enacted in 1935, the Federal Insurance Contributions Act (FICA) created a mechanism to fund the new Social Security system. Today, FICA taxes consist of both Social Security Tax and Medicare Tax. In general, employers must withhold half of the FICA tax due on each employee wages from paychecks, and pay the other half themselves. Because FICA taxes typically apply to a company's entire payroll, they are sometimes referred to as payroll taxes. (Since the pay of self-employed people is not subject to tax withholding, they generally must meet their FICA tax obligations by paying self-employment tax.)

The term filing deadline may refer to any date by which a tax form must be submitted to the IRS. The general filing deadline (often just called the IRS deadline or tax deadline) is an annual due date for many tax returns, forms and payments related to the previous year. Ordinarily, the general filing deadline falls on April 15, or the first business day after April 15 if the 15th falls on a weekend or holiday. The IRS considers mailed forms and payments to be on time if they are postmarked on or before the relevant filing deadline. Deadline extensions are often included in IRS disaster tax relief programs.

A flexible spending arrangement (FSA) is a workplace benefit plan that enables employees to make pre-tax contributions to a tax-advantaged account for a designated purpose. The most common type of FSA is a health FSA, but many employers also offer FSAs for other purposes like adoption. Generally, FSAs are subject to annual contribution limits. People with FSAs can take tax-free withdrawals to pay eligible expenses, such as qualifying medical expenses. Most FSAs operate on an annual "use it or lose it" basis, meaning that employees forfeit any unused funds at the end of the year. However, the IRS allows employers to offer either a small carryover of unused health FSA funds to the next year, or a grace period (usually through March 15) to use up remaining funds. Also see Health Savings Account (HSA).

In general, U.S. citizens and residents must report and pay federal tax on their worldwide income, including income earned in other countries. However, the foreign earned income exclusion allows eligible people to leave certain foreign earnings out of their gross income for U.S. tax purposes. To determine whether someone qualifies for this exclusion, the IRS examines the person's period of stay in a foreign country, generally by applying the bona fide residence test and/or physical presence test.

The IRS uses the term schedule to refer to a variety of specialized tax forms that accompany a more general form. For example, Form 1040 has a number of accompanying schedules that a person may need to complete to report income or claim tax benefits. The most commonly used Form 1040 schedules include:

Schedule 1, Additional Income and Adjustments to Income: Use this form to report income not accounted for on Form 1040 itself, including business income and certain capital gains. Schedule 1 also enables you to claim various above-the-line deductions, such as the educator expense deduction, the deduction for one-half of self-employment tax, and the deduction for student loan interest.
Schedule 2, Additional Taxes: Many people must use this form to report other federal taxes they must pay besides income tax. These additional taxes may include alternative minimum tax (AMT), self-employment tax, and household employment taxes.
Schedule 3, Additional Credits and Payments: This form enables people to claim credits and report payments not shown on Form 1040 itself. Credits that may be claimed on Schedule 3 include the foreign tax credit, the credit for child and dependent care, various education credits, and the healthcare Premium Tax Credit.
Schedule A, Itemized Deductions: People who choose to itemize deductions instead of claiming the standard deduction use this form to list their deductions and calculate their total deduction amount.
Schedule B, Interest and Ordinary Dividends: It may be necessary to use this form to report unearned income from interest and ordinary dividends, and also to report foreign financial accounts that you hold or control.
Schedule C or C-EZ, Profit or Loss from Business: People classified as sole proprietors by the IRS must generally use one of these two forms to report their business income and deduct business expenses. For tax purposes, the sole proprietor designation includes many self-employed people, such as independent contractors, freelancers, and gig economy workers. Net profits shown on Schedule C are usually subject to self-employment tax.
Schedule D, Capital Gains and Losses: If you have capital gains or losses, you will summarize them on this schedule, and compute your net gain or loss. In most cases, you will also have to complete Form 8949 to report the details of each transaction that resulted in a gain or loss.
Schedule E, Supplemental Income and Loss: People use this form to report rental income, real estate royalties, and some other types of income that are not accounted for on Form 1040 or other schedules.
Schedule EIC, Earned Income Credit: If you are claiming the Earned Income Tax Credit (EITC), you must file this form if you have one or more qualifying children.
Schedule H, Household Employment Taxes: People use this form to calculate the taxes they must remit on wages paid to household employees like nannies, housekeepers or gardeners. If you owe such household employment taxes, you will generally also report them on Schedule 2.
Schedule SE, Self-Employment Tax: You typically must file this schedule if you earn more than $400 during a year through self-employment activities, such as operating a business, freelancing, or working as an independent contractor or gig economy worker. Use Schedule SE to calculate your self-employment tax, which you must also report on Schedule 2.

When Form 1041 must be filed for a trust or estate, the income, deductions, credits and other amounts reported on that return usually get allocated to beneficiaries. A Schedule K-1 (Form 1041) must then be filed for each beneficiary, showing that person's share of income, credits and deductions. The main advantage of allocating figures from Form 1041 to beneficiaries is that individuals can often claim more tax benefits than an entity like an estate or trust. Therefore, assigning trust or estate income to individual beneficiaries may result in lower overall tax liability.

IRS Forms with the number 1099 are used to report forms of income that do not appear on other information returns like Form W-2. The person or organization that made the payments completes the appropriate 1099 form, and sends copies to the IRS and the payment recipient. In most cases, people who receive 1099 forms must report the income shown on them on their tax returns, and may face tax penalties for failing to do so. Here are the most commonly used forms in the 1099 series:

Form 1099-DIV: This form shows ordinary dividends, qualified dividends, and certain other distributions of corporate earnings, capital gains or profits to shareholders.
Form 1099-G, Certain Government Payments: This form shows potentially taxable payments that a person received through a government program (such as unemployment compensation).
Form 1099-INT: This form shows various types of interest income.
Form 1099-K: This form shows payments received for goods or services through a third-party payment processor.
Form 1099-MISC: This form covers various payments and income types not accounted for on other 1099 forms, such as rental income.
Form 1099-NEC (Non-employee Compensation): This form is used to report payments made by a business or self-employed person to independent contractors and other non-employees.
Form 1099-R: This form reports distributions from pensions, annuities, IRAs, other retirement plans, profit-sharing plans, insurance contracts and similar sources.
Form 1099-S: This form shows proceeds from real estate transactions, such as home sales. You may need to report information from Form 1099-S when claiming the home sale capital gain exclusion.
Form 1099-SA: This form shows distributions received from a health savings account (HSA), Archer MSA, or Medicare Advantage MSA.
Forms RRB-1099 and RRB-1099-R: These forms show various payments made by the Railroad Retirement Board, including annuity and pension payments.

Form 1120-S is the standard federal tax return used by S corporations, as well as LLCs that elect to be taxed as S corporations. These companies file Form 1120-S to report income, expenses, deductions and credits. However, because S corporations are pass-through entities, they do not pay corporate income tax. Instead, the company allocates the amounts reported on Form 1120-S to owners, shareholders or members, who then pay individual income tax on their shares of net earnings. Each owner, member or shareholder's portion of income, deductions, credits, etc. is reported on a Form 1120-S Schedule K-1.

In some cases, a person satisfies all the tests to be a qualifying child or qualifying other relative dependent, except that no one provides more than half of the person's support. Instead, the potential dependent's support comes from multiple different people. In these situations, the person who claims the dependent generally must file Form 2120. The form must list all other individuals who pay over 10% of the dependent's support, and include a statement certifying that they have waived their right to claim the dependent in writing. The IRS refers to these scenarios as multiple support agreements.

In most cases, couples whose filing status is married filing jointly share responsibility for their combined tax liability. In other words, the IRS holds both spouses responsible for paying any tax owed by the couple. However, in some situations, one spouse can legitimately claim that the other spouse should bear the sole responsibility for the couple's tax liability. A person with a sound basis for such a claim is called an innocent spouse. Innocent spouses may use Form 8857 to request relief from tax penalties and other consequences of the other spouse's actions. Residents of community property states whose filing status is married filing separately may also use this form to request relief from taxes or penalties related to community income or assets.

Many people who are required to file an FBAR form must also include Form 8938 with their tax returns, providing detailed information about foreign bank accounts and assets. Note that the reporting thresholds for the FBAR and Form 8938 are different. The two forms also have different rules regarding which assets a person must report. Therefore, a person might need to file only an FBAR form, only Form 8938 or both forms. Also remember that Form 8938 should be filed with a person's federal tax return, whereas FBAR forms must be filed separately (and usually electronically) with FinCEN.

Use this form to report transactions where you sold, donated or otherwise disposed of capital assets, including certain investments. For each transaction, you must state the selling price (if applicable), the amount realized, your basis or adjusted basis in the property, any other necessary adjustments, and any resulting capital gain or loss. Short-term gains and losses and long-term gains and losses must usually be reported separately. Report net gains and losses from this form on Schedule D.

People who purchase health insurance through the official Health Insurance Marketplace, and whose MAGI qualifies them for the Premium Tax Credit (PTC), use this form to compute the credit. If you receive the Advance Premium Tax Credit (APTC) during the year as a reduction in premiums, then you will use this form to reconcile those premium reductions with your actual credit amount. If your actual credit amount is more than the total APTC you received, you can claim the remaining credit on Form 1040, Schedule 3. However, if your total APTC was greater than your allowed PTC, then you may need to pay back a portion of your APTC, and may also have to pay a tax penalty.

IRS rules for reporting rental income and expenses vary depending on whether you also use the rental property as a personal residence. The IRS 14-day / 10% Rule states that you have used a rental property as your residence during a given year if you used it for personal purposes for more than the greater of 14 days, or 10% of the total number of days you rented it out at a fair price. Note that renting the property to someone at a substantially reduced price, or letting them stay there for free, generally counts as personal use for you. Also see the Minimal Rental Use exception.

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A generation-skipping transfer is the direct passing of property through gift or inheritance from a person to their grandchildren or other "skip" recipients. For IRS purposes, "skip" means that the recipient is separated from the donor by more than one generation, as defined by age difference and other tests. Generation-skipping transfers may be subject to the generation skipping transfer tax, or GSTT. The GSTT is assessed at a flat rate equal to the highest gift and estate tax rate currently in use. Therefore, the tax assessed on these transfers may be substantially greater than taxes on gifts and bequeathals that do not skip a generation. However, the GSTT only affects gifts above the annual exclusion, and only after the donor has exceeded the lifetime exclusion.

In general, the IRS classifies any transfer of property (including financial assets, fixed assets, and intangible property) from one person to another as a potentially taxable event. If the property is transferred as a gift or inheritance, the federal gift and estate tax may apply. However, a person can give away an unlimited number of gifts each year tax-free, as long as the total value given to each recipient is below the annual exclusion threshold. In addition, transfers only become taxable events if the total value of property given away or bequeathed by a person exceeds the lifetime exclusion. Gift and estate tax exemptions also exist for gifts to spouses, charities and political organizations. Note also that paying medical or education expenses for another person generally does not count as a gift for tax purposes.

Along with the substantial presence test, the green card test is one of the two main criteria that the IRS uses to determine whether a person is a resident alien for tax purposes. This test states that people should file their tax returns as resident aliens if, at any time during the tax year, they were granted lawful status to work and live in the U.S. Generally, immigrants with this status receive an alien registration card, commonly known as a green card, from U.S. Customs and Immigration Services (USCIS).

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The Affordable Care Act (ACA) established the official Health Insurance Marketplace, also called the Insurance Exchanges, for people to purchase individual or family healthcare coverage. If you qualify for the Premium Tax Credit (PTC), you must purchase your health plan through the official marketplace in order to receive the credit. If you qualify, you may elect to receive the Advance Premium Tax Credit (APTC) as a reduction in your monthly premiums. You can access the official Insurance Marketplace through healthcare.gov. Depending on where you live, you will use either the national website or an exchange operated by your state to purchase an ACA-approved plan. The system will also show which insurance plans qualify as high-deductible health plans (HDHPs).

A health savings account is a tax-advantaged account that an individual may create to set money aside for future medical expenses. If you have an HSA, you (or another person) can make pre-tax contributions to the account up to an annual limit. Your employer may also contribute to your HSA (generally through a cafeteria plan arrangement). As with a health flexible spending arrangement (FSA), withdrawals can be taken from an HSA tax-free, as long as the funds are used for qualified medical expenses. However, unlike FSAs, HSAs do not have an annual "use it or lose it" rule. Generally, to be eligible to contribute to an HSA, you must be enrolled in a high-deductible health plan (HDHP). In addition, it must not be possible for another person to claim you as a dependent.

The IRS classifies certain health insurance plans as high-deductible health plans, or HDHPs. To qualify as an HDHP, a healthcare plan must have an annual deductible equal to or higher than a threshold set by the IRS. The maximum yearly out-of-pocket expense for the insured person or family must also be equal to or LESS than the limit set by IRS rules. In addition, IRS rules restrict the types of healthcare procedures and expenses that an HDHP can cover. Generally, HDHPs have lower premiums than more comprehensive health insurance plans, but require the insured person or family to pay a larger share of medical expenses. You must have an HDHP in order to contribute to an HSA. The Health Insurance Marketplace shows which available plans qualify as HDHPs.

People who use a portion of their home as a daycare facility may qualify to claim the home office deduction, even if they also use the same area for personal purposes. Typically, the area used as a daycare center must be well-defined, and must be used exclusively for daycare during specified time periods (such as Monday through Friday from 8 a.m. to 3 p.m.). If you provide daycare services and qualify for this exception, then you will use modified methods to compute your home office deduction. These methods take into account the percent of time when the designated area is used for daycare, in comparison to the percent of time when it is available for personal use.

Officially called the Deduction for Expenses for Business Use of a Home, the home office deduction can reduce the tax liability of independent contractors, small business owners and other self-employed people. To claim the deduction, you typically must have a well-defined area of your home that you use regularly and exclusively for business purposes (unless the home daycare exception applies). With a few exceptions, the workspace must also be your principal place of business. Generally, home office expenses fall into two categories:

Direct Expenses: These are expenses that pertain only to your home workspace, such as the cost to repair light fixtures in that specific area or room.
Indirect Expenses: These are costs paid for your entire home, such as utilities, rent or a mortgage. Generally, you may deduct a portion of these expenses based on the area of your workspace in relation to the area of your entire home.
In most cases, you will report home office expenses on Form 8829, and claim the deduction on Schedule C. However, if you elect to use the Simplified Home Office Deduction Method, then you do not need to file Form 8829.

Selling your home may result in a capital gain, which would usually be subject to capital gains tax. However, eligible people may exclude a substantial portion or even all of the gain from selling their main home from their gross income for tax purposes. To claim this exclusion, you generally must have owned the home and lived in it as your primary residence for at least two of the five years preceding the sale. (Military personnel may qualify for an exception called the five-year test suspension.) If the gain from selling your main home is less than the allowed exclusion, you may not even have to report the sale to the IRS. However, if you receive a Form 1099-S, then you must report the sale, even if you owe no tax on it.

The IRS defines household employees, also called domestic employees, as people who work in or on the grounds of your home, under terms giving you significant control over how they perform their duties. Common examples of household employees include nannies, babysitters, housekeepers and gardeners. In general, if you pay any household employee more than $2,000 during a year, or $1,000 or more during any calendar quarter, then you may need to pay household employment taxes, sometimes called the "Nanny Tax." Failure to pay these taxes could result in substantial tax penalties.

If you pay any household employee more than $2,000 during a year, or $1,000 or more during any calendar quarter, then you may need to pay household employment taxes (sometimes called the "Nanny Tax") for that employee. These taxes may include the employer and employee shares of FICA taxes (Social Security Tax and Medicare Tax), as well as federal unemployment tax (FUTA). In order to manage and remit household employment taxes, you will need a federal Employer Identification Number (EIN), which you can obtain for free from the IRS. Generally, you do NOT need to pay household employment taxes on wages paid to your spouse, or to your child under the age of 21. You also may not need to pay these taxes on wages paid to your parent, or to a household employee under 18 years old.

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To prevent identity theft and protect people from scammers who file fraudulent tax returns in other people's names, the IRS offers the option of getting an Identity Protection (IP) PIN. Originally provided only to victims of identity theft or tax-related scams, IP PINs are now available to everyone with a Social Security number (SSN) or Individual Taxpayer Identification Number (ITIN). Obtaining and using an IP PIN helps ensure that the IRS will not accept a bogus return filed in your name, or issue your refund to the wrong person. You can apply for an IP PIN through the IRS website.

Generally, an independent contractor is someone who offers services for a fee to businesses, the general public or both. Independent contractors typically provide their services to more than one payer (client), and set their own fees and work schedules. Overall, independent contractors have more freedom than employees to decide when, how and where they work. Unlike employees, independent contractors ordinarily do not have taxes withheld from their pay. Instead, they generally must report and pay both income tax and self-employment tax on their net earnings. Often, they must make estimated tax payments in order to avoid tax penalties. Also see Employee vs. Independent Contractor.

Sometimes when a married couple files a joint return, the IRS withholds some or all of the couple's tax refund due to debts owed by one spouse. For example, one spouse may have federal debts dating back before the marriage, such as overdue child support or student loan payments. In these cases, the IRS refers to the spouse who does not have the debts in question as an injured spouse. Depending on the circumstances, an injured spouse may be able to claim and receive their share of a withheld tax refund. A person can make this request, called an injured spouse claim, by filing IRS Form 8379.

In general, people who inaccurately report income, deductions or other items on their tax returns may face tax penalties, IRS interest charges or even criminal charges. Sometimes, however, one spouse improperly reports (or fails to report) information on a married couple's joint return, without the other spouse's knowledge. In such cases, the IRS refers to the spouse who was unaware of any issues with the joint return as an innocent spouse. An innocent spouse may qualify for relief from paying any part of the tax penalties and IRS interest fees triggered by the other spouse's actions, as well as from any resulting criminal liability. People can apply for such innocent spouse relief by filing IRS Form 8857.

This term describes the process of tracking and determining the value of items held by a business or self-employed person in inventory for sale. Among other purposes, inventory accounting makes it possible to calculate the cost of goods sold (COGS) and gross profit. The primary inventory accounting techniques accepted by the IRS are FIFO, LIFO, weighted average cost (WAC), and specific identification. However, small enterprises may qualify for the small business inventory exception, which allows for simplified inventory accounting and reporting.

Any property that a person or business holds because of its potential to rise in value or generate future income is typically designated as investment property for tax purposes. The income produced by investment property can take many forms, including rents, royalties, capital gains and various uses of the property in a trade or business. Types of investment property include real estate, equipment and facilities, artwork, intangible assets like copyrights and trademarks, and financial property like stocks or virtual currency. Different tax rules may apply for investment property than for other personal property.

An IRA conversion (also called a Roth conversion) is a special type of retirement plan rollover, where a person moves funds from a traditional IRA or other qualified retirement plan into a Roth IRA or similar account. A Roth conversion may be beneficial for people whose future income projections change, or who cannot directly fund a Roth IRA because their adjusted gross income (AGI) is too high. Roth IRA conversions are typically taxable events. Under current tax laws, it is not possible to reverse a Roth conversion, so the rollover should only be undertaken after careful planning.

Generally, the IRS assesses interest fees when a person or business pays tax after the applicable due date or filing deadline. Conversely, the IRS pays interest to those whose tax refunds get excessively delayed. (In most cases, the law requires the IRS to issue a refund within 45 days after accepting a tax return for processing, or 45 days after the filing deadline for that return, whichever comes later.) The interest rates charged and paid by the IRS are periodically adjusted based on general economic conditions.

Through the IRS website, a person can set up a personal online account. Creating the account requires completing an identity verification process that typically takes about 15 minutes. Once you have an online account, you can use it to complete many tax-related tasks, like accessing information from your past returns, making payments, checking the status of your tax refund, applying for an installment agreement, or checking your eligibility for the Child Tax Credit (CTC), and other tax benefits.

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Individuals can give away a certain amount of property, either as gifts while they are living or through bequeathals after they pass away, without incurring gift and estate tax. The IRS limit for these tax-exempt property transfers is called the lifetime exclusion. Generally, each spouse in a married couple is entitled to the lifetime exclusion, regardless of the couple's filing status. Importantly, gifts that fall within the annual exclusion do not count toward a person's lifetime exclusion.

Eligible people may claim the Lifetime Learning Credit (LLC) for qualifying higher education expenses. The credit may cover a significant portion of tuition and school fees paid for a student who is enrolled at a qualifying higher education institution. The student may be the person claiming the credit, or that person's spouse or dependent. Eligibility restrictions include a limit on modified adjusted gross income (MAGI). Unlike the American Opportunity Tax Credit (AOTC), the LLC is not refundable in any amount. However, the LLC has more flexible qualification rules.

One of four common methods used in inventory accounting to determine the cost of goods sold (COGS), the LIFO method assumes that the newest items in stock are sold first ("last in, first out"). While the IRS currently accepts LIFO inventory accounting, some international reporting standards do not allow it because it tends to undervalue remaining inventory and inflate COGS. Alternatively, a business may track inventory using the FIFO, weighted average cost (WAC), or specific identification method.

The limited liability company (LLC) business entity type generally gives business owners more personal asset protection than a sole proprietorship, partnership, or LLP. The LLC structure also allows for more flexibility in how a business is operated and managed than a corporate structure (S corporation or C corporation). While single-member LLCs generally get taxed as sole proprietorships, those with multiple members may elect to be taxed as partnerships, S corporations or C corporations. Therefore an LLC may either have a pass-through taxation structure, or pay corporate income tax.

One major drawback of a business partnership is that all owners (partners) may be liable for a single partner's activities. For example, if one partner engages in an act that results in a lawsuit, every partner's personal assets might be put at risk. The limited liability partnership (LLP) business entity type reduces each partner's potential liability for the actions of others. For example, many law firms have an LLP structure. For tax purposes, the IRS generally treats LLPs the same as ordinary partnerships.

Over the course of working for an employer, an employee may qualify for a variety of benefits, such as a pension, stock bonuses or a profit-sharing plan. Often, the benefits an employee accumulates are paid out in annual distributions after the employee retires. However, under certain circumstances (for instance, as part of a severance package), an employer might pay out an employee's entire benefits balance in a single tax year. This one-time payment is called a lump-sum distribution. In most cases, lump-sum distributions are taxable income.

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The IRS usually defines a person's main home (or primary home) as the place where the person lives most of the time. Many types of dwellings besides houses and apartments can qualify as a main home, including houseboats, mobile homes and co-op housing. Generally, the home must have some type of cooking, sleeping, and bathroom facilities. If you own or maintain multiple homes and do not spend more than half the year at any of them, the IRS will consider additional factors to determine which one is your main home, such as the address listed on your driver's license or voter registration card. A home must qualify as your main home in order to be eligible for the home sale capital gain exclusion.

The modified accelerated cost recovery system (MACRS) is a common method used to calculate depreciation deductions. Generally, MACRS allows for larger depreciation deductions during the early years of an asset's useful life than the straight-line method. IRS regulations require the use of MACRS depreciation for certain assets, and forbid its use for others. In many other cases, a business or person may use either MACRS or straight-line depreciation, or request permission to use alternative techniques like the units of production method.

Also called a nominal tax rate, a marginal tax rate is the highest federal income tax rate that applies to any portion of a person's taxable income. Note that the IRS only applies a person's marginal tax rate to taxable income above the limit for the next lowest rate. Marginal tax rates also do not take into account any tax credits that a person qualifies to claim. Therefore, a person's effective tax rate may be significantly lower than their marginal tax rate, and will more accurately reflect their tax liability. Also see tax bracket.

Married couples and couples who live together in recognized common-law marriages may choose this filing status. Under this status, a couple files one tax return together (called a joint return), generally combining their income, deductions, and credits. (Note, however, that some credits and deductions, like the educator expense deduction, require separate accounting for each spouse's share, even on a joint return.) Filing jointly often, but not always, results in lower tax liability than choosing married filing separately status. People whose spouses passed away during the year covered by a tax return may generally still file under MFJ status, as long as they have not remarried by the end of that year.

Married couples and couples who live together in recognized common-law marriages may choose this filing status, where each spouse files a separate tax return. If you choose this status, you will report only your income, deductions, and credits on your return, and your spouse will do the same. However, if you live in a community property state, then all community income must generally be divided equally between your return and your spouse's. Filing separate returns often results in greater tax liability than married filing jointly (MFS) status, but there are circumstances where using MFS status reduces a couple's tax bill.

The term material participation (or materially participating) describes a high level of involvement in a trade or business during a tax year. The IRS uses a variety of tests to determine whether you materially participated in business activities, including the number of hours you devoted to those activities, and your level of involvement in fundamental business decisions and operations. In general, if you materially participate in a trade or business, then any resulting losses will not be subject to the passive activity loss rules. IMPORTANT EXCEPTION: Most rental income is considered passive income even if a person meets the usual tests for material participation, unless that person is a real estate professional.

A Medicare Advantage MSA is one of the available healthcare coverage options for people enrolled in Medicare. To create this special type of medical savings account, you must first enroll in a high-deductible Medicare Advantage health insurance plan. Next, you will need to set up an MSA with a financial services provider, usually a provider specified by the insurance company. The insurance company then periodically deposits money into the MSA. You can withdraw money from a Medicare Advantage MSA tax-free, as long as you use the funds for qualified medical expenses and have not yet met your insurance plan's deductible for the year.

Medicare tax is one of two components making up the FICA taxes that nearly all U.S. workers must pay (the other being Social Security tax). This tax is assessed at a flat rate of 2.9% of a worker's earnings. Employers and employees each pay half of Medicare tax, so the employee share is 1.45% of gross earnings. Meanwhile, people with self-employment income pay Medicare tax as part of self-employment (SE) tax. Workers with high incomes may also have to pay the additional Medicare tax. Paying Medicare tax over an extended period is necessary to qualify for Medicare benefits. It is therefore critical for people with significant earnings from self-employment (such as gig economy work) to pay SE tax, and for people with household employees to pay household employment taxes.

If you are a member of the National Guard or military reserves, then you may be able to claim a tax deduction for certain unreimbursed travel expenses. To claim the deduction, you generally must incur the expenses while traveling more than 100 miles from your home in connection with the performance of your military or Guard duties. The travel must also involve an overnight stay. This military travel expense deduction is an above-the-line deduction, so you may claim it without itemizing deductions.

Generally, income from rental activities is taxable and must be reported to the IRS. However, an exception applies if you use a property as your personal residence, and rent it out to others for fewer than 15 days of the year. For such minimal rental use, you generally do not need to report any rental income, and cannot claim any deductions for rental expenses. This exemption is sometimes referred to as the "Augusta rule," since many residents of Augusta, Georgia rent out their homes during the week of the famous Masters golf tournament. Also see 14-day / 10% of Rental Use Rule.

IRS rules set income limits for many tax benefits. In many cases, these limits are based on a person's adjusted gross income (AGI). However, certain IRS programs base eligibility on a different figure called modified adjusted gross income, or MAGI. To figure your MAGI, you will generally start with your AGI, and then add in or subtract away certain income types. The rules regarding which types of income to add or subtract vary for different programs, so your MAGI for one tax benefit may differ from your MAGI for another. Note that if the additions and subtractions required to calculate MAGI do not apply to your circumstances, then your AGI and MAGI will be identical.

Many homeowners qualify to claim a tax deduction for interest they pay on their home mortgages. Typically, both actual interest charges and mortgage insurance premiums may be included in this deduction. However, in order to claim the deduction, you must itemize deductions. Therefore, deducting mortgage interest will only lower your tax liability if your itemized deductions total more than your standard deduction. Often, a person's home mortgage interest deduction is largest during the early years of paying off a mortgage, when mortgage payments consist primarily of interest.

Generally, you must provide over half of a person's support in order to claim that person as your dependent. However, a situation may arise where you are one of several people who support an individual, with no one person providing half of the individual's support. Under those circumstances, all of the people who provide support can agree in writing which one (but only one) of them will claim the dependent. Such an arrangement is known as a multiple support agreement. The person designated to claim the dependent generally must provide details of the agreement to the IRS by filing Form 2120.

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If you and your spouse do not have employer-sponsored retirement plans, then contributions you make to a traditional IRA will generally be tax-deductible (as long as you do not exceed the annual contribution limit). However, if you or your spouse is covered by a workplace retirement plan, then your deduction for traditional IRA contributions may be limited or disallowed. The specific rules that apply may depend on your filing status and modified adjusted gross income (MAGI). A contribution that does not qualify for a tax deduction is called a nondeductible traditional IRA contribution, and generally must be included in the gross income you report on your tax return.

To be designated by the IRS as a nonprofit, an organization must be committed to a social cause or public benefit, rather than to generating profits for owners or shareholders. Common nonprofit entity types include religious and charitable organizations, scientific and public safety testing services, and societies devoted to literary or educational work. If these organizations meet additional IRS requirements related to management and oversight, then they may qualify for tax-exempt status, meaning that their earnings are not subject to federal income tax. Making donations to tax-exempt organizations may entitle you to claim a charitable contributions deduction.

A nonrefundable tax credit can reduce or eliminate a person's tax liability, but cannot result in a tax refund. Suppose, for example, that a person's total tax before credits is $8,700, and the person qualifies for a $5,500 nonrefundable tax credit. The credit would generally reduce the person's tax bill down to $8,700 - $5,500 = $3,200, so the person would get the full benefit of the credit. Now suppose that a second person qualifies for the same nonrefundable $5,500 credit, but only owes $4,300 in tax. The credit could reduce the person's tax liability to $0, but the excess credit would simply go to waste. Compare with refundable tax credit and partially refundable tax credit.

The term nontaxable income refers to types of income that are not subject to federal income tax. Examples include many gifts and inheritances, cash rebates from product purchases, child support, tax-exempt interest, rental income covered by the minimal rental use rule, and some alimony and government assistance payments. You generally do not need to include nontaxable income in the gross income you report on your tax return. However, you must report some types of nontaxable income elsewhere on your return, even though you will not owe tax on it. Also keep in mind that some nontaxable income for federal tax purposes may still be taxable at the state or local level.

Employees who receive bonus pay for overtime work, such as "time and a half" hourly wage payments, may qualify for an above-the-line deduction. This deduction can effectively shield the bonus portion of overtime wages from federal income tax. Only bonus overtime pay reported on a year-end income statement like Form W-2 qualifies for this deduction. Note also that regular pay for overtime work is still taxed at ordinary rates, and bonus overtime pay is still generally subject to FICA taxes.

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The IRS primarily divides business expenses into two main categories: operating (or ordinary) expenses and capital expenses. In general, operating expenses are expenses that regularly occur in the course of pursuing a trade or business, and do not result in the acquisition of capital business assets. Common examples of business operating expenses include labor, advertising, insurance, travel, rent, utilities, and supplies that regularly get used up. In many cases, you can deduct an operating expense all at once, rather than needing to capitalize the expense. However, the timing of the deduction may depend on whether you use cash accounting or accrual accounting. Also see Twelve-Month Rule.

The IRS uses this term to refer to all types of income that may be taxed at standard income tax rates. These income types may include wages, salaries, interest, royalties, commissions, ordinary dividends, tips, self-employment income, depreciation recaptures, and many short-term capital gains. For examples of income that may not be treated as ordinary income for tax purposes, see Excludable Income, Gift and Estate Tax, Qualified Dividends, and long-term capital gain or loss under Capital Gain or Loss.

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A paid preparer is any person or agency that charges a fee to complete and/or file tax returns for others. By law, paid preparers must obtain a PTIN from the IRS, and must sign all returns that they prepare. They are legally liable for errors and knowing misrepresentations that they make on those returns (though generally not for issues resulting from being provided with inaccurate information by clients). Anyone who requests money to prepare your tax return, but either refuses to sign the return or does not have a valid PTIN, is breaking the law. Do not trust these "ghost preparers," and if possible, report them to the IRS.

A partnership is the default business entity type for an unincorporated venture with multiple owners. Typically, a partnership must file IRS Form 1065 to report income, expenses, deductions and credits, and attach Schedule K-1s showing how those figures are allocated to the partners. The partners then report their shares of partnership tax figures on their personal tax returns. Thus, partnerships are pass-through entities. Partnership earnings may be subject to both income tax and self-employment tax. Also see Limited Liability Partnership (LLP).

This term most often refers to scenarios where a person receives income from a trade or business, without being involved in operations on a regular or substantial basis. Generally, the opposite of passive activity is material participation in an enterprise. Note, however, that the IRS classifies many rental operations as passive activities even if a person's involvement meets the usual standards for material participation, unless the person is a real estate professional. Losses from passive business or rental activities are typically subject to the passive activity loss rule. However, active participation in a rental operation, which is different from material participation, may qualify a person for a partial exemption from that rule known as the Special $25,000 Allowance.

If the IRS classifies a person's involvement in a rental operation or trade or business as a passive activity, then special tax rules apply to losses resulting from that activity. In most cases, the passive activity loss rule states that a person can only deduct expenses from passive activities up to the amount of their total passive activity income that year. In other words, passive activity losses typically cannot be used to offset other income. However, excess losses may generally be carried forward to future tax years.

Rather than paying federal income tax at the enterprise level, many businesses allocate income and expenses to shareowners or beneficiaries, who then report their shares of these figures on their personal tax returns. This process, known as pass-through taxation, also applies for many trusts and estates. As an example, if five partners own equal shares of a business, then the partners would each report one-fifth of the company's income, deductions and credits on their personal tax returns. The most common pass-through business entities are partnerships, limited liability partnerships (LLPs), limited liability companies (LLCs), and S corporations.

The IRS requires people and businesses to make regular tax payments throughout the year, as they receive income. Most people meet their pay-as-you-go tax obligations through paycheck withholding, but those with significant self-employment earnings or rental or investment income may need to make estimated tax payments. The IRS Withholding Estimator Tool can help you determine whether your withholding is staying on track. Failing to pay a sufficient amount of tax over the course of a year may trigger tax penalties and IRS interest fees.

The term pension generally refers to an employee retirement plan funded by contributions from the employer. Traditionally, pensions have taken the form of defined benefit plans, meaning that covered employees are guaranteed a specific, regular (usually monthly) payment amount in retirement. Some pensions today instead take the form of defined contribution plans, which specify how much the employer will contribute to the account, with future payment amounts depending on how the account performs over time. In some cases, employees may elect to receive their pension benefits as a lump-sum payment upon retiring. Generally, pension payments are taxable income.

For tax purposes, personal use property (or just personal property) is any property that you own but do not use in the pursuit of a trade or business, or for other income-generating purposes. A home that you rent out some of the time may be classified as personal property based on the 14-day / 10% test. If you operate a small business, work as an independent contractor or have other self-employment income, then you may have property that you use for both business and personal purposes. Special IRS rules apply to deducting business expenses related to such dual-use property.

Many tax benefits have income limits. These income limits sometimes have a phaseout range, which is a range of incomes where people may still claim the benefit in a reduced amount. Suppose, for example, that the maximum amount of a certain credit is $4,000. For couples whose filing status is married filing jointly, the phaseout range for adjusted gross income (AGI) is $100,000 to $125,000. In this case, eligible couples with an AGI of up to $100,000 could claim the full credit amount. Eligible couples with an AGI between $100,000 and $125,000 could still claim the credit, but their maximum credit amount would be less than $4,000. Couples with an AGI of $125,000 or more could not claim the credit in any amount.

The Affordable Care Act (ACA) created this refundable tax credit for individuals and families who purchase private health insurance coverage. You may be eligible for the Premium Tax Credit (PTC) if your modified adjusted gross income (MAGI) is below the limit set by the IRS for your filing status, and you cannot get affordable health insurance through your or your spouse's employer. To qualify for the credit, you must purchase coverage through the official Health Insurance Marketplace (Exchanges). Additional eligibility restrictions may apply. If you qualify, you may elect to receive the PTC as a reduction in your monthly health insurance premiums, called the Advance Premium Tax Credit (APTC).

Contributions that people make to retirement arrangements or other tax-advantaged accounts like FSAs and HSAs may be treated in two different ways by the IRS. If a contribution you make to a plan or account can be deducted from your gross income for tax purposes (in other words, it is tax-deductible), then that money is called a pre-tax contribution. Some plans funded with pre-tax contributions also allow tax-free withdrawals for eligible purposes (such as qualified medical expenses). However, withdrawals and distributions from retirement plans funded on a pre-tax basis are generally taxable income, and may also be subject to the early withdrawal penalty. Also see after-tax contributions.

Q

When allowed under IRS rules, the qualified business income (QBI) deduction enables many people with business or real estate royalty earnings to deduct a portion of those earning from their adjusted gross income (AGI). The deduction amount depends on a number of factors, but can range as high as 20% of the person's net income from business or real estate activities. People with many different forms of business income may be eligible to claim the QBI deduction, including small business owners, independent contractors, and other self-employed people. Eligible people generally do not have to itemize deductions in order to claim the QBI deduction.

In order for a withdrawal from an HSA, MSA, health FSA, or other tax-advantaged account designated for medical costs to be exempt from tax, the funds must be used for qualified medical expenses. The list of products, medicines, treatments and procedures that the IRS classifies as qualified expenses varies somewhat from year to year, and may also depend on which type of account you have. If you are unsure whether a specific cost is a qualifying medical expense, check with your plan provider before withdrawing funds from your account.

A QTP enables people to pay or set aside money for higher education expenses for a beneficiary student in advance. With a state-sponsored QTP, also called a section 529 plan, people, businesses, estates or trusts can make after-tax contributions to a tax-advantaged account to help cover the designated beneficiary's future tuition costs. The account's value can then grow tax-free over time. Withdrawals from a QTP account may be taken tax-free, as long as the funds are used for qualifying education expenses for the beneficiary (or, in some cases, the beneficiary's sibling). Overall, these accounts work similarly to a Coverdell ESA.

To be eligible for various tax benefits, such as the Child Tax Credit (CTC) and child and dependent care credit, a person must have at least one qualifying child dependent. The IRS uses a number of tests to determine whether someone is a person's qualifying child, including the relationship test, support test, joint return test, age test, and citizen or resident test. The exact requirements for qualifying children vary between programs, so a child could be your qualifying child for one tax benefit but not for another.

When a child's parents are divorced or separated, or were never married, special rules apply to determine which parent may claim the child as a dependent and/or qualifying child. The IRS generally assigns this right to whichever parent the child lives with most of the time (that is, the parent with sole or primary custody). However, in some cases, the parent with primary custody may agree to allow the noncustodial parent to claim the child as a dependent. In either situation, the child must meet all the other IRS tests to be a qualifying child for the Child Tax Credit (CTC), Earned Income Tax Credit, or other tax benefits.

Because Roth IRAs are funded with after-tax contributions, they have more flexible early withdrawal penalty rules than traditional IRAs. For example, people may generally take withdrawals from their Roth IRA accounts before they turn 59 1/2 without penalty if they use the funds for certain purposes, referred to as qualifying reasons for a Roth IRA withdrawal. Examples of qualifying reasons include certain medical and education expenses, along with first-time home purchases. Note, however, that even if no penalties apply, these withdrawals may still be taxed if the withdrawn funds have not been in the Roth IRA for at least five years, or include account earnings. Also see Roth IRA Early Withdrawal Rules.

The terms qualifying relative and qualifying other relative refer to someone that a person may claim as a dependent, but who is not the person's son or daughter (including adopted children), foster child, sibling, niece, nephew or grandchild. In addition to family members like parents, step siblings, step parents and in-laws, the qualifying relative category could also include unrelated members of your household who depend on you for support. To determine whether a person is your qualifying relative, the IRS uses tests like the relationship or member of household test, support test, joint return test, and citizen or resident test. Also see Qualifying Child.

A person who does not remarry during the year when their spouse passes away may generally file a joint return with their deceased spouse for that tax year. For the next two years after that, the person may be able to use qualifying surviving spouse (QSS) filing status, which offers many of the same benefits as joint filing. To be eligible for this status, the person must not remarry during the two years following the year when their spouse passed away. The person generally must also have a qualifying child or other qualifying dependent, and pay more than half the cost of maintaining the home.

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The IRS classifies some people with rental or other real estate income as real estate professionals. Generally, to qualify for this designation, a person must meet two tests. First, over 50% of the personal services they provide must be performed in connection with a real estate business in which they materially participate. Second, they must work at least 750 hours during the year in a retail estate trade or business. Special tax rules may apply for real estate professionals, including an exemption from standard passive activity loss rules.

When determining whether someone can be claimed as another person's dependent, the IRS looks at how the two people are related. As part of this relationship test, the IRS considers whether the potential dependent is the person's son or daughter (including adopted children), stepchild, grandchild, sibling, step sibling, parent, or niece or nephew. Other relatives like foster children and in-laws may meet the requirements of the relationship test under certain circumstances. This test is one of many used to identify dependents, such as qualifying children and qualifying other relatives. Note that some non-relatives may also qualify as your dependents. Also see Relationship or Member of Household Test.

People with rental income may generally deduct rental expenses on their tax returns. The IRS defines rental expenses as costs that are ordinary and necessary for the production of rental income and maintenance of rental properties. Common rental expenses include advertising, repairs, insurance premiums, and fees paid to a property manager or property management firm. Note that those who qualify for the minimal rental use exception generally should not report either rental income or expenses.

For tax purposes, the term rental income refers to a wide range of payments received from tenants. Examples of rental income include regular rents, advance rent payments, fees for breaking a lease and any repair costs that a tenant pays. The fair market value (FMV) of any property or services that a renter provides in exchange for a reduction in rent should also be included in rental income. In most cases, the IRS classifies rental income as passive income. Many people with rental income may deduct rental expenses on their tax returns.

Many qualified retirement plans, including traditional IRAs, SIMPLE IRAs, and 401(k) plans, require the account holder to withdraw funds from the plan on an annual basis after reaching a specified age. The amount of a person's RMD is determined by their age and the amount of money in the account. With rare exceptions, RMDs are taxable income. In general, original owners of Roth IRAs do not have to take RMDs. However, inherited Roth IRAs lose their Roth status, so beneficiaries generally must withdraw funds from the account either annually or within a specified timeframe. Also see Ten-Year Rule.

The residency test is one of many factors that the IRS analyzes to determine whether you may claim someone as your dependent (qualifying child or qualifying other relative). Generally, this test requires that the potential dependent live with you for more than half of the year, except for temporary absences like vacations or school attendance. In some cases, the residency requirement extends to the entire year. However, certain potential dependents like your parents may not need to live with you, and the IRS may waive the residency test in other situations as well.

This nonrefundable tax credit is available to many low- and middle-income individuals who contribute to an IRA, employer-sponsored qualified retirement plan or, in some cases, ABLE plan. To be eligible for the credit, you must be at least 18 years of age and not a student (IRS definition). You also cannot be claimed by any other person as a dependent. Depending on your adjusted gross income (AGI), you may be able to claim a credit of 10%, 20% or 50% of your retirement plan contributions for the year. This credit is separate from tax deductions for retirement plan contributions.

The term rollover generally refers to any transfer of funds from one tax-advantaged account to another. For example, a person might move funds from an employer-sponsored qualified retirement plan like a 401(k) to a traditional IRA. Rollovers between accounts with the same tax structure (for example, two accounts funded with pre-tax contributions), are generally not taxable events. However, a rollover between accounts with different tax structures, such as a traditional IRA and a Roth IRA, typically has tax impacts. Some rollovers can be completed through direct transfers, while others require withdrawing funds from the first account and manually depositing them into a second account, usually within 60 days.

A Roth IRA is a retirement account funded with after-tax contributions. Only people with modified adjusted gross incomes (MAGIs) below the limit set by the IRS may directly contribute to a Roth IRA. However, people who do not qualify to make direct contributions may be able to fund a Roth IRA through an IRA conversion. Tax benefits of a Roth IRA include tax-free growth, tax-free withdrawals and no required minimum distributions (RMDs) for the original account holder. Also see Traditional IRA.

Because Roth IRAs are funded with after-tax contributions, they have less stringent early withdrawal penalty rules than traditional IRAs. For example, if you are under age 59 1/2, you may be able to take penalty-free and tax-free withdrawals of funds that have been in your Roth IRA for five years or more. However, withdrawals before age 59 1/2 that include account earnings (instead of just contributed funds) may be taxable even if no penalties apply. Also see Qualifying Reason for Roth IRA Withdrawal.

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Like a C corporation, an S corporation is treated as a separate entity from its owners or shareholders for many legal purposes. However, an S corporation does not pay corporate income tax. Instead, the company's earnings, expenses, deductions and credits are allocated to shareholders based on their ownership percentages. The shareholders report these allocated figures on their personal tax returns, and pay tax on their shares of net profits. This process is known as pass-through taxation, and it may lower the company's overall tax liability by eliminating double taxation. Some LLCs may elect to be taxed as S corporations, instead of as partnerships.

The IRS allows businesses and self-employed people to deduct the entire cost of certain capital expenses during the year they are incurred, instead of claiming depreciation deductions over multiple years. Only certain types of tangible property and fixed assets qualify for these one-time deductions, which are called Section 179 expenses in reference to the relevant provision of the Tax Code. In general, Section 179 expense deductions cannot be greater than the taxable income of the trade or business, and a variety of other limitations may apply.

Named for the provision of the federal Tax Code that governs them, Section 1031 exchanges allow businesses and real estate professionals to defer capital gains tax on some real estate sales. To qualify for this tax deferral, any gain from the sale of a parcel of property must be used to purchase other real property, known as "like-kind" property. The rules for Section 1031 exchanges are complex, and any deviation from those rules could result in a loss of tax benefits. Therefore, these transactions should only be undertaken with expert guidance, which usually includes the assistance of a qualified intermediary (QI). Some Section 1031 exchanges are known as Starker exchanges, after a family whose federal court case had a major impact on how the rules for such transactions get applied today.

If you have self-employment income and purchase your own health insurance, then you may qualify for a tax deduction for the cost of your insurance premiums. This self-employed health insurance deduction is an above-the-line deduction, so you do not need to itemize deductions in order to claim it. However, if you purchase healthcare through the Health Insurance Marketplace and qualify for the Premium Tax Credit (PTC), you may generally only use the self-employed health insurance deduction for a portion of your premiums. In such cases, the calculations can grow quite complicated since the deduction affects the PTC, and vice versa. The IRS allows several different methods to resolve this issue.

Generally, the IRS considers you self-employed if you earn income by conducting a trade or business, or by pursuing any other activity for pay without being classified as an employee. Common examples of self-employment include operating a business as a sole proprietor or partner, freelancing, working as an independent contractor, selling crafts online or participating in the gig economy. For instance, if you offer dog walking services as your "side gig," then the IRS will typically classify your earnings from that activity as self-employment income. You may need to pay self-employment tax in addition to income tax on earnings from self-employment activities. Also see Employee vs. Independent Contractor.

Individuals with $400 or more of self-employment income during a year generally must pay federal self-employment (SE) tax. SE tax is made up of the Social Security and Medicare (FICA) taxes that traditional employees pay through a combination of paycheck withholding and employer contributions. Because the IRS views a self-employed person as both the employee and the employer, SE tax includes both shares of FICA taxes. Those who pay SE tax may usually claim the deduction for one half of self-employment tax as an above-the-line deduction. If you owe SE tax, you may need to make quarterly estimated tax payments to comply with the IRS pay-as-you-go rule and avoid tax penalties.

A SIMPLE IRA (Savings Incentive Match PLan for Employees) is a type of employer-sponsored retirement plan designed for small businesses and self-employed individuals. Most businesses with 100 or fewer employees are eligible to establish and maintain SIMPLE IRAs. To create the plan, the employer first sets up a traditional IRA for each eligible employee. Both the employer and employee can then make pre-tax contributions to the IRA. Managing a SIMPLE IRA plan is generally easier and less costly than establishing other qualified retirement plans for employees. Self-employed people with no employees other than themselves (such as independent contractors and freelancers) can also set up SIMPLE IRAs.

In general, businesses that sell goods must compute their cost of goods sold (COGS) by using a standard inventory accounting method, such as FIFO, LIFO, weighted average cost (WAC), or specific identification. However, small businesses and self-employed people with revenues below a limit set by the IRS may qualify to use a simplified method to track and report inventory costs. Under this exception, costs associated with acquiring or producing inventory items may be reported as expenses for non-incidental materials and supplies. However, these expenses must be reported only when inventory items are sold, used or disposed of - NOT when they are originally incurred or paid. This rule applies even if a cash accounting system is used.

Social Security is a federal government insurance program that provides benefits to eligible American workers. Primarily, these benefits consist of retirement payments, disability payments and/or a death benefit for the spouse or children of a person who passes away. People may begin receiving retirement benefits at age 62, but in most cases, waiting until age 70 to claim Social Security benefits results in a significantly higher monthly payment. The Social Security program is funded by the Social Security tax portion of FICA taxes and self-employment tax, and overseen by the Social Security Administration.

Issued by the Social Security Administration (SSA), a Social Security number (SSN) is the most common form of taxpayer identification number (TIN). When displayed on an official Social Security card, an SSN confirms a person's eligibility to work in the U.S. Most parents apply for SSNs for their children when they request an official birth certificate. If you are a natural-born U.S. citizen but did not receive an SSN as a child, you may apply for one at any SSA office. Others can apply for an SSN when they become citizens or receive legal authorization to work in the U.S. If you are not eligible for an SSN (for instance, because you are a nonresident alien), then you may instead be able to apply for an ITIN to handle tax matters.

Sole proprietorship is the default business entity type for an unincorporated enterprise with one owner. The category of sole proprietors includes not only small business owners, but also a wide range of people with self-employment income from independent contract, freelance or gig economy work. Sole proprietors usually report their business income and expenses on Schedule C of their personal tax returns. Any net profit shown on Schedule C may be subject to both income tax and self-employment tax.

Instead of using the common FIFO, LIFO, or weighted average cost (WAC) methods of inventory accounting, some businesses choose to track individual items kept in stock for sale. With this method, known as specific identification, the production or acquisition cost of each item of merchandise is computed and recorded. The cost of goods sold (COGS) is then calculated by adding up the costs of all the specific items that were sold, used or disposed of during the year. This accounting method generally only makes sense for sellers with small inventories, or inventories made up of rare, unique or custom-made items.

Rather than itemizing deductions, eligible people may choose the standard deduction for their filing status. By reducing taxable income, deductions lower a person's tax liability. People who are blind and/or 65 or older, or whose spouse is blind and/or 65 or older if they are married filing jointly, generally receive an enhanced standard deduction. However, standard deduction amounts are reduced for people who can be claimed by someone else as a dependent. Also note that certain people are not eligible to use a standard deduction, including many nonresident aliens and dual-status aliens, along with people who use married filing separately status and have a spouse who itemizes.

Business owners and other self-employed people may generally claim a business expense deduction for vehicle use. In most cases, the deduction may be calculated either by tracking actual expenses or by using the standard business mileage rate set annually by the IRS. To use the standard rate, track the miles you drive for business purposes (separate from any miles you drive while commuting or for personal reasons). Then just multiply the number of business miles by the standard mileage rate, and add in tolls and parking fees to get your total vehicle expense deduction. NOTE: If you report actual expenses for the first year when you use your vehicle for business, then you generally cannot use the standard mileage rate in future years. Also see Actual Expense Method.

By law, certain workers must be classified as employees for tax purposes, even if their working arrangements would normally make them independent contractors. These statutory employees include some salespeople, insurance agents, delivery drivers and people who work at home on materials or goods supplied by a company. Statutory employees should have taxes withheld from their pay, including FICA taxes, and generally do not owe self-employment tax on their earnings. They should receive a Form W-2 from their employers, with a box checked indicating their status as statutory employees. Also see Employee vs. Independent Contractor.

Corporations sometimes use a stock split to lower the market price of individual shares of their stock. The split is accomplished by increasing the number of shares each stockholder has, without changing the total value of those shares. The most common form of stock split is a two-for-one split, which doubles the number of shares each stockholder owns, while reducing the value of each share by half. Stock splits are not taxable events, because they do not change the overall value of the shareholder's assets. A stock split also does not change the total basis of a shareholder's stock in a company, but it does reduce the basis per share.

A commonly used technique to calculate depreciation deductions, the straight-line method generally involves distributing the cost of a capital asset equally over the years of its useful life. Suppose, for example, that a machine costs $10,000 to acquire, has a useful life of five years, and will have a $0 salvage value. The straight-line depreciation method would give an annual depreciation deduction amount of $10,000 ÷ 5 = $2,000. The primary advantage of the straight-line method is mathematical simplicity. However, for eligible property, computing depreciation by the alternative MACRS method typically results in larger deductions during the early years of the depreciation period. Also see Bonus Depreciation and Section 179 Expenses.

T

The IRS uses this general term to refer to any activity that may affect a person's tax liability. Common examples of taxable events include selling property (such as artwork or virtual currencies) at a gain, or receiving a payment for goods or services. Typically, people or businesses involved in a taxable event must report any resulting income on their tax returns. However, some events fall under IRS exemptions or exclusions, such as the lifetime gift and estate tax exclusion, the minimal rental use exemption, or the home sale capital gain exclusion. These special rules may eliminate the need to report a transaction that would ordinarily be a taxable event.

A tax credit can reduce a person's tax liability on a dollar-for-dollar basis. In most cases, tax credits have a greater impact on someone's tax bill than tax deductions. For example, while a $3,200 credit can yield tax savings up to that amount, a $3,200 deduction would typically only reduce a person's total tax by around $300-$1,000. Common tax credits include the Child Tax Credit (CTC), the Earned Income Tax Credit (EITC), the Child and Dependent Care Credit, the Credit for the Elderly or Disabled, the health insurance Premium Tax Credit, and higher education credits like the Lifetime Learning Credit and American Opportunity Tax Credit (AOTC). A tax credit may be refundable, partially refundable, or nonrefundable.

This term refers to various amounts that people may subtract away from their gross income on their tax returns. For example, many people may claim tax deductions for traditional IRA contributions, while self-employed people can take deductions for business expenses. Unlike tax credits, deductions do not lower tax liability on a dollar-for-dollar basis. Instead, they reduce taxable income, which in turn results in less tax. For example, a $2,000 tax deduction would reduce most people's total tax by around $200-$700. The three main types of deductions are above-the-line deductions, standard deductions, and itemized deductions.

To determine who may owe U.S. federal taxes, and who may qualify for the foreign earned income exclusion, the IRS identifies each person's tax home. In most cases, your tax home is the state, region or country where you permanently or indefinitely work as an employee, earn self-employment income, or operate a business. Note that this location might not be the same as the place where you and/or your family maintain a home. However, if you do not have a principal business location or workplace, then your tax home may be wherever you regularly live, even if you work elsewhere (including overseas) much of the time. Also see Domicile.

Tax liability is the total amount of tax that a person or business owes for a year. To meet the IRS pay-as-you-go requirement, individuals generally must make tax payments throughout the year that add up to at least 90% of their tax liability, or 100% of their tax liability from the previous year, whichever is less. (The standard shifts to 90% / 110% at higher income levels.) You may make these payments through paycheck withholding and/or by paying estimated tax. Any remaining tax that you owe generally must be paid by the IRS filing deadline to avoid tax penalties and IRS interest charges.

A tax penalty is a fee that the IRS charges a person or business for underpaying in tax, violating tax reporting rules or failing to make timely payments. Tax penalties get added to any tax and IRS interest that the person or business already owes. The most common reasons for IRS penalties include failing to file a tax return as required, late payments, underreporting income, improperly claiming tax benefits, and not paying enough tax throughout the year through withholding or estimated tax payments. The best ways to avoid IRS penalties are to pay tax steadily throughout the year, accurately report all your potentially taxable income and pay any remaining tax you owe by the filing deadline. If you miss a deadline or make an error on your return, you can minimize penalties by fixing the mistake and/or submitting a payment as soon as possible.

If your tax payments (generally withholding and/or estimated tax) and refundable credits add up to more than your tax liability, you will generally be entitled to a tax refund. In most cases, the IRS issues a refund within 45 days of accepting a correctly filed tax return for processing. However, the IRS sometimes reduces or withholds a refund because of federal debts like past due taxes, child support or unpaid student loans. The fastest way to receive an IRS refund is to e-file your return and provide banking information for direct deposit.

A tax return is an annual report of income, tax deductions, and tax credits filed by a person, couple, business, trust or estate. Most U.S. citizens and residents are required to file a return each year. Typically, a return consists of a summary page like Form 1040, Form 1041, Form 1065, or Form 1120, along with accompanying schedules and forms that detail specific transactions, deductions, credits, etc. Tax returns generally must be filed by the appropriate filing deadline, or up to six months after that date if the filer requests an automatic filing extension.

People have the option of authorizing another person to discuss their tax returns with the IRS. Such discussions may include providing the IRS with additional information about a return, or responding to a notice about a potential issue with the return. A representative that someone authorizes to talk to the IRS on their behalf is called a third party designee. You can name a third party designee by providing the person's name and phone number on your tax return, along with a personal identification number (PIN) chosen by the designee. If you use a paid preparer, then the preparer can usually serve as your third party designee.

Many workers in service businesses, including food servers, delivery drivers, baggage handlers and hair stylists, regularly receive tips from customers. IRS rules require employees to report most tip income to their employers, or to report tips directly to the IRS by submitting Form 4137 with their tax returns. Note that only tips reported to an employer and shown on a year-end income statement like Form W-2 can qualify for the "No Tax on Tips" deduction. Self-employed people who receive tips (that is, voluntary payments above their stated fees) should generally report these tips as part of their self-employment income.

The IRS uses the phrase "trade or business" to describe a wide range of activities that people engage in to earn income or a profit. For example, IRS publications refer to earnings from self-employment endeavors like freelancing, independent contract work, sole proprietorship, or gig economy activities as income from "pursuing a trade or business." In everyday use, the word "trade" often refers specifically to pursuits requiring specialized training, such as carpentry or plumbing. However, for tax purposes, there is no meaningful distinction between what constitutes a trade and what constitutes a business.

A traditional IRA is a tax-advantaged personal retirement account that may generally be funded with pre-tax contributions. (Note that if a person or their spouse participates in a workplace-sponsored retirement plan, then their contributions to a traditional IRA may not be tax-deductible.) Distributions from a traditional IRA are typically taxed as ordinary income, so the account's primary advantage usually lies in tax deferral. However, withdrawals from a traditional IRA taken before the age of 59 1/2 may be subject to an early withdrawal penalty. Traditional IRA owners generally must withdraw a certain amount from their accounts each year once they reach a specified age. These mandatory withdrawals are known as required minimum distributions (RMDs). Also see Roth IRA.

In general, businesses and self-employed people who use cash accounting report expenses whenever those expenses are paid. However, the IRS limits how far in advance business taxpayers may pay expenses and still deduct the full cost. The 12-month rule states that in order for an entire advance payment to be deductible, the benefit received must not extend for more than 12 months after it begins, or beyond the end of the next tax year, whichever comes first. If the benefit (such as insurance coverage) does not satisfy the 12-month rule, then portions of the expense must be allocated to different tax years. This dividing up of an expense over multiple years is an example of capitalization of an expense.

U

In most cases, unemployment benefits received from a state, local or federal government agency are taxable income that must be reported on the recipient's tax return. Recipients of taxable payments will generally receive Form 1099-G in late January or early February, summarizing their benefit payments from the previous year. Unemployment compensation is considered unearned income for purposes like determining a person's eligibility for the Earned Income Tax Credit, or to make pre-tax contributions to a traditional IRA.

In general, employers must pay unemployment taxes for their employees, including many household employees. These taxes typically consist of both Federal Unemployment Tax (FUTA) and state unemployment taxes. Note that it is often possible to claim a federal tax credit for state unemployment taxes paid, reducing the total amount of unemployment tax that a business must pay. Unlike FICA taxes, unemployment taxes do not have an employee share; only employers pay them. However, because these taxes are subject to a wage base limit, employers only have to pay them on a portion of each employee's earnings (typically, the first $7,000 that the employee earns each year).

For certain assets, businesses may use this depreciation technique instead of the more common MACRS or straight-line method. With the units of production method, depreciation deductions are based on how much an asset is used, with larger deductions for years of heavy use and smaller deductions for other years. Therefore, this method makes the most sense for equipment that loses value primarily due to wear and tear rather than age. If you wish to use the units of production method, first check IRS guidelines to make sure alternative depreciation methods are allowed for the asset in question. If so, include a statement with your tax return explaining the method used and your justification for using it.

For some workplace cafeteria benefit plans that allow pre-tax contributions, employees must use up all of their account funds on qualifying expenses by the end of the calendar year. Any funds left in the account after the year ends get forfeited to the employer. This sort of use-it-or-lose-it rule commonly applies to Flexible Spending Arrangements (FSAs). However, health FSA plans may allow a limited carryover of funds from one year to the next, or have a 2 1/2 month "grace period" during which employees can use up account funds from the previous year.

Calculations for depreciation deductions are typically based on an asset's useful life. Theoretically, this time period represents how long the property will retain substantial value and continue to serve its intended purpose. The declared value of the property at the end of its useful life may be either $0 or some other salvage value. Note that many tangible assets hold value and remain productive long after the useful lifetimes specified for them in IRS guidelines. For example, a kitchen appliance may have a useful life of five years for depreciation purposes, but may actually last for decades. Selling an asset after its useful life ends for more than its salvage value may create the need to report a depreciation recapture.

V

The IRS uses the term virtual currency to describe all traded currencies that exist only in digital forms. In other words, virtual currencies are a type of digital asset. The most widely used virtual currencies are cryptocurrencies ("crypto" for short). The IRS treats virtual currencies as property, not as money. As a result, many virtual currency transactions are taxable events, including some that would have no tax impacts if they were conducted in cash. Most commonly, crypto transactions may result in taxable capital gains. The IRS requires people to disclose a wide range of virtual currency activities on their tax returns.

W

A wage base limit is an earnings threshold that makes a worker (or the worker's employer) exempt from paying a tax. Once a worker's earnings for a particular year exceed the wage base limit, then the tax in question does not apply to the worker's pay for the remainder of that year. The two most common examples of taxes with a wage base limit are Social Security Tax and federal Unemployment Tax (FUTA). People with multiple jobs may be at risk of overpaying in Social Security tax, because each employer must withhold the tax until the person's earnings from that specific job rise above the wage base limit. If you find yourself in that situation, you can apply for a refund of excess Social Security tax withheld when you file your tax return.

Withholding refers to the process of reducing a payment amount to cover taxes that must be remitted to the IRS or another taxing authority. The most common type of withholding is employee paycheck withholding. For example, if an employee earns $100, but $7.65 in federal taxes apply to those wages, then the employer would reduce the employee's pay to $100 - $7.65 = $92.35. The employer would then remit the withheld $7.65 to the IRS. Taxes may also be withheld from other payments like gambling winnings, pensions, annuities, and unemployment compensation.

The IRS online Withholding Estimator tool helps people check whether the proper amount of federal tax is being withheld from their pay. To use the tool, you will need to enter information about your income, as well as circumstances that may influence your eligibility for tax benefits. Based on the information you provide, the tool will estimate the amount of federal income tax that should be withheld from each of your paychecks. If your current withholding amount appears to be incorrect, you can submit a new Form W-4 to your employer to request an adjustment. Note that the Withholding Estimator only calculates federal income tax withholding, not withholding for state, local or FICA taxes.