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401(k) plan |
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An employer-sponsored retirement savings plan through which employees divert part of their salary 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 Salary put in the plan is not taxed until it is later withdrawn, presumably in retirement.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 limited amounts tax- and penalty-free from their accounts. For 2007, the limit for employees is $15,500—plus an extra $5,000 for those age 50 and older by the end of the year. The maximum contribution limits will remain the same for 2008. The limits are scheduled to rise with inflation in the future. See also Roth 401(k). |
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Accelerated depreciation |
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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 percent of the cost each year; the accelerated method generally lets you deduct 20 percent of the business cost the first year, 32 percent the second, 19.2 percent the third, 11.52 percent in years four and five, and the remaining 5.8 percent in the sixth year. It takes six years to fully depreciate the property, thanks to the "midyear" convention, which basically assumes that business assets are put into service in the middle of the year. |
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Accrual method (or accrual basis). |
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One of two main accounting methods for determining when a transaction has tax significance. The accrual method says that a transaction is taxed when an obligation to pay or a right to receive payment is created (for example, at the time products are delivered, services rendered, billings sent, etc.). This method is used by all but the smallest businesses. (See "Cash method (or cash basis).") |
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Acquisition indebtedness |
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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 second home and must be secured by the property. The interest paid on up to $1 million of acquisition indebtedness is deductible if you itemize deductions. |
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Active participation |
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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. |
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Adjusted basis |
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Your basis in property is the stepping-off point for determining gain or loss when you sell it. (This is sometimes referred to as cost basis, tax basis or, simply, basis.) 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. The 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 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, and minus any return of capital payouts. |
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Adjusted gross income (AGI) |
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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 from which deductions (the standard deduction or itemized deductions) and personal and dependent exemptions are deducted to arrive at the amount of taxable income that will actually be taxed. The adjustments - sometimes called above-the-line deductions because you can claim them whether or not you itemize deductions - 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 percent of the self-employment tax paid by self-employed taxpayers, alimony payments, up to $2,500 of interest on higher education loans and certain qualifying college costs. Also deductible as adjustments to income: the $250 teacher deduction and qualifying travel expenses for members of the Reserves and National Guard. |
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Adoption credit |
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This credit effectively refunds to you part of what you pay to adopt a qualifying child. For 2007, the credit can be as high as $11,390. 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 $11,390 even if the adoption costs less than that. The right to the credit phases out on 2007 returns as AGI rises from $170,820 to $210,820. For 2008, the credit can be as high as $11,650 and the phase-out zone will be $174,730 to $214,730. |
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Advocate |
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See Taxpayer advocate. |
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Alternative minimum tax (AMT) |
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A special tax designed primarily to prevent the wealthy from using so many legal tax breaks that their regular tax bill is reduced to little or nothing. In recent years, it has hit more and more taxpayers who live in high-tax states, have many children or exercise incentive stock options and will increasingly hit taxpayers who do not consider themselves rich. The AMT ignores certain tax benefits allowed by the regular rules and applies special rates - 26 percent and 28 percent - to a larger amount of income than is hit by the regular tax. New for 2007: taxpayers who paid the AMT in 2003 or earlier because of exercising incentive stock options will be eligible for a refundable credit of 20% (or at least $5,000) of the AMT they have already paid plus 20% of the remaining balance over each of the succeeding four years. The refundable credit is subject to the same income phase-outs used to limit personal exemption for high-income taxpayers—affecting individuals with adjusted gross income of more than $156,400 and married couples with AGI of more then $234,600. |
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Amended return |
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A revised tax return, filed on Form 1040X, to correct an error on a return filed during the previous three years. An amended return can result in owing extra tax or getting a refund, depending on the mistake you correct. |
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Amortization |
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The write-off of an amount spent for certain capital assets, similar to depreciation. This tax meaning is different from the common meaning of the term that describes, for example, payment schedules of loans. |
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Applicable Federal Rates (AFRs) |
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Minimum interest rates that must be charged on various transactions that involve payments over a number of years. If the parties to a transaction do not adhere to these rates, the IRS will impute the interest. (See "Imputed interest.") |
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At-risk rules |
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Rules that limit an investor’s deductible losses from an investment to the amount invested. Complications arise when investors finance their investment through loans that they are not personally on the hook for (nonrecourse financing). Without these rules, investors could raise their deduction limit considerably without being at-risk for the actual loss. |
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Audit |
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As if you didn't know, 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. Most audits are done by mail and involve specific issues, not the entire return. |
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Bargain sale to charity |
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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. |
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Basis |
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The starting point for computing gain or loss on a sale or exchange of property or for depreciation. (See "Adjusted basis.") For property that is purchased, basis is its cost. The basis of inherited property is its value at the date of death (or alternative valuation date). The basis of property received as a gift or a nontaxable transaction is based on the adjusted basis of the transferor (with some adjustments). Special rules govern property transferred between corporations and their shareholders, partners and their partnership, etc. |
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Below-market-rate loans |
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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 believes you should have charged. |
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Blind |
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A person is considered legally blind for purposes of qualifying for a larger standard deduction if: |
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He or she is totally blind. |
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He or she can't see better than 20/200 in the better eye with glasses or contact lenses, or |
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His or her field of vision is 20 degrees or less. |
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Bond premium |
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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. |
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Burden of proof |
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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 has shifted the burden of proof to the IRS in certain tax disputes, don't throw away 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 very rarely—and then only if the taxpayer has complied with all record keeping requirements and has cooperated with IRS requests for information. In almost all cases, then, the burden of proof remains on your shoulders. |
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Cafeteria plan |
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A plan maintained by an employer that allows employees to select from a menu of taxable and nontaxable benefits. |
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Capital expenditure |
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The cost of a permanent improvement to property. Such expenses, such as adding central air conditioning or an addition to your home, increase the property's adjusted basis. |
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Capital gain |
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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 capital gains" and are taxed in your top tax bracket, just like salary. For most assets owned more than 12 months, profits are considered "long-term capital gains" and are taxed at 15 percent. Taxpayers who otherwise fall in the 10 percent or 15 percent bracket get an even better deal. Their rate on long-term gains is just 5 percent. 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 percent rate applies (unless you are in the 10 percent or 15 percent bracket, in which that rate applies) to this "recaptured" depreciation. Also, long term-gains from the sale of collectibles are taxed at 28 percent. |
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Capital loss |
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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. |
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Capital-loss carryover |
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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. |
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Carrybacks and carryforwards |
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Deductions that may be transferred to a year other than the current year because they exceeded certain limits. These deductions are typically carried back to earlier years first and, if they exceed the limits for those years, are then carried forward to later years until the deduction is used up. Charitable contributions and net operating losses are examples of deductions that may be carried back or forward. |
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Cash method (or cash basis) |
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One of two main accounting methods for determining when a transaction has tax significance. The cash method says that a transaction is taxed when payment is made. This method is used by most individuals. (See "Accrual method (or accrual basis).") |
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Casualty loss |
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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 percent of your adjusted gross income. |
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Charitable contribution |
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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. Starting in 2007, you must have either a receipt or a bank record (such as a cancelled check) to back up any donation of cash. |
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Child credit |
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For 2007 and 2008, 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. |
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Child- and dependent-care credit |
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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 disabled dependent while you work. For 2007 and 2008, the credit—which ranges from 20 percent to 35 percent 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. |
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Child support |
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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. |
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College credits |
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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 2007 adjusted gross income rises between $ $47,000 and $ 57,000 on an individual return and between $ $94,000 and $ $114,000 on a joint return. For 2008, the phase-out zones are $48,000 to $58,000 and $96,000 to $116,000. |
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College expense deduction |
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Qualifying taxpayers can deduct up to $4,000 of college expenses if their adjusted gross income is under $65,000 on a single return or $130,000 on a joint return. This break is available whether or not your itemize deductions, but is not available to students who are claimed as dependents on their parents' return. A write-off of up to $2,000 will be allowed for qualifying taxpayers whose AGI fall between $65,000 and $80,000 on a single return and between $130,000 and $160,000 on a joint return. You can not claim the deduction in the same year you claim a Hope or Lifetime Learning credit for the same student. But because the income phase-out range for this deduction are higher than for the credits, some taxpayers whose income is too high to benefit from the credits will benefit from this write-off.) |
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Combat pay |
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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. Although tax-free, combat pay may now be counted as compensation when determining whether the taxpayer can contribute to an IRA or Roth IRA. |
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Community property |
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A system governing spousal ownership of property and income that is the law in certain western and southern states and Wisconsin. The differences between community property and "common law" can change how federal tax law applies to spouses. For example: married taxpayers filing separately in a common law state do not have to report income earned by the other spouse. They do have to report income earned in a community property state. |
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Constructive receipt |
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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, even if don't get and 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. |
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Consumer interest |
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See Personal interest. |
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Coverdell education savings account |
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This was 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. In addition to being used for college expenses, ESA funds can also be spent for primary and high school bills. Even the cost of a computer is a qualifying expense. |
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Coverdell ESA |
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See Coverdell education savings account. |
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Credit for qualified retirement savings contributions |
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See Retirement credit. |
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Declaration Control Number (DCN) |
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A 14-digit number assigned to an electronically filed tax return by your intermediate service provider and/or transmitter. |
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Deductions |
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Expenses you are permitted to subtract from your taxable income. All taxpayers may claim a standard deduction amount - $ 10,700 for 2007 joint returns, for example, half that amount on individual returns. For 2008, the standard deduction will increase to $10,900 for joint returns and to $5,450 for individuals. 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. For higher income taxpayers, the amount of their otherwise allowable itemized deductions will be reduced when AGI exceeds a threshold amount. The reduction is equal to the lesser of 3% of AGI over the threshold amount or 80 percent of itemized deductions otherwise allowable. For 2007, the threshold amount is $156,400 for all returns except those returns filed married filing separately. That threshold is $78,200. For 2008, those thresholds increase to $159,950 and $79,975. Starting in 2008, taxpayers only lose one-third of the amount otherwise required under the phaseouts, down from two-thirds in 2007. |
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Deferred compensation |
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An arrangement that allows an employee to receive part of a year’s pay in a later year and not be taxed in the year the money was earned. |
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Dependent |
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Someone you support and for whom you can claim a dependency exemption on your tax return. For each dependent you claim, the exemption knocks $ 3,400 off your taxable income in 2007. The value increases each year with inflation. (It will be $3,500 on 2008 returns.) Each dependent under age 17 also qualifies his or her parent for a tax credit that's worth $1,000. Higher-income taxpayers (with AGI over $ $234,600 on 2007 joint returns, for example) can lose up to two-thirds of the value of the personal exemption, brining its value down to $1,133. In 2008, no more than one-third of the value of the exemption can be taken away and in 2009, the phase out for high incomers disappears. |
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Depletion |
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A system similar to depreciation that allows the owner of natural resources (for example: a coal mine or an oil well) to deduct a portion of the cost of the asset during each year of its presumed productive life. |
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Depreciation |
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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 also Accelerated Depreciation. |
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Direct transfer |
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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 such as a 401(k) 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 each year 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 percent of the money withdrawn from the company plan will be withheld for the IRS, even if no taxes are due. |
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Earned income |
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Compensation, such as salary, commissions and tips, you receive for your personal services. This is distinguished from "unearned" income such as interest, dividends and capital gains. |
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Earned income credit |
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A tax credit aimed at lower-income taxpayers. This credit is refundable, meaning that if it more than wipes out the worker's income tax liability, he or she will receive a check from the IRS that basically refunds part of the Social Security taxes he or she paid. |
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Education interest |
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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, but this tax-saver -- like so many others -- is phased out at higher income levels. For 2007, the deduction phases out as income rises between $ $55,000 and $70,000 for single filers and $ $110,000 and $140,000 for joint filers. For 2008, the zones are the same for single filers and increase to $115,000 to $145,000 for joint filers. |
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Education IRA |
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See Coverdell education savings account. |
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Education savings account |
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See Coverdell education savings account. |
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Electronic filing |
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The fastest way to get your tax return (or a request for an extension of time to file) to the IRS (and state revenue office). In 2007, more than 76 million returns were filed electronically, including about 22 million from home computers. |
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Employee stock ownership plan (ESOP) |
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A type of profit-sharing plan in which benefits come in the form of stock in the employer. |
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Enrolled agent |
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A tax preparer who, by virtue of passing a tough IRS test or prior IRS work experience, can represent clients at IRS audits and appeals. |
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Estate tax |
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The federal tax that applies—beginning at a 45 percent rate—when a decedent's taxable estate exceeds $2 million in 2007 and 2008 and exceeds $3.5 million in 2009. The estate tax is scheduled to disappear in 2010, but don't count on it. |
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Estimated tax |
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If you have income that's 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 or 90 percent of the tax owed on your 2007 return or 100% of the tax shown on your 2006 return. Higher income taxpayers—individuals with adjusted gross incomes of more than $75,000 or married taxpayers with joint AGIs of more than $150,000—are subject to a higher standard to avoid an underpayment penalty. Their quarterly estimated payments must equal at least 90% of their 2007 tax bill or 110% of their 2006 return. |
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Excess Social Security tax withheld |
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If you hold more than one job during the year—either at the same time or successively—too much Social Security could be withheld from your pay. Each employer is required to withhold the full 7.65 percent tax from the first $ $97,500 of wages paid in 2007 . But no taxpayer has to pay the full tax on more than the annual limits. If wages from two jobs pushes you over the limit, too much tax will be withheld. You get a credit for the excess when you file your tax return for the year. In 2008, the Social Security wage base is expected to reach six figures for the first time, reaching an estimated $102,000. |
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Exemptions |
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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 $ $3,400 in 2007 and $ 3,500 in 2008. (The value of exemptions is partially phased out at higher income levels, beginning, for example, when adjusted gross income passes $156,400 on individual returns and $234,600 on joint returns in 2007. For 2007, high-income tax payers can lose as much as two-thirds of their personal exemptions and starting in 2008, they can lose more than one-third of their personal exemptions. The phaseout for personal exemptions will begin a $159,950 for individual returns in 2008 and $239,950 for joint returns. |
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Expensing |
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Also known as the Section 179 deduction, expensing lets you treat up to $125,000 of 2007 expenditures that normally would be depreciated over a number of years as current business expenses to be deducted immediately. The limit rises to $128,000 in 2008. Businesses that put more than $500,000 worth of new equipment into service during 2007 (or $510,000 in 2008) gradually lose the right to use expensing. |
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Fellowships |
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See Scholarships and fellowships. |
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FICA (Federal Insurance Contributions Act) |
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The Federal Insurance Contribution Act tax that pays for Social Security and Medicare is split 50/50 between employers and employees. For 2007, each pays 7.65 percent on the first $ $97,500 of wages. The rate drops to 1.45 percent each for any additional wages (which is the Medicare portion of the tax). Although the government has not yet officially announced the new wage base for 2008, it is expected to reach six figures for the first time. Based on preliminary estimates, the full 7.65 percent will apply to the first $102,000 of wages next year. |
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Filing status |
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Your status determines the size of your standard deduction and the tax-rates that apply to your income. For tax purposes, you are considered single, married filing jointly, married filing separately, head of household or qualifying widow or widower. |
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First-in, first-out (FIFO) |
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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 acquired were the first ones sold. This is important if the items in the group were acquired or manufactured at different times or for different costs. The rule may be overridden by identifying the specific item sold, if possible. (See "Last-in, first-out (LIFO).") |
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Five-year averaging |
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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. |
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Five-year gain |
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This special kind of capital gain—it first appeared on 2001 tax forms —has been abolished. |
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Flexible spending account |
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See Reimbursement account. |
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FUTA (Federal Unemployment Tax Act) |
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Unemployment taxes. |
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Generation-skipping transfer tax |
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An extra tax on gifts or on-death transfers of money or property that would otherwise escape the once-per-generation transfer taxes that apply to gifts and estates. For example: a gift from a grandfather to a granddaughter skips a generation and might be subject to this tax. |
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Gift tax |
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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. The $12,000 limit applies for 2007 and 2008. It may increase in the future. 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. |
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Golden parachutes |
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Bonuses payable to key executives in the event control of their corporation changes, as in the case of a takeover. "Excess" golden parachute payments are subject to tax penalties. |
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Gross income |
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All of your income from taxable sources, before subtracting any adjustments, deductions or exemptions. |
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Head of household |
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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. |
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Health Savings Account |
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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 be eligible to contribute to an HSA, you must have a qualified insurance policy, which, for 2007, is one that has a deductible of at least $ $1,100 for individuals or $ $2,200 for families. You can contribute up to $ $2,850 to an HSA in 2007 if you're single or up to$5,650 if you are married and have a family policy. (Those 55 and older can contribute—and deduct— an extra $800 in 2007. The catch-up contribution will increase to $900 in 2008.) 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 percent penalty is imposed. After you reach age 65, contributions to the HSA must cease and non-qualifying withdrawals are taxed but not penalized. |
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Hobby-loss rule |
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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 (or two out of seven years if you're into breeding, showing or racing horses). 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. |
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Holding period |
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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, and are stuck with short-term treatment. 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. |
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Home office expenses |
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If you use part of your home regularly and exclusively as the principal place of your business or the place you meet with clients, patients or customers, you can qualify to deduct certain expenses that are otherwise nondeductible personal expenses. Examples include a portion of your utilities, homeowner's insurance premiums and depreciation (if you own your home) or part of your rent (if you are a renter). |
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Home-equity loans |
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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. |
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Hope credit |
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See College credits. |
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Household employees |
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If someone works in your home—as a child-care provider, for example, or housekeeper or gardener—as your employee (rather than as an independent contractor or an employee of a service company), you may be responsible for paying Social Security and Medicare taxes for the employee. This requirement is triggered in 2007 if you pay the employee $1,500 or more during the year. This is also sometimes called the "nanny tax." (If you pay an employee $1,000 or more in any calendar quarter, you must pay federal unemployment tax.) |
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Imputed interest |
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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. |
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Incentive stock option |
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An option that allows an employee to purchase stock of the employer below current market price. For regular income tax purposes, the "spread" or "bargain element"—the difference between the price paid and market value of the stock—is not taxed when the option is exercised. Rather, it is taxed when the stock is sold. For alternative minimum tax purposes, however, the spread is taxed in the year the option is exercised. |
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Indexing |
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To prevent inflation from eroding certain tax benefits—including standard deductions and exemption amounts and the beginning and end of each tax bracket—they are automatically adjusted annually for increases in the consumer price index. |
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Individual 401(k) plan |
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Recent changes in the 401(k) rules allow a self-employed person with no employees (other than his or her spouse) to use a 401(k) plan to sock away—and deduct—far more for his or her retirement than in the past. For 2007, self-employed individuals can contribute up to $45,000 to a solo 401(k). Those 50 and older can shelter an additional $5,000 in "catch-up" contributions. The contribution limits will remain the same for 2008. |
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Individual retirement account (IRA) |
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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 2007—deductible or not—is $4,000 or 100 percent of the compensation earned during the year, whichever is less. The maximum annual contribution increases to $5,000 for 2008. 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 in 2007 and $6,000 in 2008. Also, a husband or wife can 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. The right to deduct contributions phases out at higher income levels for those covered by a retirement plan at work. For single taxpayers covered by a company plan, the deduction phases out as income rises between $52,000 and $62,000 in 2007 and $53,000 to $63,000 in 2008; for married couples filing joint returns, the deduction phases out as income rises between $83,000 and $103,000 in 2007 and between $85,000 and $105,000 in 2008. See Roth IRA. |
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Individual retirement arrangement |
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See Individual retirement account (IRA) |
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Innocent-spouse rules |
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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 error 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. |
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Installment sale |
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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. |
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Investment credit |
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A credit against tax available for investment in a limited range of business property. The general investment credit was repealed in 1986, but this type of credit has been enacted and repealed repeatedly throughout history. |
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Investment interest |
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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 percent or 15 percent rates) you report. |
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Involuntary conversion |
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The conversion of property into money 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 by the government and "converted" into a condemnation award. Owners may avoid tax on any gain that may result (if the insurance settlement or condemnation award exceeds the adjusted basis of the property) by reinvesting in similar property within certain time limits. |
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Itemized deductions |
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Personal deductions that may be taken if they total more than the standard deduction. (See "Standard deduction.") The following deductions are then itemized or listed on Schedule A of Form 1040: medical expenses, charitable contributions, state and local taxes, home mortgage interest, real estate taxes, casualty losses, unreimbursed employee expenses, investment expenses and others. |
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Joint return |
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An optional filing status available to married taxpayers that offers generally (but not always) lower taxes than "married filing separately." |
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Keogh plan |
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Also known as an H.R. 10 plan, this is a retirement plan for the self-employed. As much as 20 percent of your net earnings from 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 tapping the account before age 59 1/2. |
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Kiddie cards |
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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. |
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Kiddie tax |
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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 2007. In 2008, the kiddie tax will be expanded to include dependent children under 19 and dependent college students under 24. The kiddie tax will apply to income in excess of $1,800 in 2008. |
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Last-in, first-out (LIFO) |
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A rule that applies to the sale of part of a group of similar items in an inventory that assumes the last ones acquired were the first ones sold. This is important if the items in the group were acquired or manufactured at different times or for different costs. (See "First-in, first-out (FIFO).") |
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Lifetime learning credit |
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See College credits. |
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Like-kind exchange |
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The tax-free exchange of similar 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. |
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Limited liability company (LLC) |
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A legal structure that allows a business to be taxed like a partnership but function generally like a corporation. An LLC offers members (among other things) protection against liability for claims against the business that is not available in a partnership. |
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Limited partnerships |
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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. |
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Listed property |
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"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 percent. |
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Long-term gain or loss |
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See capital gain or capital loss. |
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Lump-sum distribution |
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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 tax treatment—other requirements must be met. |
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Luxury-car rules |
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The restrictions that limit annual depreciation deductions for business automobiles that cost more than a certain amount. The maximum first-year combined expensing and depreciation deduction assuming 100% business use is $3,060 for an auto bought and placed in service in 2007. Heavy SUVs—those that weigh more than 6,000 pounds—are exempt from the luxury auto dollar caps. Up to $25,000 of the cost of a SUV placed in service after October 22, 2004, and used 100% for business may be expensed and the balance of the heavy SUV's cost may be depreciated over five years. Pending legislation could close the heavy SUV loophole for 2008 and beyond. |
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Marginal tax rate |
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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, so that 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. |
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Marital deduction |
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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. |
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Market discount |
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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. |
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Master limited partnerships |
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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. |
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Material participation |
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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. |
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Medicare tax |
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The portion of the Social Security tax—1.45 percent for employees and 2.9 percent for self-employed taxpayers - that pays for Medicare. Although the part of the tax that pays for retirement benefits stopped at $97,500 in 2007, the Medicare portion applies to all wages and self-employment income. In 2008, the limit for the Social Security portion of the tax is expected to reach six figures for the first time. Preliminary estimates put the 2008 wage base at $102,000. |
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Midmonth convention |
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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. |
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Mid-quarter convention |
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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 percent of the business property you put into service for the year during the fourth quarter, the mid-quarter 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. |
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Midyear convention |
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See Mid-quarter convention. |
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Mileage rate |
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See Standard mileage rate. |
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Modified Accelerated Cost Recovery System (MACRS) |
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The system for computing depreciation for most business assets. |
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Mortgage interest |
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A term often used to refer to deductible interest paid on debt that qualifies as acquisition indebtedness or home-equity debt. |
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Multiple-support agreement |
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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. |
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Nanny tax |
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See Household employee. |
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Net operating loss |
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The excess of business expenses over income. A business may apply a net operating loss to get a refund of past taxes (or a reduction of future taxes) by carrying it back to profitable years as an additional deduction (or by carrying it forward as a deduction to future years). |
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Net unrealized appreciation |
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NUA comes into play if you take a total payout from a company retirement plan that includes appreciated employer securities. Rather than make a tax-free rollover of the entire amount to an IRA, you can roll the stock into a taxable account and owe tax only on the stock's value when you acquired the shares. The net unrealized appreciation that accrued while the stock was inside the plan will not be taxed until you ultimately sell the stock. At that point, the profit can qualify for special long-term capital gain treatment. If you rolled the stock into an IRA, all appreciation would be taxed as ordinary income when withdrawn, at your top tax rate. |
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Nonbusiness bad debt |
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A bad debt not connected with your trade or business. An uncollectible loan to a friend or a deposit to a contractor who becomes insolvent are examples. You must be able to show that you tried to collect the debt. When those efforts are unsuccessful, a nonbusiness bad debt is deductible as a short-term capital loss in the year the debt becomes entirely worthless. |
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Nonqualified stock options |
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Options to purchase company stock that are granted to employees as compensation but do not meet restrictions necessary to qualify as incentive stock options. (See Incentive stock options.) There is no tax consequence when the options are granted but when employees exercise the options to purchase stock, the "spread" or "bargain element"—the difference between purchase price and the stock's value—is taxed as additional compensation. |
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Original issue discount (OID) |
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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. |
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Passive-loss rules |
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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 an exception for real estate professionals and a limited exception for rental real estate in which non-professionals actively participate. Losses you can't use because you have no passive income to offset can be carried over to future years. |
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Personal exemption |
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See Exemptions. |
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Personal interest |
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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. |
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Points |
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In connection with getting a home mortgage, each point is equal to 1 percent 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, as long as you paid enough cash at closing—as a down payment, for example—to cover the points. 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. |
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Preference items |
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Tax breaks allowed under the regular income tax but not under the alternative minimum tax, including the deduction of state and local taxes and interest on home-equity loans. One that is becoming more and more important to more and more 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. |
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Premature distribution |
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Withdrawals from a company retirement plan which are subject to a 10 percent penalty (in most cases) if you're under age 55 in the year you leave the job or from a traditional IRA if you're under age 59 1/2. |
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Prizes and awards |
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The value of a prize or award is generally taxable, so if you hit the lotto, Uncle Sam is a winner, too. One exception is that certain non-cash employee awards—the proverbial gold watch, for example—can be tax-free. |
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Qualified plan |
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An employee benefit plan—such as a pension or profit-sharing plan—that meets IRS requirements designed to protect employees' interests. |
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Real estate investment trust (REIT) |
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A kind of "mutual fund" that invests in real estate rather than stocks and bonds. |
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Real estate mortgage investment conduit (REMIC) |
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A kind of "mutual fund" that invests in real estate mortgages rather than stocks and bonds. |
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Recapture of depreciation |
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When you depreciate investment real estate, your tax basis declines. To the extent that profit when you sell is due to the reduced basis (rather than appreciation), the law recaptures part of the depreciation tax break by taxing that part of your profit at 25 percent, rather than the regular top 15 percent rate for capital gains. |
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Regulated investment company (RIC) |
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A mutual fund. |
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Reimbursement account |
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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 state income taxes as well. |
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Retirement saver's credit |
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This credit is worth as much as 50 percent 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 percent 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. |
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Rollover |
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The tax-free transfer of funds from one individual retirement account to another or from a company plan to an IRA. If you take possession of the funds, the money must be deposited in the new IRA within 60 days. Beware that when the rollover method is used to move money from a company plan to an IRA, 20 percent 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 Direct transfer. You can also use a rollover to move money from a medical savings account (MSA) to a health savings account (HSA). |
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Roth 401(k) |
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In 2006, the Roth idea came to 401(k)s. Employers are allowed to add a Roth option to allow employees to invest after-tax money in the company plan with the promise of tax-free withdrawals in retirement. With the regular 401(k), you invest pre-tax money but have to pay tax on all withdrawals in retirement. If your firm offers a matching contribution, it must go into the traditional 401(k), and you will be taxed on distributions from that part of the plan. The same dollar limits apply to Roth 401(k)s as to regular plans. The maximum contribution in 2007 is $15,500, plus a $5,000 catch-up contribution for workers age 50 and older. The limits will remain the same for 2008. You can choose to divert part of your pay to each kind of account, but the limit is a single $15,500 in 2007 and 2008 (or $20,500 for workers 50 and older.). |
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Roth IRA |
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The back-loaded IRA is named after a chief supporter—the late Sen. William Roth of Delaware. It's called back-loaded because the tax benefits come at the end of the line. 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. Contribution limits are the same as for traditional IRA: $4,000 in 2007 and $5,000 in 2008, with an extra $1,000 catch-up contribution allowed for those age 50 and older. But there's a catch: If your income is too high, you can't contribute to a Roth. What's too high? In 2007, the right to use the Roth IRA phases out between $99,000 and $114,000 on a single return and between $156,000 and $166,000 on a joint return. For 2008, the phase out zones are$101,000 and $116,000 for single returns and $159,000 and $169,000 for joint returns. If your income is under $100,000 (on either a single or joint return) you can roll over funds from an old IRA to a Roth IRA—so that all future earnings would be tax-free rather than simply tax deferred. But to do so, you have to pay tax on the money you move from the old IRA to the Roth. In 2010, the $100,000 income limit disappears and anyone will be permitted to convert a traditional IRA to a Roth. |
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S corporation |
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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. |
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Salary reduction plan |
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See Reimbursement account. |
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Saver's credit |
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See Retirement saver's credit. |
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Savings Incentive Match Plan for Employees (SIMPLE plans) |
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A simplified retirement arrangement for small businesses that comes in two varieties: one similar to a 401(k) plan and one that funds IRAs for employees. |
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Scholarships and fellowships |
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Scholarships and fellowships received by degree candidates to cover tuition, fees, books and supplies are generally tax-free. But amounts for room and board are taxable. |
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Section 179 deduction |
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See Expensing. |
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SECA |
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The Self Employment Contributions Act tax that pays for Social Security and Medicare. While employees share this 15.3 percent tax with their employers (each pays half), self-employed must the full tax themselves. For 2007, the rate was 15.3 percent on the first $97,500 of earnings and 2.9 percent on all amounts over that amount. Based on preliminary estimates for 2008, the full 15.3 percent will apply to the first $102,000 of earnings. |
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Short sale |
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The sale of borrowed stock, usually with the hope that the stock price will fall. If it does, the investor profits by repaying the loan with shares purchased at the lower price. If the stock price increases, the investor loses and has to repay the loan with shares that cost more than those sold. As far as the IRS is concerned, the transaction doesn't count for tax purposes until the investor delivers stock to the lender to close the sale. |
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Short-term gains and losses |
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See Capital gain or Capital loss. |
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Simple |
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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 percent or contribute 2 percent 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 2007, a self-employed person with no employees could open a SIMPLE and contribute up to $10,500 of self-employment earnings (plus a $2,500 catch-up contribution for those age 50 or older by the end of the year). |
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Social Security Tax |
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See FICA and SECA. |
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Standard deduction |
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A no-questions-asked write-off that reduces taxable income, the amount of which varies depending on your filing status. For 2007, for example, the standard deduction is $10,700 on a joint return, $5,350 on a single return and $7,850 on a head of household return. Taxpayers age 65 and older or blind 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 rather than itemize. For 2008, the standard deduction will be $10,900 on joint returns, $5,450 for singles and $8,000 for heads of household. Special rules can reduce the standard deduction for children who are claimed as dependents on their parents' returns. |
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Standard mileage rate |
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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. For 2007, the standard rate for business travel is 48.5 cents a mile; for medically-related use of your car and job-related moving purposes, it's 20 cents a mile. For driving connected with a charity, it's 14 cents a mile. In any case, you add the cost of parking and tolls. The IRS has not yet announced the standard miles rates for 2008 but they probably will be increased from 2007 levels. |
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Stepped-up basis |
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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. If the value of property declined while it was owned by the decedent, the basis is stepped-down to date of death value. |
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Straight-line depreciation |
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A depreciation method that allows equal deductions in each year of an asset’s "life" or recovery period. (See "Accelerated depreciation.") |
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Student loan interest deduction |
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You can deduct to $2,500 of interest on student loans used to pay for college or other post-high-school education expenses for yourself, your spouse or your dependents. This tax break is phased out for 2007 as income rises between $55,000 and $70,000 on single returns and between $110,000 and $140,000 on joint returns. For 2008, the phase out zones remains the same for single returns and increases to $115,000 to $145,000 for joint filers. You can claim this write-off whether or not you itemize deductions. |
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Swaps, tax-free |
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Exchanges of like-kind property that result in no capital gains tax (commonly used for real estate). |
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Sales and repurchases of stock (or other securities) designed to realize a tax loss without discontinuing the investment. Transactions must comply with the wash sale rules to be effective. (See "Wash sales.") |
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Tax bracket |
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Each tax bracket encompasses a certain amount of income to be taxed at a set rate. The rates now run from 10 percent to 35 percent. You are said to be in the 25 percent bracket if your highest dollar of income falls in that bracket. Even if you're in the 25 percent bracket, part of your income is taxed at the 10 percent rate and some at 15 percent. 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. |
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Taxable income |
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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—that is, the amount on which your tax bill is computed. |
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Tax-exempt interest |
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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. Note that some interest that is exempt from the regular tax is taxed by the Alternative Minimum Tax. |
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Tax-free income |
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All sorts of income can be tax-free, including: Auto rebates; car-pool receipts; casualty insurance proceeds; child-support payments; combat pay; damages in lawsuits for physical injury; disability payments, if you paid the premiums for the policy; dividends on a life insurance policy, up to the total of premiums paid; Education Savings Account withdrawals used for qualifying expenses; gifts; Health Savings Account withdrawals used for qualifying payments; inheritances; life insurance proceeds; municipal bond interest; policy officer survivor payments; profits form the sale of a home, up to $250,000 if you're single or $500,000 if you're married; Roth IRA and Roth 401(k) withdrawals; scholarships and fellowship grants; Social Security benefits (between 15 percent and 100 percent are tax-free); state tax refunds; veterans benefits; and workers' compensation. |
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Taxpayer advocate |
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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. |
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Taxpayer identification number (TIN) |
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In the case of an individual, the Social Security number. In the case of a business (even an individual in business), the employer identification number. |
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Tax preference item |
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See Preference item. |
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Telephone tax refund |
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After losing several court cases, the IRS threw in the towel on collecting the federal excise tax on long-distance telephone service. And, the agency agreed that taxpayers deserve a refund of all such taxes paid after February 28, 2003. So you don't have to dig up your old bills, the IRS developed a standard credit of between $30 and $60, based on the number of exemptions you claim on your tax return. If you didn't claim your refund for 2006, you can file an amended return and get it now. There is no telephone tax refund for 2007. |
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Ten-year averaging |
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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. |
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Ten-year forward averaging |
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See Ten-year averaging. |
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Top-heavy plan |
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An employee retirement or profit-sharing plan that disproportionately benefits top executives. |
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Traditional IRA |
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See IRA. |
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Tuition credit |
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See College credits. |
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Tuition deduction |
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For 2007, qualifying taxpayers can deduct up to $4,000 of college expenses if their adjusted gross income is under $65,000 on a single return or $130,000 on a joint return. A $2,000 write-off is allowed for qualifying taxpayers whose AGI fall between $65,000 and $80,000 on a single return and between $130,000 and $160,000 on a joint return. This break is available whether or not your itemize deductions but is not available to students who are claimed as dependents on their parents' return. It is available to their parents, though, if they pay the tuition. You can not claim the deduction in the same year you claim a Hope or Lifetime Learning credit for the same student. But because the income phase-out ranges for this deduction are higher than for the credits, some taxpayers whose income is too high to benefit from the credits will benefit from this write-off. |
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Underpayment penalty |
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The penalty is the IRS's not-so-subtle reminder that taxes are due as income is earned, not just on April 15 of the following year. Basically, it works like interest on a loan, with the penalty rate applied to the amount of estimated tax due but unpaid by each of four payment dates during the year. The penalty rate is set by the IRS and can change each quarter. It was 8 percent at the end of 2007. There are several exceptions to the penalty. See Estimated tax. |
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Unearned income |
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Income from investments, such as interest, dividends and capital gains. See Earned income. |
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Uniform capitalization rules (Unicap) |
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A set of uniform rules for computing the cost of goods produced by a business that prevents current deductions for costs that must be capitalized (See "Capital expenditures.") or added to inventory. |
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Vacation home |
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Special tax rules apply if you rent out a vacation home, and the rules differ depending on how much you use the home personally. While all rental income is to be reported, the deductibility of expenses can be limited if you engage in "too much" personal use—generally defined as using the home for more than 14 days during the year or more than 10 percent of the number of days it is rented for fair market rent. |
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Vested benefits |
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Benefits in a company retirement plan that are yours to keep if you leave the job. Your own contributions, to a 401(k), say, are immediately 100 percent vested. But employer contributions on your behalf can be vested gradually over a period of time, as a way to encourage you to stay with the employer. If you quit a job when just 50 percent of your benefits are vested, for example, you would forfeit half of the amount the employer has set aside for you. Starting in 2007, a new law requires faster vesting than was demanded in the past. Employers can choose "cliff vesting," which gives you no rights to benefits until you have been in the plan for three years, after which you are 100 percent vested; or gradual vesting at a rate of 20 percent each year after the first year in the plan, so that you are 100 percent vested after six years. |
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Voluntary withholding |
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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. You can also ask a retirement plan sponsor to withhold from payouts from IRA distributions. |
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Wage base |
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The level of earnings to which the full Social Security tax applies. For 2007, the full 15.30 percent tax (the combined rate paid by employers and employees) applies to the first $95,700 of wages or self-employment income and the 2.9 percent Medicare portion applies to all income over that level. For 2008, we think the full 15.30 percent will hit about $ $102,000 of earnings. (Employees pay half the tax—7.65 percent up to the wage base limit and 1.45 percent after that—and their employers pay the other half. Self-employed taxpayers have to pay both halves.) |
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Wash sale |
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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. |
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Withholding |
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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 W-4 form you file with your employer. |
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Worthless security |
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If a stock you own becomes completely worthless during the year, you can claim a capital loss as though you sold the stock for $0 on December 31 of the year the stock became worthless. |
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Updated for tax year 2008 |
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