Welcome back! This month we’re talking about all things tax related, including tax terms. If you missed our other posts this month, we invite you to check them out now. To learn how to choose the right entity, click here. To find out how you can take advantage of some surprising tax deductions, check this out. And to get your arms around tax obligations you need to know about, look here.
This week we want to share some key tax terms you need to know to win the tax game. While CPAs are responsible for having a solid command of all tax-related terms, it’s important for you, as the financial advisor, to be able to provide help with basic tax questions as well. This glossary of tax terms should help you out.
The Certified Tax Coach Glossary of Key Terms You Need To Know To Win The Tax Game:
Accelerated Depreciation: A depreciation method that allows larger deductions in the early years of the “life” of an asset and smaller deductions in later years.
Accrual method (or accrual basis): An accounting method for determining when a transaction has tax significance. A transaction is taxed when an obligation to pay or a right to receive payment is created (for example, products are delivered, services rendered, etc.).
Adjusted basis: The cost of property with adjustments made to account for depreciation, improvements, withdrawals or reinvestment, etc. Part of the computation for determining gain or loss on a sale and for determining depreciation.
Adjusted gross income: The amount of income eligible to be taxed.
Basis: The basis of an asset is its value, used for computing gain or loss when the asset is sold.
Capital gains: The profit that results from selling a capital asset, such as stock, bond, or real estate.
Defined benefit plan: Also known as a traditional pension plan. This type of retirement plan promises a specified monthly benefit at retirement. That benefit is usually based on the participant’s salary, age, and the number of years he or she worked for their company.
Defined contribution plan: More common than the defined benefit plan. This type of retirement plan includes contributions from the employee and/or the employer. The value of the account will change based on contributions and how the investments do. Common types of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.
Dependent: A dependent is a person other than yourself or your spouse who you can claim a tax exemption for. To count someone as a dependent, he or she must be your qualifying child or other relative.
Employer Contributions (“Free Money”): Money made available by the employer to employees specifically to be added to a retirement investment or account. Many employers provide contributions toward employee retirement accounts. Some will match the employee’s contribution up to a certain percent. An employer may also contribute to eligible employees’ Health Savings Accounts as another way of providing retirement savings.
Exempt from withholding: Free from federal income tax being withheld from your paycheck.
Exemption: The amount that a taxpayer can claim for himself or herself, spouse, and eligible dependents. Your total exemption is subtracted from your adjusted gross income before tax is calculated.
Itemized deduction: A deduction that is allowed on Schedule A (Form 1040) for medical and dental expenses, taxes, home mortgage interest and investment interest, charitable contributions, casualty and theft losses, and other miscellaneous deductions.
Standard deduction: Taxpayers who choose not to itemize deductions can take a standard deduction.
Tax credit: A tax credit reduces your tax liability. Credits are allowed for purposes such as child-care expenses, higher education costs, qualifying children, and earned income of low-income taxpayers.
- 1040: U.S. Individual Tax Return; Used for personal income taxes
- 5500: Ensures that employee benefit plans are properly managed and provides participants and beneficiaries with the information necessary to protect their rights
- 1065: U.S. Return of Partnership Income; Used by partnerships for tax returns
- 1120: Used by corporations to report income, gains, losses, deductions, credits and to figure out tax liability.
- 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return
- 941: Employer’s Quarterly Federal Tax Return
- 943: Employer’s Annual Federal Tax Return for Agricultural Employees
- 944: Employer’s Annual Federal Tax Return
- 1099: Used to report various income outside of wages, salaries, an tips
- W-2: Used to report wages paid to employees and the taxes withheld from them.
- W-9: Request for Taxpayer Identification Number and Certification; Used by third parties to collect identifying information to help file information returns with the IRS; Helps the payee avoid backup withholding.
Depending on how much you know about how the tax process works, some of this may feel like more than you can easily digest. That said, we encourage you to print this puppy out and to store it somewhere that you can get to it easily and quickly should you need to review it.
Taxes can be confusing for business owners who lack the knowledge necessary to navigate the tax terms, laws and regulations. By positioning yourself as your clients’ go-to person for their basic tax questions and needs, you’ll set both of you up for success down the road. Tax laws and processes are complex and constantly changing but we hope that our series this month has given you a glimpse into our world and helped you to feel more prepared to face tax season.