Tax Glossary
Over 114 tax terms explained in plain language with real-world examples. Bookmark this page for quick reference during tax season.
A
Abatement
A reduction or elimination of a tax penalty or the amount of tax owed. The IRS may grant a penalty abatement if you can show reasonable cause for failing to file or pay on time.
Example: You were hospitalized and missed the filing deadline. The IRS grants a penalty abatement, removing the $500 late-filing penalty from your account.
Above-the-Line Deduction
A deduction subtracted from gross income to arrive at adjusted gross income (AGI). These deductions are available whether you itemize or take the standard deduction, making them especially valuable.
Example: Student loan interest, educator expenses, and HSA contributions are all above-the-line deductions. A teacher who pays $300 for classroom supplies can deduct that amount even while taking the standard deduction.
Accrue
To accumulate or grow over time. In tax contexts, it refers to income that has been earned or expenses that have been incurred but not yet received or paid. Accrual-basis taxpayers report income when earned regardless of when payment arrives.
Adjusted Gross Income (AGI)
Your total gross income minus specific above-the-line deductions such as student loan interest, IRA contributions, and self-employment tax. AGI is a key figure on your tax return because it determines eligibility for many credits and deductions.
Example: You earn $90,000 in wages and contribute $6,000 to a traditional IRA. Your AGI is $84,000, which may qualify you for education credits that phase out at higher income levels.
Alternative Minimum Tax (AMT)
A parallel tax system designed to ensure that high-income taxpayers who benefit from certain deductions and exclusions still pay a minimum amount of tax. You calculate your tax under both the regular system and the AMT system and pay whichever is higher.
Example: You earn $250,000 and exercise incentive stock options worth $100,000. The spread on those options is not taxed under the regular system but is added back for AMT purposes, potentially triggering an additional tax bill.
Amended Return
A tax return filed on Form 1040-X to correct errors or make changes to a previously filed return. You can amend a return to claim a missed deduction, correct income, or change your filing status.
Example: After filing, you discover you forgot to report $2,000 in freelance income. You file an amended return on Form 1040-X and pay the additional tax owed to avoid penalties.
Audit
An examination of your tax return by the IRS to verify that income, deductions, and credits are reported accurately. Audits can be conducted by mail (correspondence audit), at an IRS office, or at your home or business.
Example: You claimed $15,000 in charitable deductions and the IRS selects your return for audit. They ask you to provide receipts and acknowledgment letters to substantiate the donations.
B
Backup Withholding
Tax withheld at a flat 24% rate from certain payments such as interest, dividends, and non-employee compensation when the payee has not provided a correct taxpayer identification number (TIN) or has been notified by the IRS to do so.
Example: You open a savings account but fail to provide your Social Security number. The bank withholds 24% of all interest payments and sends it to the IRS on your behalf.
Basis
The original cost of an asset for tax purposes, used to calculate gain or loss when the asset is sold. Basis can be adjusted upward for improvements or downward for depreciation.
Example: You buy stock for $5,000 (your basis). If you sell it later for $8,000, your taxable gain is $3,000.
Beneficiary
A person or entity designated to receive assets or benefits from a retirement account, life insurance policy, trust, or estate. Beneficiaries may owe income tax on inherited retirement account distributions.
Example: You name your spouse as the primary beneficiary of your 401(k). Upon your death, your spouse inherits the account and can roll it into their own IRA.
Bracket
See Tax Bracket. A range of taxable income that is taxed at a specific rate under the progressive federal income tax system.
Business Expense
A cost incurred in the ordinary course of operating a business that is deductible from business income. Expenses must be both ordinary (common in your trade) and necessary (helpful and appropriate) to qualify.
Example: A freelance graphic designer deducts $1,200 for Adobe Creative Suite and $400 for a Wacom tablet as business expenses on Schedule C.
C
Capital Gains
The profit realized from selling a capital asset (such as stocks, bonds, or real estate) for more than its purchase price. Capital gains are classified as short-term (held one year or less) or long-term (held more than one year), with long-term gains taxed at lower rates.
Example: You bought shares for $10,000 and sold them two years later for $15,000. Your $5,000 long-term capital gain is taxed at 0%, 15%, or 20% depending on your income.
Capital Loss
The loss incurred when a capital asset is sold for less than its purchase price. Capital losses can offset capital gains, and up to $3,000 of excess losses can be deducted against ordinary income each year, with the remainder carried forward.
Example: You sell stock at a $7,000 loss and have $2,000 in capital gains. After offsetting, you have a $5,000 net loss. You deduct $3,000 this year and carry forward the remaining $2,000.
Carryforward
The ability to apply a tax deduction, credit, or loss to a future tax year when it cannot be fully used in the current year. Common carryforwards include net operating losses, capital losses, and charitable contributions.
Example: You have $10,000 in capital losses but only $4,000 in gains. After deducting $3,000 against ordinary income, the remaining $3,000 carries forward to next year.
Casualty Loss
A loss of property resulting from a sudden, unexpected, or unusual event such as a natural disaster, fire, or theft. Since 2018, personal casualty losses are deductible only if they result from a federally declared disaster.
Example: A tornado damages your home and you live in a federally declared disaster area. You can deduct the unreimbursed loss exceeding 10% of your AGI after a $100 reduction.
Charitable Deduction
A deduction for donations of money or property to qualified tax-exempt organizations. You must itemize deductions on Schedule A to claim charitable contributions, and donations generally cannot exceed 60% of AGI for cash gifts.
Example: You donate $5,000 to a local food bank and $2,000 worth of clothing to Goodwill. If you itemize, you can deduct the full $7,000 on Schedule A.
Child Tax Credit
A tax credit of up to $2,000 per qualifying child under age 17. Up to $1,700 of the credit is refundable (as the Additional Child Tax Credit), meaning you can receive it even if you owe no tax. The credit phases out at higher income levels.
Example: A married couple with two children under 17 and an AGI of $100,000 qualifies for a $4,000 Child Tax Credit, directly reducing their tax bill.
COBRA
The Consolidated Omnibus Budget Reconciliation Act, which allows employees to continue their employer-sponsored health insurance for a limited time after leaving a job. COBRA premiums are paid by the individual and may be deductible as a medical expense if you itemize.
Example: After being laid off, you elect COBRA continuation coverage for 18 months, paying $600 per month. These premiums count toward your medical expense deduction if your total medical costs exceed 7.5% of AGI.
Contribution Limit
The maximum amount you can contribute to a tax-advantaged account in a given year as set by the IRS. Contribution limits are adjusted annually for inflation and vary by account type and age.
Example: In 2026, the 401(k) contribution limit is $23,500 ($31,000 if you are 50 or older). Contributing above this limit results in penalties.
Cost Basis
The original purchase price of an asset plus any associated costs such as commissions and fees. Cost basis is used to determine your capital gain or loss when you sell the asset.
Example: You buy 100 shares at $50 each and pay a $10 commission. Your cost basis is $5,010. If you sell for $7,000, your capital gain is $1,990.
Coverdell ESA
A Coverdell Education Savings Account is a tax-advantaged trust used to pay qualified education expenses for a designated beneficiary. Contributions are not deductible, but earnings grow tax-free and withdrawals for qualified expenses are tax-free.
Example: You contribute $2,000 per year to a Coverdell ESA for your child. The funds can be used tax-free for private K-12 tuition or college expenses.
Credit
A dollar-for-dollar reduction in your tax liability. Unlike deductions, which reduce taxable income, credits directly reduce the amount of tax you owe. Credits can be refundable or nonrefundable.
Example: You owe $3,000 in taxes and qualify for a $1,000 tax credit. Your tax bill drops to $2,000. If the credit were refundable and exceeded your tax liability, you would receive the excess as a refund.
D
Deduction
An expense that reduces your taxable income, thereby lowering your tax bill. Deductions can be taken as the standard deduction or by itemizing individual qualifying expenses on Schedule A.
Example: You are in the 22% tax bracket and claim a $1,000 deduction. This saves you $220 in taxes (22% of $1,000).
Dependent
A person you support financially who qualifies you for certain tax benefits. Dependents include qualifying children (under 19, or under 24 if a full-time student) and qualifying relatives who meet income and support tests.
Example: Your 10-year-old daughter lives with you and you provide more than half her support. She is your dependent, qualifying you for the Child Tax Credit and possibly Head of Household filing status.
Dependent Care Credit
A nonrefundable tax credit for expenses paid for the care of a qualifying dependent (child under 13 or a disabled spouse/dependent) so that you can work or look for work. The credit ranges from 20% to 35% of qualifying expenses.
Example: You pay $8,000 in daycare costs for your 4-year-old while you work. You can claim a credit on up to $3,000 in expenses (one child), saving you $600 to $1,050 depending on your income.
Depreciation
A tax deduction that allows you to recover the cost of a business asset over its useful life. Rather than deducting the entire cost in the year of purchase, you spread the deduction over several years according to IRS schedules.
Example: You buy a $30,000 work vehicle. Using the Modified Accelerated Cost Recovery System (MACRS), you depreciate it over 5 years, deducting a portion of the cost each year.
E
Earned Income
Income received from working, including wages, salaries, tips, and net self-employment earnings. Earned income is distinguished from unearned income such as investment returns, rental income, and Social Security benefits.
Example: Your $60,000 salary and $5,000 in freelance earnings are earned income. The $800 in dividends from your brokerage account is unearned income.
Earned Income Tax Credit (EITC)
A refundable tax credit for low- to moderate-income workers, particularly those with children. The credit amount depends on income, filing status, and number of qualifying children. It can result in a refund even if no tax is owed.
Example: A single parent with two children earning $35,000 qualifies for an EITC of approximately $6,600, which is fully refundable.
Effective Tax Rate
The average rate at which your total income is taxed, calculated by dividing your total tax liability by your total income. This is different from your marginal tax rate, which is the rate on your last dollar of income.
Example: You earn $80,000 and pay $12,000 in federal income tax. Your effective tax rate is 15% ($12,000 / $80,000), even though your marginal rate is 22%.
Estimated Tax
Quarterly tax payments made to the IRS by individuals who do not have sufficient tax withheld from their income, such as self-employed workers, freelancers, and investors. Payments are due in April, June, September, and January.
Example: As a freelancer earning $100,000, you pay approximately $6,250 in estimated taxes each quarter to avoid an underpayment penalty at year-end.
Estimated Tax Payment
A quarterly payment made to the IRS to cover expected tax liability for the current year. Taxpayers who expect to owe $1,000 or more when filing must make estimated payments to avoid penalties.
Example: You use Form 1040-ES to calculate and submit quarterly estimated payments of $3,000 each to the IRS in April, June, September, and January.
Exemption
An amount of income excluded from taxation. Personal and dependent exemptions were eliminated for tax years 2018-2025 by the Tax Cuts and Jobs Act, though exemptions still apply in contexts like AMT and gift tax.
Extension
A filing extension (Form 4868) that gives you an additional six months to file your federal tax return, moving the deadline from April 15 to October 15. An extension to file is not an extension to pay; any taxes owed are still due by April 15.
Example: You are waiting on a Schedule K-1 from a partnership. You file Form 4868, giving you until October 15 to submit your return, but you estimate and pay your tax liability by April 15.
F
Fair Market Value
The price at which property would sell between a willing buyer and a willing seller, both having reasonable knowledge of the relevant facts. Fair market value is used to determine the value of donated property, inherited assets, and investment gains.
Example: You donate a used car to charity. An independent appraisal determines the fair market value is $4,500, which becomes the amount of your charitable deduction.
Federal Tax Lien
A legal claim by the government against your property when you fail to pay a tax debt. The lien protects the government interest in all your property, including real estate, personal property, and financial assets.
Example: You owe $25,000 in back taxes and do not set up a payment plan. The IRS files a federal tax lien, which appears on your credit report and can complicate selling your home or obtaining loans.
FICA
The Federal Insurance Contributions Act tax, which funds Social Security and Medicare. Employees pay 7.65% of wages (6.2% Social Security up to the wage base and 1.45% Medicare), and employers match that amount.
Example: On a $60,000 salary, you pay $4,590 in FICA taxes ($3,720 for Social Security and $870 for Medicare). Your employer pays an identical $4,590.
Filing Status
A classification that determines your tax rates, standard deduction amount, and eligibility for certain credits. The five filing statuses are Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Surviving Spouse.
Example: An unmarried parent supporting a child may file as Head of Household, which provides a larger standard deduction ($21,900 vs. $14,600 for Single) and more favorable tax brackets.
Filing Threshold
The minimum amount of gross income that requires you to file a federal tax return. The threshold varies by filing status, age, and type of income. Even below the threshold, you may want to file to claim refundable credits.
Example: A single filer under 65 with gross income below $14,600 in 2026 is not required to file. However, if they had taxes withheld from a part-time job, filing would get them a refund.
Foreign Tax Credit
A credit for income taxes paid to a foreign government on income that is also taxed by the United States. The credit prevents double taxation and is generally limited to the U.S. tax on foreign-source income.
Example: You earn $10,000 in dividends from a UK stock fund and pay $1,500 in UK taxes. You claim a $1,500 foreign tax credit on your U.S. return, reducing your U.S. tax bill dollar-for-dollar.
Form 1040
The standard federal income tax return form used by individual taxpayers to report annual income, claim deductions and credits, and calculate the tax owed or refund due. Most other tax schedules and forms attach to Form 1040.
Example: You file Form 1040 reporting $75,000 in wages, a $14,600 standard deduction, and $2,000 in credits, resulting in a refund of $800.
Form 1099
A family of information returns used to report various types of non-employment income to the IRS. Common variants include 1099-NEC (nonemployee compensation), 1099-INT (interest), 1099-DIV (dividends), and 1099-MISC (miscellaneous income).
Example: A client pays you $5,000 for freelance web design. They send you a 1099-NEC in January showing the amount, and you report it as self-employment income on Schedule C.
Form W-2
The wage and tax statement that employers must provide to employees by January 31 each year. It shows total wages earned, federal and state income taxes withheld, Social Security and Medicare taxes paid, and other compensation details.
Example: Your W-2 shows $65,000 in wages, $8,500 in federal tax withheld, and $4,973 in FICA taxes. You use these figures to complete your Form 1040.
Form W-4
The Employee Withholding Certificate that you give to your employer to determine how much federal income tax to withhold from your paycheck. You should update your W-4 after major life changes like marriage, divorce, or having a child.
Example: After getting married and having a child, you submit a new W-4 to your employer, increasing your withholding allowances so less tax is taken from each paycheck.
G
Gambling Winnings
All gambling winnings are fully taxable and must be reported on your tax return, including winnings from casinos, lotteries, horse racing, and sports betting. Gambling losses can be deducted only up to the amount of winnings if you itemize.
Example: You win $5,000 at a casino and lose $3,000 over the year. You report $5,000 as income and, if you itemize, deduct $3,000 in losses on Schedule A.
Generation-Skipping Tax
A federal tax on transfers of property to beneficiaries who are two or more generations below the donor, such as grandchildren. The tax is designed to prevent families from avoiding estate tax by skipping a generation.
Gift Tax
A tax on the transfer of property from one person to another in which the giver receives nothing or less than full value in return. In 2026, you can give up to the annual exclusion amount per recipient without filing a gift tax return.
Example: You give your daughter $18,000 to help with a down payment. Because this is at or below the annual exclusion, no gift tax return is required and no gift tax is owed.
Gross Income
The total of all income you receive during the year from all sources before any deductions or adjustments. This includes wages, salaries, interest, dividends, rental income, capital gains, business income, and other earnings.
Example: Your gross income includes $70,000 in salary, $500 in bank interest, $1,200 in dividends, and $3,000 in freelance work, totaling $74,700.
H
Head of Household
A filing status for unmarried taxpayers who pay more than half the cost of maintaining a home for a qualifying dependent. It provides a larger standard deduction and more favorable tax brackets than filing as Single.
Example: A single mother who provides a home for her child and pays more than half the household expenses can file as Head of Household, getting a standard deduction of $21,900 instead of $14,600.
Health Savings Account (HSA)
A tax-advantaged savings account available to individuals enrolled in a high-deductible health plan (HDHP). Contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free, making HSAs triply tax-advantaged.
Example: You contribute $4,150 to your HSA, deducting the full amount from your taxable income. The funds grow tax-free and can be withdrawn tax-free to pay for prescriptions, doctor visits, or dental work.
Hobby Loss Rule
An IRS rule that limits deductions for activities not conducted with a profit motive. If an activity is classified as a hobby rather than a business, you must report all income but cannot deduct expenses against it. An activity is generally presumed to be a business if it shows a profit in three of the last five years.
Example: You sell handmade candles at craft fairs and have lost money for four straight years. The IRS may reclassify your business as a hobby, disallowing the $3,000 in losses you deducted on Schedule C.
I
Installment Agreement
A payment plan with the IRS that allows you to pay your tax debt over time in monthly installments. Penalties and interest continue to accrue until the balance is paid in full, but the IRS will not take further collection action while the agreement is active.
Example: You owe $12,000 in taxes and cannot pay in full. You set up a 36-month installment agreement with the IRS, paying $333 per month plus interest.
IRS
The Internal Revenue Service, the U.S. federal agency responsible for tax collection and enforcement of the Internal Revenue Code. The IRS processes returns, issues refunds, conducts audits, and administers tax law.
Itemized Deduction
Individual qualifying expenses listed on Schedule A that can be deducted instead of the standard deduction. Common itemized deductions include state and local taxes (SALT, capped at $10,000), mortgage interest, charitable contributions, and medical expenses exceeding 7.5% of AGI.
Example: You paid $8,000 in state taxes, $12,000 in mortgage interest, and $5,000 in charitable donations. Your $25,000 in itemized deductions exceeds the $14,600 standard deduction, so itemizing saves you more.
K
Kiddie Tax
A tax rule that applies the parent's marginal tax rate to a child's unearned income above a certain threshold. The rule applies to children under 19 (or under 24 if a full-time student) and is designed to prevent parents from shifting investment income to children in lower tax brackets.
Example: Your 16-year-old earns $5,000 in dividends from an inherited brokerage account. The first $1,300 is tax-free, the next $1,300 is taxed at the child's rate, and the remaining $2,400 is taxed at the parent's rate.
L
Like-Kind Exchange
A tax-deferred exchange of investment or business property for property of a similar nature. Since 2018, like-kind exchanges under Section 1031 are limited to real property only (no longer applicable to personal property, vehicles, or artwork).
Example: You exchange a commercial building you own for a retail storefront of equal or greater value. Because both are real property, you defer capital gains tax under Section 1031.
Long-Term Capital Gain
The profit from selling a capital asset held for more than one year. Long-term capital gains are taxed at preferential rates of 0%, 15%, or 20%, depending on your taxable income, which are lower than ordinary income tax rates.
Example: You bought shares in January 2024 and sold them in March 2026 for a $10,000 profit. Because you held them longer than one year, the gain is taxed at the long-term capital gains rate of 15% (for most taxpayers).
M
Marginal Tax Rate
The tax rate applied to your last dollar of taxable income. Because the U.S. uses a progressive tax system, different portions of your income are taxed at different rates, and the marginal rate is the highest rate you pay.
Example: If your taxable income is $50,000 as a single filer, your marginal rate is 22%. However, only the income above $44,725 is taxed at 22%; income below that amount is taxed at lower rates.
Married Filing Jointly
A filing status for married couples who combine their income, deductions, and credits on a single tax return. This status generally provides the most favorable tax rates and the highest standard deduction for married taxpayers.
Example: A married couple with a combined income of $120,000 files jointly and receives a $29,200 standard deduction, compared to $14,600 each if they filed separately.
Married Filing Separately
A filing status for married individuals who choose to file their own separate tax returns. This status generally results in a higher tax bill and disqualifies you from many credits, but it can be advantageous when one spouse has significant medical expenses or student loan debt.
Example: One spouse has $50,000 in income and $20,000 in unreimbursed medical expenses. Filing separately with a lower AGI makes it easier to exceed the 7.5% medical expense threshold.
Medicare Tax
A payroll tax of 1.45% on all wages with no income cap, paid by both employees and employers. An additional 0.9% Medicare surtax applies to wages exceeding $200,000 for single filers ($250,000 for joint filers).
Example: You earn $250,000 as a single filer. You pay 1.45% on the first $200,000 ($2,900) and 2.35% on the remaining $50,000 ($1,175), totaling $4,075 in Medicare tax.
Modified Adjusted Gross Income (MAGI)
Your adjusted gross income with certain deductions added back in. MAGI is used to determine eligibility for Roth IRA contributions, education credits, premium tax credits, and other tax benefits. The specific add-backs vary depending on which benefit is being evaluated.
Example: Your AGI is $140,000 but you add back $3,000 in student loan interest deduction and $5,000 in foreign earned income exclusion for a MAGI of $148,000, which affects your Roth IRA contribution limit.
N
Net Investment Income Tax (NIIT)
A 3.8% surtax on the lesser of net investment income or the amount by which your MAGI exceeds $200,000 (single) or $250,000 (married filing jointly). Investment income includes interest, dividends, capital gains, rental income, and royalties.
Example: A single filer has a MAGI of $230,000 and $50,000 in net investment income. The NIIT applies to the lesser of $50,000 or $30,000 ($230,000 minus $200,000), so the tax is 3.8% of $30,000 = $1,140.
Net Operating Loss
A net operating loss (NOL) occurs when your allowable tax deductions exceed your taxable income in a given year. NOLs can be carried forward indefinitely to offset future taxable income, limited to 80% of taxable income in the carryforward year.
Example: Your business loses $50,000 in its first year. You carry the NOL forward and use it to offset $40,000 of income next year (80% of $50,000), reducing your tax bill significantly.
Nonrefundable Credit
A tax credit that can reduce your tax liability to zero but cannot produce a refund beyond that. Any excess credit amount is lost unless carryforward rules apply.
Example: You owe $500 in taxes and qualify for a $700 nonrefundable credit. Your tax bill drops to $0, but the remaining $200 does not result in a refund.
Nonresident Alien
An individual who is not a U.S. citizen and does not meet the green card test or the substantial presence test. Nonresident aliens are generally taxed only on U.S.-source income and file Form 1040-NR.
O
Offer in Compromise
An agreement with the IRS to settle your tax debt for less than the full amount owed. The IRS considers your ability to pay, income, expenses, and asset equity when evaluating an offer. There is a $205 application fee.
Example: You owe $40,000 in back taxes but can only afford $12,000 based on your income and assets. The IRS accepts your offer in compromise, settling the debt for $12,000.
Ordinary Income
Income taxed at regular graduated rates, including wages, salaries, commissions, interest, short-term capital gains, and business income. Ordinary income is distinguished from capital gains, which may qualify for lower tax rates.
Example: Your $70,000 salary, $1,000 in bank interest, and $3,000 in short-term stock gains are all ordinary income, taxed at your regular rates ranging from 10% to 37%.
P
Pass-Through Entity
A business structure (such as a sole proprietorship, partnership, LLC, or S corporation) where income passes through to the owners' personal tax returns rather than being taxed at the entity level. Owners pay tax at their individual rates.
Example: Your LLC earns $100,000 in profit. Rather than the LLC paying corporate tax, the $100,000 flows through to your personal Form 1040 and is taxed at your individual rate.
Passive Income
Earnings from a business in which you do not materially participate, or income from rental activities. Passive losses can generally only offset passive income, not active income such as wages.
Example: You own a rental property that generates $12,000 in annual rent. Because you are not actively managing the property on a daily basis, this is passive income.
Payroll Tax
Taxes withheld from employee wages and matched by employers to fund Social Security and Medicare (FICA). The combined employee and employer rate is 15.3% on wages up to the Social Security wage base, plus 2.9% Medicare on all wages.
Example: On a $50,000 salary, total payroll taxes are $7,650 — split evenly at $3,825 between you and your employer.
Penalty
A charge imposed by the IRS for noncompliance, such as failing to file on time, failing to pay taxes owed, or underpaying estimated taxes. Common penalties include the failure-to-file penalty (5% per month) and the failure-to-pay penalty (0.5% per month).
Example: You file your return three months late and owe $5,000. The failure-to-file penalty is 5% per month, costing you $750 in penalties ($250/month for 3 months).
Personal Property Tax
A tax levied on movable personal property such as vehicles, boats, and equipment. Unlike real property tax (on land and buildings), personal property tax applies to tangible items and is assessed by state or local governments.
Example: Your state charges a $500 annual personal property tax on your car based on its assessed value. This tax is deductible on Schedule A as part of the $10,000 SALT cap.
Phaseout
A gradual reduction in the amount of a tax credit or deduction as your income rises above a certain threshold. Phaseouts ensure that tax benefits are targeted to lower- and middle-income taxpayers.
Example: The Child Tax Credit begins phasing out at $200,000 MAGI for single filers. For every $1,000 above the threshold, the credit is reduced by $50.
Progressive Tax
A tax system in which the tax rate increases as the taxable amount increases. The U.S. federal income tax is progressive, with seven tax brackets ranging from 10% to 37%. Higher earners pay a larger percentage of their income in taxes.
Example: A single filer earning $50,000 pays 10% on the first $11,600, 12% on income from $11,601 to $47,150, and 22% on income from $47,151 to $50,000.
Q
Qualified Business Income (QBI)
The net amount of qualified items of income, gain, deduction, and loss from a pass-through business. Eligible taxpayers can deduct up to 20% of their QBI under Section 199A, subject to income limits and business type restrictions.
Example: Your S corporation generates $100,000 in QBI. You qualify for a 20% QBI deduction of $20,000, reducing your taxable income to $80,000.
Qualified Dividend
A dividend that meets IRS holding period and company requirements and is taxed at the lower long-term capital gains rates (0%, 15%, or 20%) rather than ordinary income rates. Most dividends from U.S. corporations are qualified.
Example: You receive $3,000 in qualified dividends from your index fund. In the 22% bracket, these are taxed at just 15% ($450) instead of 22% ($660), saving you $210.
R
Real Property Tax
A tax assessed on land and permanent structures such as homes and commercial buildings. Real property tax is levied by local governments and is based on the assessed value of the property. It is deductible as an itemized deduction subject to the $10,000 SALT cap.
Example: Your county assesses your home at $300,000 and charges a property tax rate of 1.2%, resulting in a $3,600 annual tax bill that you can deduct on Schedule A.
Recapture
The process of adding back to income certain deductions or credits that were previously claimed when the conditions for those benefits are no longer met. Common examples include depreciation recapture when selling business property and first-time homebuyer credit recapture.
Example: You claimed $50,000 in depreciation on a rental property. When you sell it for a gain, the $50,000 in depreciation is recaptured and taxed at a 25% rate.
Refund
The amount returned to you by the IRS when your total tax payments (through withholding and estimated payments) exceed your actual tax liability for the year. Refunds can be received via direct deposit, paper check, or applied to next year's taxes.
Example: Your employer withheld $10,000 in federal taxes, but your actual tax liability was $8,500. The IRS sends you a $1,500 refund.
Refundable Credit
A tax credit that can reduce your tax liability below zero and result in a cash refund for the excess amount. Examples include the Earned Income Tax Credit, the refundable portion of the Child Tax Credit, and the American Opportunity Credit (40% refundable).
Example: You owe $500 in tax and qualify for a $2,000 refundable credit. Your tax drops to $0 and you receive a $1,500 refund.
Required Minimum Distribution (RMD)
The minimum amount you must withdraw annually from tax-deferred retirement accounts (such as traditional IRAs and 401(k)s) starting at age 73 (as of 2023). RMDs are calculated based on your account balance and life expectancy. Failure to take an RMD results in a 25% penalty on the amount not withdrawn.
Example: You turn 73 and have $500,000 in your traditional IRA. Based on the IRS life expectancy table, your RMD is approximately $18,868, which you must withdraw and pay ordinary income tax on.
Rollover
The tax-free transfer of funds from one retirement account to another, such as from a 401(k) to an IRA. To avoid taxation, the rollover must be completed within 60 days (for indirect rollovers) or done as a direct trustee-to-trustee transfer.
Example: You leave your job and roll over your $150,000 401(k) balance directly into a traditional IRA. Because it is a direct rollover, no taxes or penalties apply.
Roth IRA
An individual retirement account funded with after-tax dollars. Contributions are not deductible, but qualified withdrawals in retirement are completely tax-free, including all investment gains. There are income limits for direct contributions.
Example: You contribute $7,000 per year to your Roth IRA. After 30 years, the account grows to $600,000. In retirement, you withdraw the entire balance tax-free.
S
S Corporation
A corporation that elects to pass income, losses, deductions, and credits through to its shareholders for federal tax purposes. Shareholders report the flow-through of income and losses on their personal tax returns and are taxed at their individual rates.
Example: Your S corp earns $200,000 in profit. You pay yourself a $100,000 salary (subject to payroll taxes) and receive the remaining $100,000 as a distribution (not subject to self-employment tax).
Saver's Credit
A nonrefundable tax credit of up to $1,000 ($2,000 for joint filers) for low- and moderate-income taxpayers who contribute to a retirement account such as a 401(k), IRA, or ABLE account. The credit rate is 50%, 20%, or 10% depending on income.
Example: A single filer earning $22,000 contributes $2,000 to an IRA. They qualify for the 50% Saver's Credit, receiving a $1,000 credit that directly reduces their tax bill.
Schedule A
The IRS form attached to Form 1040 used to report itemized deductions. Categories include medical and dental expenses, state and local taxes (SALT), home mortgage interest, charitable gifts, and casualty/theft losses from federally declared disasters.
Example: You list $10,000 in SALT, $14,000 in mortgage interest, and $4,000 in charitable contributions on Schedule A, totaling $28,000 in itemized deductions.
Schedule C
The IRS form used by sole proprietors and single-member LLCs to report business income and expenses. Net profit from Schedule C flows to your Form 1040 and is subject to both income tax and self-employment tax.
Example: Your freelance business earned $80,000 in revenue and had $20,000 in expenses. You report a $60,000 net profit on Schedule C, which is taxed as ordinary income plus self-employment tax.
Schedule D
The IRS form used to report capital gains and losses from the sale of investments and other capital assets. Schedule D summarizes short-term and long-term transactions and calculates the net gain or loss carried to Form 1040.
Example: You report three stock sales on Schedule D: two with long-term gains totaling $5,000 and one with a short-term loss of $2,000. Your net capital gain of $3,000 is added to your Form 1040 income.
Schedule K-1
A tax form issued by partnerships, S corporations, and trusts to report each partner's or shareholder's share of income, deductions, and credits. The information from your K-1 is reported on your personal tax return.
Example: You are a 25% partner in a partnership that earned $200,000. Your Schedule K-1 shows $50,000 in ordinary business income, which you report on your Form 1040.
Section 121 Exclusion
A provision that allows you to exclude up to $250,000 ($500,000 for married couples filing jointly) of capital gains from the sale of your primary residence. You must have owned and used the home as your main residence for at least two of the five years before the sale.
Example: A married couple sells their home for $650,000, having purchased it for $300,000. They exclude the full $350,000 gain from taxation because it is under the $500,000 limit and they have lived in the home for more than two years.
Section 179 Deduction
A tax provision that allows businesses to deduct the full purchase price of qualifying equipment and software in the year it is placed in service, rather than depreciating it over several years. The 2026 deduction limit is over $1 million.
Example: You buy a $50,000 delivery truck for your business. Instead of depreciating it over 5 years, you use Section 179 to deduct the entire $50,000 in the first year.
Self-Employment Tax
The Social Security and Medicare tax paid by self-employed individuals on their net self-employment earnings. The combined rate is 15.3% (12.4% Social Security up to the wage base plus 2.9% Medicare on all earnings). You can deduct half of your self-employment tax as an above-the-line deduction.
Example: Your freelance net income is $80,000. You pay $11,304 in self-employment tax (15.3% of 92.35% of $80,000) and deduct half ($5,652) on your Form 1040.
Short-Term Capital Gain
The profit from selling a capital asset held for one year or less. Short-term capital gains are taxed as ordinary income at your marginal tax rate, which is typically higher than long-term capital gains rates.
Example: You buy stock in March and sell it in August of the same year for a $3,000 profit. This short-term gain is taxed at your ordinary income rate of 22%, costing you $660 in tax.
Social Security Tax
A payroll tax of 6.2% on employee wages up to the annual wage base ($168,600 in 2024, adjusted annually). Employers match the 6.2%. Self-employed individuals pay both halves (12.4%) as part of self-employment tax.
Example: On a $100,000 salary, you pay $6,200 in Social Security tax. Your employer pays an additional $6,200. If self-employed, you pay the full $12,400.
Standard Deduction
A fixed dollar amount that reduces your taxable income if you do not itemize deductions. The standard deduction varies by filing status and is adjusted annually for inflation. For 2026, it is $14,600 for single filers and $29,200 for married filing jointly.
Example: As a single filer, you take the $14,600 standard deduction instead of itemizing because your total deductible expenses are only $8,000.
T
Tax Bracket
A range of income taxed at a specific rate within the progressive federal tax system. The U.S. has seven brackets (10%, 12%, 22%, 24%, 32%, 35%, and 37%), and only the income within each bracket is taxed at that rate.
Example: A single filer with $100,000 in taxable income is in the 24% bracket, but only the income between $100,525 and their total is taxed at 24%. Lower portions are taxed at 10%, 12%, and 22%.
Tax Home
The city or general area where your main place of business is located, regardless of where you maintain your personal residence. Your tax home determines whether you can deduct travel expenses when working away from home.
Example: You live in Philadelphia but your regular workplace is in New York City. Your tax home is New York City. Travel between Philly and NYC is commuting (not deductible), but travel from NYC to a client in Boston is a deductible business trip.
Tax Liability
The total amount of tax you owe to the IRS for a given year, calculated by applying the tax rates to your taxable income and subtracting credits. Your liability is compared against payments already made (withholding and estimated taxes) to determine if you owe more or get a refund.
Example: Your taxable income of $75,000 results in a tax liability of $11,600. You had $10,000 withheld, so you owe an additional $1,600 when you file.
Tax Treaty
An agreement between two countries to resolve issues of double taxation. Tax treaties may reduce withholding rates on cross-border income such as dividends, interest, and royalties, and determine which country has the right to tax certain types of income.
Example: Under the U.S.-UK tax treaty, dividends paid from UK companies to U.S. residents are subject to a reduced withholding rate of 15% instead of the standard 30%.
Tax Year
The 12-month period for which a tax return is filed. Most individuals use the calendar year (January 1 through December 31). Some businesses use a fiscal year that ends in a month other than December.
Tax-Deferred
A status applied to investment earnings that are not taxed until a later date, typically upon withdrawal. Traditional IRAs, 401(k)s, and annuities are tax-deferred — contributions may reduce current taxes, but withdrawals in retirement are taxed as ordinary income.
Example: You contribute $20,000 to your 401(k). The money grows tax-deferred for 30 years. When you withdraw in retirement, the contributions and gains are taxed as ordinary income.
Tax-Exempt
Income or an entity that is not subject to taxation. Municipal bond interest is generally tax-exempt at the federal level. Tax-exempt organizations (501(c)(3) nonprofits) do not pay income tax on most earnings.
Example: You invest in a municipal bond fund that pays $2,000 in annual interest. This interest is exempt from federal income tax and potentially state tax if the bonds are from your home state.
Taxable Income
The portion of your income that is subject to federal income tax, calculated by subtracting the standard deduction or itemized deductions (and any qualified business income deduction) from your adjusted gross income.
Example: Your AGI is $85,000 and you take the $14,600 standard deduction. Your taxable income is $70,400, which is the amount used to calculate your tax using the tax brackets.
Traditional IRA
An individual retirement account to which you may contribute pre-tax dollars, reducing your current taxable income. Earnings grow tax-deferred, and withdrawals in retirement are taxed as ordinary income. Contributions may be fully or partially deductible depending on your income and whether you have an employer plan.
Example: You contribute $7,000 to a traditional IRA and deduct the full amount from your taxable income. In retirement, you withdraw $7,000 and pay ordinary income tax on it.
U
Underpayment Penalty
A penalty charged when you do not pay enough tax during the year through withholding or estimated payments. You can avoid the penalty by paying at least 90% of the current year tax or 100% of the prior year tax (110% if your AGI exceeds $150,000).
Example: You owe $15,000 but only paid $10,000 through withholding and estimates. Because you did not meet the safe harbor threshold, the IRS charges an underpayment penalty on the shortfall.
Unrealized Gain
The increase in value of an asset that you still own and have not yet sold. Unrealized gains are not taxed until the asset is sold and the gain is realized. Also called a paper gain.
Example: You bought stock for $10,000 and it is now worth $18,000. Your unrealized gain is $8,000. You will not owe tax on it until you sell the shares.
V
W
Wash Sale
A tax rule that disallows a loss deduction on a security if you purchase a substantially identical security within 30 days before or after the sale. The disallowed loss is added to the basis of the replacement security.
Example: You sell 100 shares of XYZ at a $2,000 loss on December 15 and buy 100 shares of XYZ back on January 5. The wash sale rule disallows the $2,000 loss because you repurchased within 30 days.
Withholding
The portion of your paycheck that your employer sends directly to the IRS on your behalf to cover your estimated income tax, Social Security tax, and Medicare tax. The amount withheld is based on the information you provide on Form W-4.
Example: Your employer withholds $800 per biweekly paycheck for federal income tax. Over 26 pay periods, that totals $20,800 in withholding applied toward your annual tax liability.
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1031 Exchange
A tax-deferred exchange that allows you to swap one investment property for another of equal or greater value without immediately paying capital gains tax. Also called a like-kind exchange.
Example: You sell a rental duplex for $400,000 and use the proceeds to buy a fourplex for $500,000. Because both are investment properties and you followed 1031 rules, you defer the capital gains tax on the sale.
401(k)
An employer-sponsored retirement savings plan that allows employees to contribute pre-tax earnings, reducing current taxable income. Many employers match a percentage of contributions. Withdrawals in retirement are taxed as ordinary income.
Example: You earn $80,000 and contribute $10,000 to your 401(k). Your taxable income drops to $70,000, saving you roughly $2,200 in taxes if you are in the 22% bracket.
529 Plan
A tax-advantaged savings plan designed to encourage saving for future education costs. Contributions grow tax-free, and withdrawals for qualified education expenses are not taxed at the federal level.
Example: You contribute $5,000 per year to a 529 plan for your child. After 18 years of growth, the balance can be used tax-free for college tuition, room, board, and required textbooks.
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