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Tax Glossary

Tax Glossary

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Published by: BeaBurgos Aquí Tetuán on Feb 16, 2011
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Tax GlossaryAccelerated depreciation.
A depreciation method thatallows larger deductions in the early years of an asset's "life"and smaller deductions at the end of the period. (See"Straight-line depreciation.")
Accrual method (or accrual basis).
One of two mainaccounting methods for determining when a transaction hastax significance. The accrual method says that a transaction istaxed when an obligation to pay or a right to receive paymentis created (for example, at the time products are delivered,services rendered, billings sent, etc.). This method is used byall but the smallest businesses. (See "Cash method (or cashbasis).")
Adjusted basis.
The cost of property (or a substitute figure-see "Basis") with adjustments made to account fordepreciation (in the case of business property), improvements(in the case of real estate), withdrawals or reinvestment (inthe case of securities, funds, accounts, insurance orannuities), etc. Adjusted basis is part of the computation fordetermining gain or loss on a sale or exchange and fordepreciation.
Adjusted gross income.
The amount of income consideredactually "available" to be taxed. Adjusted gross income isgross income reduced principally by business expensesincurred to earn the income and other specified reductions(such as alimony).
Alternative minimum tax.
An alternative tax system thatsays: your tax shall not go below this level. The alternativeminimum tax works by negating (or minimizing) the effects of tax preferences or loopholes.
The write-off of an amount spent for certaincapital assets, similar to depreciation. This tax meaning isdifferent from the common meaning of the term thatdescribes, for example, payment schedules of loans.
Applicable Federal Rates (AFRs).
Minimum interest ratesthat must be charged on various transactions that involvepayments over a number of years. If the parties to atransaction do not adhere to these rates, the IRS will imputethe interest. (See "Imputed interest.")
At-risk rules.
Rules that limit an investor's deductible lossesfrom an investment to the amount invested. Complicationsarise when investors finance their investment through loansthat they are not personally on the hook for (nonrecoursefinancing). Without these rules, investors could raise theirdeduction limit considerably without being at-risk for theactual loss.
The starting point for computing gain or loss on a saleor exchange of property or for depreciation. (See "Adjustedbasis.") For property that is purchased, basis is its cost. Thebasis of inherited property is its value at the date of death (oralternative valuation date). The basis of property received asa gift or a nontaxable transaction is based on the adjustedbasis of the transferor (with some adjustments). Special rulesgovern property transferred between corporations and theirshareholders, partners and their partnership, etc.
Cafeteria plan.
A plan maintained by an employer thatallows employees to select from a menu of taxable andnontaxable benefits.
Capital expenditures.
Amounts spent to acquire or improveassets with useful lives of more than one year. Theseexpenditures may not be deducted, but are added to the basisof the property (See "Adjusted basis.") and, for businessproperty, may be converted into deductions throughdepreciation or amortization.
Capital gain or loss.
Gain or loss from the sale or exchangeof investment property, personal property (such as a home) orother "capital asset," which is often entitled to preferential taxtreatment.
Carrybacks and carryforwards.
Deductions that may betransferred to a year other than the current year because theyexceeded certain limits. These deductions are typically carriedback to earlier years first and, if they exceed the limits forthose years, are then carried forward to later years until thededuction is used up. Charitable contributions and netoperating losses are examples of deductions that may becarried back or forward.
Cash method (or cash basis).
One of two main accountingmethods for determining when a transaction has taxsignificance. The cash method says that a transaction is taxedwhen payment is made. This method is used by mostindividuals. (See "Accrual method (or accrual basis).")
Community property.
A system governing spousalownership of property and income that is the law in certainwestern and southern states and Wisconsin. The differencesbetween community property and "common law" can changehow federal tax law applies to spouses. For example: marriedtaxpayers filing separately in a common law state do not haveto report income earned by the other spouse. They do have toreport income earned in a community property state.
Deferred compensation.
An arrangement that allows anemployee to receive part of a year's pay in a later year andnot be taxed in the year the money was earned.
A system similar to depreciation that allows theowner of natural resources (for example: a coal mine or an oilwell) to deduct a portion of the cost of the asset during eachyear of its presumed productive life.
A system that allows a business or individualto deduct a portion of the cost of an asset ("recover its cost")during each year of its predetermined "life" (or "recoveryperiod").
Earned income.
Income earned by working for it. Interest,dividends and other kinds of profits are examples of unearnedincome.
Earned income credit.
A tax credit available to individualswith low earned income. An individual is entitled to the fullamount of this credit even if it exceeds the amount of taxotherwise due.
Employee stock ownership plan (ESOP).
A type of profit-sharing plan in which benefits come in the form of stock in theemployer.
Estimated tax.
Quarterly down payments on a year's taxesthat are required (on April 15, June 15, September 15, and January 15) if the total year's taxes will exceed $1,000 and theamount is not covered by withholding.
Federal Insurance Contributions Act (FICA).
Socialsecurity taxes (for both old-age, survivors and disabilityinsurance-OASDI-and Medicare).
Federal Unemployment Tax Act (FUTA).
Filing status.
One of four tax ranks determined by yourmarital status, your dependents and the way you file your taxreturn: (1) single, (2) married filing jointly, (3) married filingseparately and (4) head of household. Filing status determinesyour tax rates and your eligibility for various tax benefits (forexample: alimony deduction, IRA deduction, standarddeduction, etc.).
First-in, first-out (FIFO).
A rule that applies to the sale of part of a group of similar items (such as inventory, shares of the same stock, etc.) that assumes the first ones acquiredwere the first ones sold. This is important if the items in thegroup were acquired or manufactured at different times or fordifferent costs. The rule may be overridden by identifying thespecific item sold, if possible. (See "Last-in, first-out (LIFO).")
Generation-skipping transfer tax.
An extra tax on gifts oron-death transfers of money or property that would otherwiseescape the once-per-generation transfer taxes that apply togifts and estates. For example: a gift from a grandfather to agranddaughter skips a generation and might be subject to thistax.
Golden parachutes.
Bonuses payable to key executives inthe event control of their corporation changes, as in the caseof a takeover. "Excess" golden parachute payments aresubject to tax penalties.
Gross income.
All income that might be subject to tax. Most"realized" increases in wealth are considered income. Themain exceptions for individuals are gifts, inheritances,increases in value of property prior to sale, loan repaymentsand some personal injury awards. For businesses, investmentsin their capital are not considered income.
Head of household.
A filing status available to qualifyingsingle parents (or others supporting certain dependents) thatallows lower taxes than the normal rates for singles.
Imputed interest.
A portion of a future payment that istreated as interest if parties to the transaction do not providea stated amount of interest at a rate acceptable to the IRS.(See "Applicable Federal Rates (AFRs).") This preventsimproper use of certain tax advantages (capital gains rates ortax deferral). For example: if a business sells an asset on theinstallment basis, part of all future payments is treated asinterest whether the transaction states it or not.
Incentive stock option.
A stock option that may be grantedto an employee under tax-favored terms.
Itemized deductions.
Personal deductions that may betaken if they total more than the standard deduction. (See"Standard deduction.") The following deductions are thenitemized or listed on Schedule A of Form 1040: medicalexpenses, charitable contributions, state and local taxes,home mortgage interest, real estate taxes, casualty losses,unreimbursed employee expenses, investment expenses andothers.
Investment credit.
A credit against tax available forinvestment in a limited range of business property. Thegeneral investment credit was repealed in 1986, but this typeof credit has been enacted and repealed repeatedlythroughout history.
Involuntary conversion.
The conversion of property intomoney under circumstances beyond the control of the owner.For example: (1) property that is destroyed and "converted"into an insurance settlement or (2) property that is seized bythe government and "converted" into a condemnation award.Owners may avoid tax on any gain that may result (if theinsurance settlement or condemnation award exceeds theadjusted basis of the property) by reinvesting in similarproperty within certain time limits.
 Joint return.
An optional filing status available to marriedtaxpayers that offers generally (but not always) lower taxesthan "married filing separately."
Keogh plan.
A retirement plan available to self-employedindividuals.
Last-in, first-out (LIFO).
A rule that applies to the sale of part of a group of similar items in an inventory that assumesthe last ones acquired were the first ones sold. This isimportant if the items in the group were acquired ormanufactured at different times or for different costs. (See"First-in, first-out (FIFO).")
Like-kind exchanges.
Tax-free swaps of investmentproperty. Commonly used for real estate.
Limited liability company (LLC).
A legal structure thatallows a business to be taxed like a partnership but functiongenerally like a corporation. An LLC offers members (amongother things) protection against liability for claims against thebusiness that is not available in a partnership.
Listed property.
Property listed in the tax code or by the IRSthat must comply with special rules before depreciation maybe claimed. Cars and personal computers are examples of listed property. The special rules are designed to preventdeductions where the property is used for personal ratherthan business purposes.
Medical Spending Accounts (MSAs).
An investment fundsimilar to an IRA that can be used to pay more routine medicalexpenses, when used in conjunction with "high-deductible"health insurance, which pays the big bills. Only 750,000 of these MSAs are available nationwide under a pilot programthat runs through the year 2000. To qualify, you have to beself-employed or employed by a small employer that offersthe program.
Modified Accelerated Cost Recovery System (MACRS).
 The system for computing depreciation for most businessassets.
Net operating loss.
The excess of business expenses overincome. A business may apply a net operating loss to get arefund of past taxes (or a reduction of future taxes) bycarrying it back to profitable years as an additional deduction(or by carrying it forward as a deduction to future years).
Original issue discount (OID).
The purchase discountoffered on some bonds (and similar obligations) in lieu of interest. For example: zero-coupon bonds. OID is generallytreated as interest income to the holder rather than as acapital gain.
Passive activity loss (PAL).
Loss on an investment that isdeductible only up to the limit of gains from similar
investments. The limit mainly affects tax shelters and doesnot apply to stocks, bonds or investments in businesses inwhich the investor materially participates. Special rules applyto investments in real estate.
Qualified plan.
A retirement or profit-sharing plan thatmeets requirements about who must be covered, the amountof benefits that are paid, information that must be given toplan participants, etc. Qualified plans are entitled to taxbenefits unavailable to nonqualified plans.
Real estate investment trust (REIT).
A kind of "mutualfund" that invests in real estate rather than stocks and bonds.
Real estate mortgage investment conduit (REMIC).
Akind of "mutual fund" that invests in real estate mortgagesrather than stocks and bonds.
The undoing of a tax benefit if certainrequirements are not met in future years. For example: (1) The low-income housing credit may be recaptured or addedback to tax if the credit property ceases to be used as low-income housing for a minimum number of years. (2) Thealimony deduction may be retroactively lost or recaptured if payments do not continue at the requisite level for a minimumnumber of years.
Regulated investment company (RIC).
A mutual fund.
The tax-free termination of one investment andreinvestment of the proceeds. For example: An individual mayroll over a lump-sum distribution from an employer'sretirement plan into an IRA.
S corporation.
A corporation with no more than 35shareholders that is not taxed, but treated similarly to apartnership, if other requirements are met.
Savings Incentive Match Plan for Employees (SIMPLEplans).
A simplified retirement arrangement for smallbusinesses that comes in two varieties: one similar to a 401(k)plan and one that funds IRAs for employees.
Standard deduction.
A deduction allowed individualsinstead of listing or itemizing deductible personal expenses.(See "Itemized deductions.") The amount depends on theindividual's filing status. Additional amounts are available fortaxpayers who are blind or are age 65 or over. Individuals maydeduct either their standard deduction or the total of theiritemized deductions, whichever is greater.
Straight-line depreciation.
A depreciation method thatallows equal deductions in each year of an asset's "life" orrecovery period. (See "Accelerated depreciation.")
Swaps, tax-free.
(1) Exchanges of like-kind property thatresult in no capital gains tax (commonly used for real estate).(2) Sales and repurchases of stock (or other securities)designed to realize a tax loss without discontinuing theinvestment. Transactions must comply with the wash salerules to be effective. (See "Wash sales.")
Taxable income.
What is left after all deductions are taken. This is the amount upon which tax is computed.
Taxpayer identification number (TIN).
In the case of anindividual, the Social Security number. In the case of abusiness (even an individual in business), the employeridentification number.
Top-heavy plan.
An employee retirement or profit-sharingplan that disproportionately benefits top executives.
Uniform capitalization rules (Unicap).
A set of uniformrules for computing the cost of goods produced by a businessthat prevents current deductions for costs that must becapitalized (See "Capital expenditures.") or added toinventory.
Wash sales.
Simultaneous or near-simultaneous purchasesand sales of the same property, usually stocks or bonds, madeto generate deductible tax losses without discontinuing theinvestment. Losses on the transactions are ignored for taxpurposes, however, unless a 30-day waiting period isobserved between them.
Withholding allowances.
Adjustments made to assurecorrect withholding on wages for individuals who may haveunusually large deductions or who may be subject to otherspecial circumstances.
401(k) Plan
– A qualified retirement investment planprovided by your employer that allows you to put apercentage of earned wages into a tax-deferred investmentaccount selected by the employer. The amount put into the401(k) plan is not taxed currently, but is taxed when youwithdraw funds upon retirement.
Accelerated Cost Recovery System (ACRS)
– Instead of depreciating an asset uniformly over its useful life (as is thecase with the straight-line depreciation method), ACRS usesfixed percentages and a predetermined number of years,depending on the asset’s class life, to calculate a depreciationdeduction. This method allows for a greater depreciation inthe earlier years, and generally applies to tangible propertyplaced into service after 1980 and before 1987.
Accelerated Depreciation
– Any method of depreciationthat results in greater depreciation deductions for an asset inthe earlier years of its life than the straight-line depreciationmethod.
Accountable Plan
– An accountable plan is one in which allthree of the following rules are satisfied: (1) your expenses(such as for travel, transportation, meals, and entertainment)must have been paid or incurred while performing services asan employee of the employer; (2) you must adequatelyaccount to the employer for these expenses; and (3) you mustreturn any excess reimbursement or allowance. When anemployer reimburses you, the reimbursement will not beconsidered income on your tax return, and the expenses willnot be allowed as a deduction on your tax return.
Accounting Method
– The method used to account forincome and expenses for tax purposes. Most taxpayers useeither the cash method or an accrual method. The accountingmethod is chosen when you file your first income tax return. To change accounting methods after that, generally IRSapproval is required.
Accounting Period
– The 12-month period you use as yourtax year when filing a tax return. Most individual tax returnscover a calendar year. If a calendar year is not used, theaccounting period is a fiscal year. The accounting period (taxyear) is chosen when you file your first income tax return. It

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