Tax Form Terminology

Key Tax Terminology

1. Gross and Taxable Income

Gross income is your total income over the year. This includes everything from wages and tips to any interest, dividends, or capital gains you earned. Right off the bat, you can subtract certain things from your gross income – above-the-line deductions. That will give you what's called your adjusted gross income.

From there, you may claim certain exemptions and deductions. Once those exemptions and deductions are taken, the number you are left with is called your taxable income. You calculate your taxes based on that amount.

2. Tax Deductions

You may deduct certain expenses when calculating your taxable income. For example, if you made $45,000 last year and have $5,000 in deductions, you effectively pay taxes on $40,000 of income.

Above-the-Line Deductions: These are subtracted from your gross income right off the bat; they include qualified contributions to retirement accounts and alimony payments.
Itemized Deductions: Additional deductions are calculated using the IRS Form 1040 Schedule A. These deductions include certain medical expenses, charitable contributions, and more.
Standard Deduction: If you choose not to itemize, you can generally qualify to take a standard deduction. This is available to most people, though certain restrictions apply, and the amount is determined by your filing status. You may choose to itemize if your itemized deductions would exceed the amount of the standard deduction.

3. Tax Credits

A tax credit reduces the taxes you owe the government dollar for dollar. With some credits, if your credit exceeds how much you owe, you're entitled to get the difference back as a refund.

One of the most popular credits is the Earned Income Credit (EIC), meant to reduce taxes for lower- and middle-income families. The amount of the credit is determined by your income and number of children.

4. Dependents

A dependent is someone you support financially – for example, elderly parents or children. Claiming dependents may help qualify you for exemptions and credits. Children may qualify as dependents until age 19 or 24 if they are full-time students.

Older children or adults who qualify as dependents may still file tax returns and may even be required to file if their incomes exceed certain amounts.

5. Exemptions/Allowances*

In the past, "exemptions" or "allowances" were like special money coupons that could lower the amount of your pay that was taxed. The amount you could lower your taxes by was based on the number of people living in your home.

However, after new tax laws were passed in 2018, they said goodbye to these specific terms. Even though we don't use these names anymore, we still provide similar info through the W-4 form that helps the IRS figure out how much money to set aside from our paychecks for taxes. So, while the rules changed a little, the overall idea is still pretty much the same: the number of people living in your home affects your taxes.

a funnel. On top of the funnel is Gross income. Under it is minus sign and Above the line deductions. Under that is equal sig

Taxes are calculated on the amount that is left over after all deductions (and exemptions*) are taken out.

6. Marriage Penalty vs. Bonus

Married couples can file taxes together or separately. Depending on how much money you both make and how that income is distributed, the amount you owe the government as a couple filing together may be higher or lower than if you file separately. If you owe more as a married couple, it is often called a marriage penalty. If you owe less, it is often referred to as a marriage bonus.

7. Tax Brackets and Rates

Because the U.S. tax system is progressive, different portions of your income are taxed at different rates. Income levels are divided into brackets with higher tax rates on higher income brackets. Whatever tax bracket the highest dollar of your income falls into is your marginal tax rate. But because of the progressive system, your tax bill is likely smaller than that. What you actually pay is known as your effective tax rate.

* The term "exemption" is no longer a tax term but refers to the fact that a number of people living in a household affects the amount of taxes taken out.