Tax Terms for Beginners

Are you confused by tax terminology? Here are a few basic terms to get you started.

Adjusted Gross Income [AGI] is all of your income adjusted for a handful of items. If you contributed to an IRA, paid alimony, or have school loan interest. These items are reductions to your AGI.

A standard deduction is based simply on your filing status (joint, single, etc.). Alternatively you can itemize your deductions. You use the deduction that provides you the greatest overall benefit.

Itemized deductions are deductions that are allowed in the tax code to reduce your taxable income. Examples include your mortgage interest, real estate taxes, state and local taxes paid in the current tax year.

Exemptions are like deductions. You generally get an exemption for yourself. If you are married, have three small kids and you file jointly, you will get an exemption for each person. In this case you would have 5 exemptions. Exemptions, like deductions, reduce your taxable income. Each exemption is assigned a value. You multiply the exemption value by the number of exemptions. The total will be used to reduce your taxable income.

Taxable Income is your Adjusted Gross Income less your deductions and exemptions.

Tax - Once your taxable income is determined you then compute the tax owed on this income. The IRS provides tax tables for this. It is simply a matter of locating your taxable income amount on the tax table.

Credits reduce your tax. They are different than deductions and exemptions. For example, if your tax is $2,000 and you have a credit of $500, your tax will be reduced to $1,500. Common credits are the child tax credit, education credits, and the credit for child care expenses. Credits reduce your tax, dollar for dollar.

The most important concept to know is that a tax return filing is a reconciliation of what you owe for the year versus what you paid in. A large tax refund means that you loaned the government your money interest free. See my earlier post [Tax Refunds] on 1/13/07 for an idea of what you can do with your refund.

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For more tax information, visit the IRS website at http://www.irs.gov/