Your guide to key tax terms
Filing your tax return can be intimidating, especially if you don’t understand all of the words you come across during the process. Before you get started, brush up on valuable tax vocabulary so you can feel more confident when you file.
Gross and taxable income
Gross income is your total income over the course of the year. This includes everything from wages and tips to any interest, dividends or capital gains you earned. Right off the bat, you may be allowed to subtract certain things from your gross income—these are called above-the-line deductions. This will give you what’s commonly referred to as your adjusted gross income. From there, you may claim certain deductions. Once those deductions are subtracted, the number you are left with is called your taxable income. You calculate your tax liability based on that amount.
You may deduct certain expenses when calculating your taxable income. For example, if your gross income totaled $55,000 last year and have $15,000 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, such as qualified contributions to retirement accounts.
- 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 generally determined by your filing status. You may choose to itemize if your itemized deductions would exceed the amount of the standard deduction.
A tax credit reduces the amount of tax you owe the government dollar for dollar. In some cases, 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 low- to modest-income earners. The amount of the credit is determined by your income and number of children, among other criteria.
A dependent is someone you support financially—for example, elderly parents or children. Claiming dependents may help qualify you for certain credits. Children may qualify as dependents until they reach age 19, or age 24 if they’re 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.
Marriage penalty vs. bonus
Married couples can choose to file a joint tax return or to file separately. Depending on how much money you both make, and how that income is distributed, the amount you owe the government as a couple may be higher or lower than if you weren’t married and filed as single individuals instead. If you owe more as a married couple, it is often referred to as a marriage penalty. If you owe less, it is often referred to as a marriage bonus.
Tax brackets and rates
Because the U.S. income 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 brackets of income. Whatever tax bracket the highest dollar of your income falls into is known as your marginal tax rate. But because of the progressive system, your tax liability is likely less than your marginal tax rate multiplied by your taxable income. The average rate at which you pay is known as your effective tax rate.
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Bank of America and its affiliates do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.