An employer-provided retirement savings plan through which employees divert part of their pay to a tax-deferred investment account. Salary put in the plan is not taxed until it is later withdrawn, presumably in retirement. Employers often match part or all of the employee's deposits. Penalties usually apply to withdrawals before age 55, although most plans allow employees to borrow tax- and penalty-free from their accounts. The amount workers can set aside in these plans is gradually increasing. For 2006, the limit for employees was $15,000 — plus an extra $5,000 for those age 50 and older. Beginning in 2007, the maximum contribution limit will be increased each January 1st based on the cost-of-living increase during the prior year. The new limit will be announced by the federal government in mid-October.
For most business property, except real estate, the law allows you to depreciate the cost at a rate faster than would be allowed under straight-line depreciation. For example, automobiles and computers are assumed to have a five-year life for tax purposes. With straight-line depreciation you would be permitted to write off 20% of the cost each year; the accelerated method generally lets you deduct 20% of the business cost the first year, 32% the second, 19.2% the third, 11.52% in years four and five, and the remaining 5.8% in the sixth year. It takes six years to fully depreciate the property, thanks to the "midyear" convention, which, for simplicity, basically assumes that business assets are put into service in the middle of the year.
This is the technical term that Congress uses for what most of us call home mortgage debt on which the interest is deductible. To qualify, the debt must be used to buy, build or substantially improve your principal residence or a second home and must be secured by the property. The interest on up to $1 million of acquisition indebtedness is deductible.
The level of involvement that real estate owners must meet to qualify to deduct up to $25,000 of losses from rental real estate. Failure to pass this test could make such losses nondeductible under passive-loss rules.
Your basis in property is the stepping-off point for determining taxable gain or loss when you sell it. The basis generally starts out as what you pay for the property; although special rules apply to assets you inherit or receive as a gift. Your basis can be adjusted while you own property. When you buy rental property, for example, the basis begins at what you pay for the place, including certain buying expenses and it is adjusted upward by the cost of permanent improvements. The basis is reduced by the amount of any depreciation you are allowed to deduct (regardless of whether you actually claim it) while you own the property. You use your adjusted basis to figure the gain or loss on the sale. When stock or mutual fund shares are involved, your adjusted basis is the cost of the shares plus any brokerage commissions or load fees minus any return of capital payouts.
This is your income from all taxable sources minus certain adjustments and is the key to determining your eligibility for certain tax benefits and the phase-out of your eligibility for others. It's the amount which deductions (the standard deduction or itemized deductions) and the value of personal and dependent exemptions are deducted from to arrive at the amount that will be taxed. The adjustments are called above-the-line deductions because you can claim them whether or not you itemize deductions. Some include deductible contributions to IRAs (individual retirement accounts), SIMPLE and Keogh plans, contributions to HSAs (health savings accounts), job-related moving expenses, any penalty paid on early withdrawal of savings, the deduction for 50% of the self-employment tax paid by self-employed taxpayers, alimony payments, and up to $2,500 of interest on higher education loans. Also deductible as adjustments to income are qualifying travel expenses for members of the Reserves and National Guard.
This credit effectively refunds to you part of what you pay to adopt a qualifying child. For 2006, the credit can be as high as $10,960. An eligible child is generally one under age 18 or one who is physically or mentally incapable of caring for himself or herself.
If you adopt a special-needs child, the credit is $10,960 even if the adoption costs less than that. The right to the credit phases out on 2006 returns as AGI rises from $164,410 to $204,410.
See Taxpayer Advocate.
Alimony is qualifying payments to an ex-spouse that can be deducted as adjustments to income whether or not you itemize. The recipient must include the payments in his or her taxable income.
A special tax designed primarily to prevent the wealthy from using so many tax breaks that their regular tax bill is reduced to little or nothing. In recent years, it has affected more and more taxpayers who exercised incentive stock options at work and will increasingly affect taxpayers who do not consider themselves rich. The AMT ignores certain tax benefits allowed by the regular rules and applies special rates - 26% and 28% - to a larger amount of income than is taxed by the regular tax.
A revised tax return is used to correct an error on a return filed during the previous three years and is filed on Form 1040X. An amended return can result in owing added tax or receiving a refund. This depends on the mistake you are correcting.
This is a review of your tax return by the IRS, during which you are asked to prove that you have correctly reported your income and deductions.
Selling property to a charity for less than the property's actually worth. Depending on the circumstances, this could result in a tax deduction or extra taxable income.
See Adjusted basis.
If you make an interest-free or bargain-rate loan to a friend or relative, you may be required to include in your taxable income some of the interest the IRS figures you should have charged.
A person is considered legally blind if:
You are totally blind.
You can't see better than 20/200 in your better eye with glasses or contact lenses, or
Your field of vision is 20 degrees or less.
The amount over face value that you pay to buy a bond paying higher than current market rates. With taxable bonds, a portion of the premium can be deducted each year that you own the securities.
It is the responsibility of the taxpayer to prove that his or her tax return is accurate, rather than the IRS having to provide convincing evidence that it is inaccurate. Although Congress recently shifted the burden of proof to the IRS in certain tax disputes, you still need to retain copies of your records. The change will have no effect on the vast majority of taxpayers. The burden shifts only if a case gets to court which happens vary rarely and then only if the taxpayer has complied with all recordkeeping requirements and has cooperated with IRS requests for information. In almost all cases the burden of proof remains with the taxpayer.
The cost of a permanent improvement to property. Such expenses increase the property's adjusted basis.
The profit from the sale of such property as stocks, mutual-fund shares and real estate. Gains from the sale of assets owned for 12 months or less are "short-term gains" and are taxed in your top tax bracket, just like salary. For most assets owned more than 12 months, profits upon sale are considered "long-term gains" and are taxed at 15%. Taxpayers who otherwise fall in the 10% or 15% bracket get an even better deal on long-term gains. Their rate is just 5%. The special rates for long-term gains do not, however, apply to all gains from investment real estate. To the extent that gain results from depreciation (depreciation deductions reduce your basis in the property and therefore increase gain dollar for dollar upon sale), a 25% rate applies (unless you are in the 10% or 15% bracket, in which case that rate applies) to this "recaptured" depreciation. Also, long term-gains from the sale of collectibles are taxed at 28%.
The loss from the sale of assets such as stocks, bonds, mutual funds and real estate. Such losses are first used to offset capital gains and then up to $3,000 of excess losses can be deducted against other income, such as your salary. Long- and short-term losses (distinguished by whether the property was held for more than one year or a shorter period of time) are first used to offset gains of a similar nature. Any excess first offsets the other kind of gain, then other types of income.
Capital losses can be used to offset capital gains, and up to $3,000 of any excess loss can be deducted against other income, such as your salary. Losses not currently deductible because of the $3,000 limit can be carried over to future years.
Damage that results from a sudden or unusual event. After being reduced by $100, such personal losses are deductible to the extent that they exceed 10% of your adjusted gross income. Congress, however, has eliminated these limitations on personal property losses caused by hurricanes Katrina, Rita, and Wilma.
A gift of cash or property to a qualified charity for which a tax deduction is allowed. A receipt is required as proof for any single contribution of $250 or more.
For 2006, this credit is $1,000 for each child under age 17 you claim as a dependent on your return. The right to this credit is phased out as adjusted gross income rises over $110,000 on a joint return, $75,000 on an individual return or head of household return and $55,000 if you're married filing separately. For each $1,000 (or part thereof) that your AGI exceeds the threshold, you lose $50 of credit.
Not to be confused with the child credit, this one offsets part of the cost of paying for care for a child under the age of 13 or a disabled dependent of any age while you work. For 2006, the credit — which ranges from 20% to 35% depending on your income — can be applied to as much as $3,000 of qualifying expenses if you pay for the care of one qualifying child or up to $6,000 if you pay for the care of two or more.
These are payments made under a divorce or separation agreement for the support of a child. The payments are neither deductible by the person who pays them nor considered taxable income to the person who receives the money.
The Hope credit is worth up to $1,650 per year per student and is available for the first two years of vocational school or college. A lifetime learning credit is worth up to $2,000 per year for additional schooling. You can claim a Hope credit for each qualifying student (including yourself, your spouse or your dependent child) for whom you pay tuition and other qualifying fees (but not the cost of books or room and board), so three children in college at the same time could earn you $4,950 of credit. Only one lifetime learning credit can be claimed each year, however, for a maximum credit of $2,000 per tax return. The right to these credits disappears as 2006 adjusted gross income rises between $45,000 and $55,000 on an individual return and between $90,000 and $110,000 on a joint return.
Pay received by members of the U.S. Armed Forces and support personnel in combat zones, including peace keeping efforts. Military pay received by enlisted personnel serving in combat or designated peace-keeping efforts is tax-free. Officer pay is tax-free up to the maximum pay for enlisted personnel (plus imminent danger/ hostile fire pay), an amount that increases each year.
This is a concept of tax law that taxes income at the time you could have received it, even if you don't actually have it. A paycheck you could pick up in December is considered constructively received and taxed in that year. It doesn’t matter if don't receive or cash the check until the following January. Also, interest paid on a savings account is considered constructively received and taxable in the year it is credited to your account, whether or not you withdraw the money.
See Personal interest.
Originally known as the education IRA, even though it has nothing to do with retirement. A Coverdell ESA allows you to put up to $2,000 a year in a special account that will be used to pay a student's school bills. There's no deduction for contributions but if the money is used to pay qualifying expenses, withdrawals are tax free. The $2,000 cap is the limit on how much can be set aside for any student in one year, regardless of how many people contribute. Prior to 2002, only college bills or the cost of other post-secondary education could qualify for tax-free disbursements. Now, primary and high school bills count, too—even the cost of a computer can qualify.
See Coverdell education savings account.
See Retirement credit.
A 14-digit number assigned to your return by your intermediate service provider and/or transmitter.
Expenses you are permitted to subtract from your taxable income. All taxpayers may claim a standard deduction amount - $10,000 for 2006 joint returns, for example, half that amount on individual returns. If your qualifying expenses exceed your standard deduction, you may claim the higher amount by itemizing your deductions. Although no records are needed to back up your right to the standard deduction, you must maintain records of qualifying expenditures if you itemize.
Someone for whom you can claim a dependency exemption on your tax return. Your children or other relatives often qualify to be your dependents, though certain tests are applied to determine if someone is your dependent. The tests have to do with the dependent’s relationship to you, whether they live with you, and their age, among other things.
For each dependent you claim, the exemption knocks $3,300 off your taxable income in 2006. The value increases each year with inflation. (We project that this exemption will be worth $3,400 on 2007 returns.) Each dependent under age 17 also qualifies his or her parent for a tax credit that's worth $1,000 on 2006 returns. Higher-income taxpayers (with AGI over $225,750 on 2006 joint returns, for example) can lose the credit and up to two-thirds of the value of the exemption.
A deduction to reflect the gradual loss of value of business property as it wears out. The law assigns a tax life to various types of property, and your basis in such property is deducted over that period of time. (See "Accelerated Depreciation.")
A method to move funds from one individual retirement account or Keogh plan to another. You can also use this method to move money from a company retirement plan to an IRA. With a direct transfer, you order one sponsor to transfer the money directly to your new IRA; you do not take possession of the funds. There is no limit on the number of times you can move your money via direct transfer. However, if you take possession of the funds and personally deposit them in the new IRA, the switch is considered a rollover. You can use the rollover method only once in any one year period for each IRA account you own. The direct transfer method must be used to move funds from a company retirement plan to an IRA, or else 20% of the money withdrawn from the company plan will be withheld for the IRS, even if no taxes are due.
A person is permanently and totally disabled if both of the following apply:
He or she cannot engage in any substantial gainful activity because of a physical or mental condition; and
A physician determines that the condition has lasted or can be expected to last continuously for at least a year or can lead to death.
Compensation, such as salary, commissions and tips, you receive for your personal services. Income reported on Schedule C and Schedule F is also considered earned income. This is distinguished from "unearned" income such as interest, dividends and capital gains.
Interest on college loans can be deducted as an adjustment to income, so you get a benefit even if you don't itemize deductions. To qualify for the write off, the debt had to be incurred to pay higher education expenses for you, your spouse or your dependent. Up to $2,500 of such interest can be deducted in 2006, but this tax-saver is phased out at higher income levels.
See Coverdell education savings account.
See Coverdell education savings account.
A tax professional who, by virtue of passing an IRS test or IRS experience, can represent clients at IRS audits and appeals.
The federal tax that applies – beginning at a 46% rate – when a decedent's taxable estate exceeds $2 million in 2006. That tax rate will decrease as part of a plan to abolish the estate tax by 2010.
If you have income not subject to withholding, such as investment or self-employment income, you may have to make quarterly payments of the estimated amount needed to cover your expected tax liability for the year. You can be penalized if estimated payments, combined with withholding from wages, don't come within $1,000 of 90% of the tax owed. If you think you might be liable for the penalty, be sure to check out the exceptions to it.
You can claim a personal exemption for yourself. On joint returns a personal exemption is claimed for each spouse. You also get an exemption for each dependent you claim on your return. Each exemption reduces taxable income by $3,300 in 2006 and, we project by $3,400 in 2007. (The value of exemptions is partially phased out at higher income levels, beginning, for example, when adjusted gross income passes $225,750 on joint returns in 2006.)
Also known as the Section 179 deduction, expensing lets you treat up to $108,000 of 2006 expenditures that normally would be depreciated over a number of years as current business expenses to be deducted immediately. Businesses that put more than $430,000 worth of new equipment into service during the year gradually lose the right to use expensing.
Your status determines the size of your standard deduction and the tax-rates that apply to your income. Also, several tax breaks are calculated based on your filing status. For tax purposes, you are considered single, married filing jointly, married filing separately, head of household or qualifying widow or widower.
This special tax-computation method for qualifying lump-sum distributions from company retirement plans is no longer available, but see the discussion of ten-year averaging.
This kind of capital gain, which first appeared on 2001 tax forms — has been abolished.
To prevent people from avoiding the estate tax by giving their property away, the law includes a gift tax, too. You may give up to $12,000 yearly to as many people you want without worrying about this tax. Larger gifts are taxable, but a tax credit offsets the tax on the first $1 million of lifetime taxable gifts. Any part of the credit used to protect taxable gifts will not be available to reduce estate taxes. When the gift tax is owed, it is owed by the giver, not the recipient.
Gross income is your income from taxable sources, before subtracting any adjustments, deductions or exemptions.
A filing status with lower tax rates for unmarried or some married persons considered unmarried (for purposes of this filing status) who pay more than half the cost of maintaining a home, generally, for themselves and a qualifying person, for more than half the tax year.
First available in 2004, HSAs (health savings accounts) allow Americans under age 65 to make tax-deductible contributions to a special account tied to a high-deductible health insurance policy. Earnings inside the HSA are tax deferred (just like in an IRA). To qualify to contribute to an HSA, you must have a qualified insurance policy, which for 2006 is one that has a deductible of at least $1,050 for individuals or $2,100 for families. In 2006, you can contribute to an HSA up to the amount of the policy deductible — to a maximum annual contribution of $2,700 if you're single or $5,450 if you are married and have a family policy. (In 2006, those born before 1952 can contribute — and deduct — an extra $700 a year to their HSAs.) Money from the HSA can be used tax — and penalty — free to pay the insurance policy deductible, co-payments and any other qualifying expenses. Money left in the account at the end of a year can be rolled over to the next year. Non-qualifying withdrawals of earnings before age 65 are taxed and a 10% penalty is imposed. After you reach age 65, contributions to the HSA must cease and non-qualifying withdrawals are taxed but not penalized. Contributions to an HSA are deducted as an adjustment to income, which means you get the tax benefit whether or not you itemize deductions.
One requirement for deducting business losses is that you show you are trying to make a profit. The law presumes you're in business for profit if you report a taxable profit for three years out of any five-year period. Otherwise, your activity is assumed to be a hobby, unless you can prove otherwise. The distinction is important because if the expenses of a hobby exceed the income, the difference is considered a personal expense, not a tax-deductible loss.
See College credits.
The period of time you own an asset for purposes of determining whether profit or loss on its sale is a short- or long-term capital gain or loss. Sales of assets owned one year or less produce short-term results. The sale of assets owned more than 12 months produces long-term results. The holding period begins on the day after you purchase an asset and ends on the day you sell it. If you buy on January 4, for example, your holding period begins January 5. If you sell the following January 4, you have owned the asset for exactly one year, which is considered a short-term sale. To be eligible for the gentler long-term tax treatment, you'd need to hold on until January 5, so that you have owned the asset for more than one year. (See Capital gain.)
Debt secured by your principal residence or second home – such as a second mortgage or home-equity line of credit – that is not used to buy, build or substantially improve the property. Although interest on most loans is no longer deductible, interest on up to $100,000 of home-equity debt remains deductible.
Interest you are considered to have earned – and therefore owe tax on – if you make a below-market-rate loan. The term is also used to refer to the interest income you must report on taxable zero-coupon bonds. Although the bonds pay no interest until maturity, you must report and pay tax on the interest as it accrues.
To prevent inflation from eroding certain tax benefits, including standard deductions and exemption amounts and the low and high end of each tax bracket. They are automatically adjusted for increases in the consumer price index.
Recent changes in the 401(k) rules allow a self-employed person with no employees to use a 401(k) plan to deposit — and deduct — far more for his or her retirement than in the past or in other retirement plans used by the self-employed, such as SEP and Keogh plans.
A reference to an IRA without the moniker "Roth" in front of it is a reference to a traditional IRA, a tax-favored account designed to encourage saving for retirement. If your income is below a certain level or you are not covered by a retirement plan at work, deposits into a traditional IRA can be deducted. The maximum annual contribution for 2006 — deductible or not — is $4,000 or 100% of the compensation earned during the year, whichever is less. Those who are age 50 or older at the end of the year can add a $1,000 "catch up" contribution, bringing their annual limit to $5,000. Also, a husband or wife can, however, contribute part of his or her compensation to an IRA for a non-working spouse. The tax on all earnings inside the IRA is postponed until you withdraw the funds. In most cases there is a penalty for withdrawing funds before you reach age 59 1/2. For 2007, the maximum regular contribution remains at $4,000 and the catch up for older workers stays at $1,000, for a maximum contribution of $5,000. The right to deduct contributions phases out at higher income levels for those covered by a retirement plan at work. (See Roth IRA.)
See Individual retirement account (IRA).
You may be an Injured Spouse if the IRS has or you suspect that they might withhold part of your joint refund to pay for past-due debts that only your spouse is liable for. These debts include unpaid child support, spousal maintenance, federal debts (for example student loans, income tax) or state income taxes. The injured spouse must have income and tax payments (or refundable credits) that are reported on the joint return. If the injured spouse lives in a community property state then this requirement does not need to be met. Form 8379 is used to file a claim and is attached to Form 1040 if filed in the current year or filed separately if it is for a prior year.
Tax rules designed to protect married taxpayers who file joint returns from being held responsible for taxes due to erroneous actions by their spouses — such as failing to report income or claiming unsubstantiated deductions. Basically, if you can show that you didn't know and didn't have reason to know about errors that resulted in the underpayment of tax on the joint return, you can be relieved of responsibility for that underpayment. You have two years from the time the IRS begins trying to collect the underpayment to petition for innocent spouse relief. Request relief by filing Form 8857. Although Form 8857 is not part of TaxCut, you can find Form 8857 on the IRS website at www.irs.gov/pub/irs-pdf/f8857.pdf. You should file this form separately from your tax return.
With an installment sale you agree to have the purchaser pay you over a number of years, and you report the profit on the sale as you receive the money instead of all at once in the year of the sale.
Interest paid on loans used for investment purposes, such as to buy stock on margin. You can deduct this interest on Schedule A if you itemize, up to the amount of investment income (not including capital gains or dividends that qualify for the new 5% or 15% rates) you report.
See Deductions.
Also known as an H.R. 10 plan, this is a retirement plan for the self-employed. As much as 20% of self-employment income can be deposited in a Keogh, and contributions can be deducted. There is no tax on the earnings until the money is withdrawn, and there are restrictions on withdrawing from the account before age 59 1/2.
A reference to the Social Security cards needed by any child you claim as a dependent on your tax return. The nine-digit identifying number shown on the card must be reported on the tax return of the parent who claims the child as a dependent. What if a child is born late in the year and you haven't received a social security number by the time you're ready to file? The IRS says you must delay filing, even if it means getting an extension to file past the April 15 deadline. If you claim a dependent and fail to include the number, the exemption will be rejected and your tax bill hiked accordingly.
The tax — at the parents' tax rate — imposed on unearned income of children who are under age 18 at the end of the year. The kiddie tax applies to the child's unearned income in excess of $1,700 in 2006.
See College credits.
The tax-free exchange of similar business or investment use assets, such as real estate for real estate. The tax on profit accrued in the first property is deferred until the subsequent property is sold.
Investments — in real estate and oil and gas, for example — that pass both profits and losses on to investors. By definition, limited partnerships are passive investments, subject to the passive-loss rules.
"Listed property" is the term used for depreciable assets that Congress has put on a special list for special scrutiny by the IRS. Basically, this includes things Congress worries you might use for personal as well as business purposes — a car, computer, cellular telephone, boat, airplane and photographic and video equipment. (If a computer or photographic or video equipment is used exclusively at your regular place of business, however, it is not considered listed property.) There are special restrictions on the depreciation of listed property if business use does not exceed 50%.
See capital gain or capital loss.
The payment within one year of the full amount of your interest in a pension or profit-sharing plan. To qualify as a lump-sum distribution — and for favorable ten-year averaging — other requirements must be met.
The restrictions that limit annual depreciation deductions for business automobiles.
This is the share of each extra dollar of income that will go to the IRS. It's not necessarily the same as the rate in your top tax bracket because in many cases rising income squeezes the value of tax breaks. This means the extra income is effectively taxed more harshly than advertised. Knowing your marginal rate tells you how much of each additional dollar you make will go to the IRS and how much you'll save for every dollar of deductions you claim.
The deduction that allows any amount of property to go from one spouse to the other — via lifetime gifts or bequests — free of federal gift or estate taxes.
The difference between what you pay for a bond and its higher face value. The tax treatment varies depending on whether the bond is taxable or tax-free and whether you redeem it at maturity or sell it before that time.
Similar to regular limited partnerships, but MLPs shares are traded on the major exchanges, making for a much more liquid investment. Although limited-partnership losses are considered passive, income from an MLP is considered investment income rather than passive income. That means passive losses can't be used to shelter MLP income.
The test used to determine whether you are involved enough in a business to avoid the passive-loss rules. To be considered a material participant, you must be involved on a "regular, continuous and substantial basis." One way to pass the test is to participate in the business for more than 500 hours during the year.
The portion of the Social Security tax — 1.45% for employees and 2.9% for self-employed taxpayers - that pays for Medicare. Although the part of the tax that pays for retirement benefits stopped at $94,200 in 2006, the Medicare portion applies to all wages and self-employment income. In 2007, we estimate that the limit for the Social Security portion of the tax will be around $98,400.
The rule that treats certain kinds of depreciable property, including real estate, as though it were placed in service in the middle of the month it was first used.
In general, business property is depreciated under a midyear rule that allows half a year's depreciation for the first year, whether you buy property in January or December. However, if you buy more than 40% of the business property you put into service for the year during the fourth quarter, the midquarter convention takes over. With it, you depreciate each piece of property as though it were placed into service in the middle of the calendar quarter in which it was purchased. You claim just six weeks' worth of depreciation for property put in service during the final quarter, for example.
A term often used to refer to deductible interest paid on debt that qualifies as acquisition indebtedness or home-equity debt.
An agreement under which two or more taxpayers, who together provide more than half the support for someone else, agree that one will claim that person as a dependent and the others will not.
The amount by which the face value of a bond exceeds its issue price. Part of the discount on taxable bonds must be reported as taxable interest income each year that you own the securities.
Passive activities are investments in which you do not materially participate. Losses from such investments can be used only to offset income from similarly passive investments. Passive losses generally can't be deducted against other kinds of income, such as salary or income from interest, dividends or capital gains. Generally, all real estate and limited-partnership investments are considered passive activities, but there is a limited exception for rental real estate in which you actively participate. Losses you can't use because you have no passive income to offset can be carried over to future years.
See Exemptions.
Basically, this is interest that doesn't qualify as mortgage, business, student loan or investment interest. Included is interest you pay on credit cards, car loans, life insurance loans and any other personal borrowing not secured by your home. Personal interest can not be deducted.
In connection with getting a home mortgage, each point is equal to 1% of the mortgage amount. Points paid on a mortgage to buy or improve your principal residence are generally fully deductible in the year you pay them. You get to deduct the points even if you convince the seller to pay them for you. Points paid to refinance the mortgage on a principal home or to buy any other property must be deducted over the life of the loan.
Tax breaks allowed under the regular income tax but not under the alternative minimum tax, including the deduction of state and local taxes and some interest on home-equity loans. One that that has a large impact on taxpayers is the "spread" between the exercise price and the value of stock purchased with incentive stock options. Although that amount is not taxed under the regular tax, it is a preference item subject to tax if you're hit by the AMT.
Withdrawals from company retirement plans subject to a 10% penalty if you're under age 55 (in the year you leave the job) or under age 59 1/2 (if you're still employed).
An employee benefit plan — such as a pension or profit-sharing plan — that meets IRS requirements designed to protect employees' interests.
A fringe benefit, sometimes called a flexible spending account or salary reduction plan, that allows an employee to divert some of his or her salary to a special account that is used to reimburse the employee for medical or child-care expenses. Funds channeled through the account escape federal income and Social Security taxes and, in all states but New Jersey, state income taxes as well.
This credit is worth as much as 50% of up to $2,000 contributed to an IRA, 401(k) or other retirement plan. It is designed to encourage lower-income workers to save for their retirement. It is worth 50% of up to $2,000 contributed if your AGI is under $15,000 on a single return or $30,000 on a joint return. It gradually diminishes as income rises and disappears when income passes $25,000 on single returns and $50,000 on joint returns. Taxpayers under age 18 and those claimed as dependents on their parents' returns are not eligible, regardless of their income.
The tax-free transfer of funds from one individual retirement account to another. If you take possession of the funds, the money must be deposited in the new IRA within 60 days. You can only use the rollover method only once in any one year period to move money from one IRA to another. The once-a-year rule applies to each IRA you own so, for example, if you own two different IRAs — accounts A and B — you may use the rollover to transfer the money from account A to account C and, during the same year, use a rollover to move money from account B to account D.
You can also use a rollover to transfer funds from a company plan — when you receive a lump-sum distribution at retirement, for example — to an IRA or another company plan (if the plan accepts such rollovers). The tax bill is delayed until you withdraw funds from the IRA. (Beware that when the rollover method is used to move money from a company plan to an IRA, 20% of the amount will be withheld for the IRS, even though the rollover is tax-free if the money is in the IRA within 60 days. To avoid this automatic withholding, use the direct transfer method to move money from a company plan to an IRA.) See also, Direct transfer.
You can also use a rollover to move money from a medical savings account (MSA) to a health savings account (HSA).
The Roth IRA is named after its chief supporter — Sen. William Roth of Delaware. Contributions are not deductible but all withdrawals are tax-free, as long as they come after you reach age 59 1/2 and at least four calendar years after the year in which the account was opened. Joint filers who are under the age of 50 can each contribute up to $4,000 to a Roth IRA in 2006. This amount is reduced when adjusted gross income is $150,000 and is completely phased-out at $160,000. For joint filers age 50 and older, the 2006 cap is $5,000. (The same phase-outs apply). Taxpayers who are filing as head of household, single or qualifying widower are allowed reduced contributions with adjusted gross incomes of $95,000 and are ineligible to make Roth Contributions at $110,000.
Roth contributions for 2007 remain at $4,000 for those under 50, and stays at $5,000 for those ages 50 and older.
You can roll over funds from a traditional IRA to a Roth IRA. A rollover makes all future earnings tax-free rather than simply tax deferred. However, you have to pay tax on the money you move from your traditional IRA to your Roth IRA. The income is reported on the tax return for the year the transfer took place.
Named after the subchapter of the tax law that authorizes it, an S corporation generally pays no tax because profits and losses are passed on and taxed to the shareholders.
See Retirement savings credit.
See Expensing.
The tax due on self-employment income to pay for Social Security retirement and Medicare benefits. For 2006, the rate was 15.30% on the first $94,200 of earnings and 2.9% on all amounts over that amount. For 2007, we estimate that the full 15.30% will apply to the first $98,400 of earnings.
See Capital gain or Capital loss.
The Savings Incentive Match Plan for Employees (SIMPLE) is a retirement plan that can be offered by firms with 100 or fewer employees. A key is that the employer generally must match employee contributions up to 3% or contribute 2% of pay for each employee, whether or not they contribute on their own. The rules are simpler than for other tax-qualified retirement plan, and Congress hopes that this will encourage smaller employers to establish plans. For 2006, a self-employed person with no employees could open a SIMPLE and contribute up to $10,000 of self-employment earnings ($12,500 if age 50 or older by the end of the year). For 2007, the general limit will rise with inflation and the add-on for older workers will also rise with inflation for those age 50 and older.
The standard deduction is a no-questions-asked write-off from taxable income. The amount varies depending on your filing status. For 2006, for example, the standard deduction is $10,300 on a joint return, $5,150 on a single return and $7,550 on a head of household return. Taxpayers age 65 and older get larger standard deductions. Unlike taxpayers who itemize deductions, you need no records to prove you deserve this deduction. Even if you somehow made it through the year without incurring any deductible expenses, you may still claim the full standard deduction. About two-thirds of all taxpayers use the standard deduction instead of itemizing their deductions.
This the deductible amount you can claim for each mile you use your car for business, charitable, job-related moving or medical purposes without having to keep track of the actual cost.
The 2006 business mileage rate is 44.5 cents. For driving to a new location as part of a job-related move and for travel for medical care the rate for 2006 is 18 cents a mile. For volunteer work — a rate that is set by Congress, not the IRS — the rate is 14 cents a mile. For volunteer work related to hurricane Katrina, the rate is 32 cents per mile. In any case, you add the cost of parking and tolls.
The basis of inherited property is stepped-up to its value on the date of death of the owner, or a slightly later date if chosen by the executor of a taxable estate. In other words, tax on any appreciation during his or her lifetime is forgiven. The heir uses the higher basis to figure his or her gain when the property is ultimately sold.
This can mean different things. It can refer to income that is taxable (such as wages, interest and dividends) rather than tax-exempt (such as the interest on municipal bonds). On tax returns, "taxable income" is your income after subtracting all adjustments, deductions and exemptions —. This is the amount on which your tax bill is computed.
Each tax bracket encompasses a certain amount of income to be taxed at a set rate. The rates now run from 10% to 35%. You are considered to be in the 25% bracket if your highest dollar of income falls in that bracket. Even if you're in the 25% bracket, part of your income is taxed at the 10% rate and some at 15%. Some of your income — such as the amounts protected by your personal and any dependent exemptions and your standard or itemized deductions — is not taxed at all.
Interest paid on bonds issued by states or municipalities that is tax-free for federal income tax purposes. Although you must report this income on your return, it is not taxed.
The official inside the IRS who is charged with helping individuals resolve their problems with the IRS, as well as identifying changes in IRS procedures that could make the agency more taxpayer-friendly. This official oversees IRS Problem Resolution Officers (PRO) around the country. You should go to a PRO, or ultimately the Advocate, if you are getting the run-around - or worse - from regular IRS channels.
Even though five-year averaging has been abolished, this special tax-computation method for lump-sum distributions from pension and profit-sharing plans is still available. . .but only to taxpayers born before January 2, 1936. If you qualify, it could save you a substantial amount.
See Ten-year averaging.
See Ten-year averaging.
See College credits.
Income from investments, such as interest, dividends and capital gains. See Earned income.
You can ask the Social Security Administration to withhold taxes from your social security benefits. This could make sense if withholding allows you to avoid making quarterly estimated tax payments. To request voluntary withholding, file form W-4V with Social Security.
The level of earnings to which the full Social Security tax applies. For 2006, the full 15.30% tax applies to the first $94,200 of wages or self-employment income and the 2.9% Medicare portion applies to all income over that level. For 2007, we estimate that the full 15.30% will hit about $98,400 of earnings. (Employees pay half the tax — 7.65% up to the wage base limit and 1.45% after that — and their employers pay the other half. Self-employed taxpayers have to pay it all.)
The sale of stocks, bonds or mutual fund shares for a loss when, within 30 days before or after that sale, you buy the same or substantially identical securities. The law forbids the deduction of the loss.
The amount held back from your wages each payday to pay your income and social security taxes for the year. The amount withheld is based on the size of your salary and the form W-4 you file with your employer.