It seems like during tax season there is a new set of vocabulary flying around and much of it might go over some people’s heads. Here are some tax terms that are worth learning that will help you get through tax season.
AGI or Adjusted Gross Income is the income you have earned after you have factored in certain deduction, credits and business expenses.
Credit vs. Deduction
A tax deduction reduces your taxable income amount. For example, if you have a $1,000 deduction on a $50,000 income, your taxable income is $49,000 after taking the deduction. Unlike a deduction, however, a tax credit directly reduces your tax bill. So, if you owe $7,000 in taxes and have a $1,000 tax credit, your tax bill will be reduced to $6,000.
Standard deduction vs. Itemized Deduction
All taxpayers are offered a standard deduction regardless of their tax status. The standard deduction is a set amount which changes based on your filing status and the rate of inflation. If you choose to itemize your deductions, you list all of your qualified expenses and deduct them from your AGI. You are not allowed to claim the standard deduction and itemize, instead you pick the higher of the two amounts.
Anyone who relies on your income for basic needs can be claimed as an exemption. Usually you claim yourself, spouse and/or children as exemptions. After you have figured out your AGI, each exemption is applied to that amount to calculate your taxable income.
The IRS requires employers to withhold a certain portion of your check throughout the year to ensure that you can pay your tax bill at the end of the year. Once you complete your taxes, this amount is applied to your bill to determine if you either owe more or are entitled to a refund.