THIS IS NOT INTENDED to be a comprehensive set of definitions of all tax terms—just some of main words, acronyms, and concepts in this book that TaxMama thinks need a bit more clarification. Some of the definitions include additional tax tips. Consider them a bonus.
For a more complete set of definitions, you can find a terrific glossary on the IRS’s VITA training site (https://apps.irs.gov/app/understandingTaxes/student/glossary.jsp). And yes, VITA is defined in the following entries.
Adjusted Gross Income (AGI)—the number on the very last line of your Form 1040 page 1. It is also the same number on the first line of your Form 1040 page 2. This number is only found and clearly visible on the long form, not the Form 1040 EZ or 1040-A. You will see this acronym used throughout this book. This number is very important. It is the basis for all IRS income limits, phaseouts of credits and deductions, reductions of itemized deductions, and more. It affects the Alternative Minimum Tax, your tax bracket, and practically every tax benefit and loophole there is. So if you remember nothing else, please remember the AGI.
Americans with Disabilities Act (ADA)—rules from the ADA effect medical deductions and related credits.
Beneficiary—the person who gets the “benefit” from any number of things. It could be from an IRA, pension plan, estate, insurance policy, or a gift. It’s a good idea to review all your policies and accounts to make sure that you are showing the correct beneficiary. (For instance, my husband still shows his father as the beneficiary of one of his pensions. Pop died in 2007.) It’s important to remove former spouses or other people who are no longer in your life. If you have minor children, do not name them as beneficiaries. Name a trust to be created on their behalf as the beneficiary to avoid court oversight on every single expenditure.
Code of Federal Regulations (CFR)—the entire body of US law. You can find the most current version on the Government Publishing Office’s website (http://www.gpo.gov/fdsys/browse/collectionCfr.action?collectionCode=CFR).
Covenants, Conditions, and Restrictions (CC&Rs)—these rules bind all owners of condominiums, co-ops, and some communities or cities. These are the rules that define noise levels, outside parking, the color(s) you may paint the exterior of your home, how frequently you must mow your lawn, and if you are permitted to put up holiday decorations. Before buying a home in any community, the seller is required to give you a copy. Most people don’t read them. You should. Once you do, you may find that you don’t want to live in a community with some of the restrictions included in the CC&Rs. Finding out after you buy the home can be a disaster and make you hate your new home or community.
Dividend Reinvestment Programs (DRIPs)—this is when you buy stock and use the company’s dividends to buy more of their stock. Generally, you have no fees, or the fees are very low (see Tip #198).
Earned Income—to the IRS, this means the total of all your wages and your self-employment profits. Self-employment profits can be found on your Schedule C and your general partnership income, which is passed through to you from a Form 1065 via a Schedule K-1. This income is reported on the Schedule E, page 2. (Schedule E, page 1 is generally passive income only.) Sometimes you have miscellaneous income that is considered self-employment as well. That would be found on line 21 of your Form 1040. To determine your total earned income easily, add up your wages and line 3 of your Schedule SE, Self-Employment Tax (https://www.irs.gov/pub/irs-pdf/f1040sse.pdf). Why is earned income important? This is the basis for a variety of credits as well as the limit for all IRA and retirement contributions.
First Time Penalty Abatement (FTA)—this is a special provision of Tax Code that allows people to get large penalties waived by the IRS. You may only use this provision once (as in “first time”). You must meet some rigorous qualifications, including never having gotten into tax trouble before and being in compliance now. There are other procedures to help you get other kinds of penalties cancelled.
Frequently Asked Questions (FAQs)—the IRS has many pages with FAQs on a variety of subjects. Some of the pages are helpful. Some, not as helpful. However, if you find that some of their information is seriously unclear, or lacking in usefulness, do me a favor. Send me the link to the page and tell me what you feel is missing. TaxMama will ask the IRS to update it. And believe me, the IRS is pretty responsive to those requests. When I can give them specific wording or specific suggestions, they make the changes in days rather than months. Send your notes to DeductEverything@gmail.com.
In Compliance—when the IRS talks about being “in compliance,” they mean this:
Individual Retirement Account (IRA)—this is exactly what it says: an IRA is for a distinct individual. Couples do not share IRAs. Each person has their own. (I explain because this is a common misconception.) However, you will generally specify your spouse or child as your beneficiary. IRAs come in several flavors—plain, Roth, deductible, nondeductible. So it’s important to track your IRA contributions and accounts.
Internal Revenue Code (IRC)—also known as Title 26 of the US Code of Federal Regulations (see CFR). You can find the most current version on the Cornell University Law School’s website (https://www.law.cornell.edu/uscode/text/26). Please donate money to them if you use it regularly. I do.
LITCs—(see VITA)
Modified Adjusted Gross Income (MAGI)—for certain tax benefits or attributes, the IRS modifies the AGI by adding things like nontaxable income to it or removes certain taxable items to create a different threshold. Because the IRS uses different revisions to AGI for different deductions and credits to arrive at MAGI, this is generally confusing and inconsistent. When reading anything that refers to a MAGI, you need to look up exactly what the modifications are and what income ranges apply.
Net Operating Loss (NOL)—this amount is generated from business losses or business or personal casualty losses. While ending up with any losses is always a bad thing, the consolation is that when it comes to NOLs, you can deduct the full amount in the year of the loss and carry the unused losses to earlier years or future years, whichever work better for you.
Preparer Tax Identification Number (PTIN)—by law, each paid preparer must put this on your tax return in the signature area of your tax return. If it’s missing from a paid tax return, report the preparer to the Internal Revenue Service (https://www.irs.gov/Tax-Professionals/Make-a-Complaint-About-a-Tax-Return-Preparer). They are operating illegally. If they say they didn’t know they should have used a PTIN, that means they are so totally out of touch with the current Tax Code that you should avoid them like the plague. Any tax return they prepare will be wrong or falsified.
Qualified Education Expenses (QEE)—this can mean different things depending on the education tax benefit you want to use. In all cases, tuition, fees, books, and course supplies are included. However, in some cases, transportation and housing are also included. Before using any education tax or credit, it’s important to look up the conditions tied to that tax benefit.
Refund—this is a return of your money from the IRS or state. It could also be a payment to you from refundable credits that you may have earned. Many people call this a “return,” which is incorrect.
Refundable Credits—credits from which you can get money back without paying anything in. They are often targets of tax scammers and identity thieves. Refundable credits change from year to year, depending on Congress’ whim. However, they consistently include these credits:
Required Minimum Distributions (RMDs)—this is the minimum amount required to be withdrawn from a senior’s taxable retirement accounts once they turn age 70½. They may always draw more money, but not taking the minimum draws can subject them to huge penalties (see Tip #166).
Return—a tax return or form. It does not mean a refund. So when you use the word return to refer to your tax refund and you see bewildered looks on the face of your tax professional, it’s because it takes us a while to understand what you’re talking about.
Tax Basis—the tax value of your asset(s) (https://www.irs.gov/taxtopics/tc703.html). Sometimes it’s what you paid for it, plus the cost of improvements. Other times it’s what the person who gave it to you paid for it, plus their cost of improvements. When you inherit the asset, it could be the fair market value on the date of death or six months after death. It’s a lot more complicated than it appears to be. In fact, in college, they can spend weeks teaching the concept. Why is this so important? Because in order to know how much your profit is when you sell something, you must know the basis of the asset being sold. When someone bought an asset a long time ago and doesn’t have records, this could make a huge difference. A perfect example of this is Walmart stock. If you had invested $5,000 in 1970, that stock would have been worth about $65 million by 2011 (http://askville.amazon.com/todays-original-share-walmart-stock/AnswerViewer.do?requestId=83432494). That same $5,000 invested in 1980 would have only been worth $26 million by 2011. (This is very raw and approximate data from an unknown source. But it illustrates the concept.)
Tax Clinic—(see VITA)
Tax Liability—this is not the balance due on the bottom of your tax return. It is the total amount of your taxes for the year after deducting all your credits but before deducting your payments. You used to be able to find that number on line 63 of the long Form 1040, where it now says “Total Tax.” However, if you look below that, you see several refundable tax credits that reduce the total tax. So the form no longer shows you the tax liability. You must do the math yourself. Still remember how to subtract?
Taxpayer Identification Number (TIN)—any number used by a taxpayer. For American individuals, this would be their Social Security Number (SSN). For foreigners, it would be an Individual Taxpayer Identification Number (ITIN). An adopted foreign child would get an Adoption Taxpayer Identification Number (ATIN) until their SSN was issued. For businesses, this would an Employer Identification Number (EIN). There are a variety of other specialized numbers issued to tax professionals for a variety of purposes. The one that’s important for you to see on every tax return prepared by a tax professional that you pay is the PTIN.
TCE—(see VITA)
Social Security Administration (SSA)—you know these folks. This is the agency that runs the Social Security system. They have a useful website: https://www.ssa.gov/.
Stolen Identity Refund Fraud (SIRF)—trying to stop this type of fraud is a major goal for the IRS and all divisions of the US Treasury. They claim that more than $30 billion has been stolen via identity theft fraud (http://www.justice.gov/tax/stolen-identity-refund-fraud). If we could stop this, do you think Congress would cut our taxes?
Volunteer Income Tax Assistance Program (VITA)—this system also includes the Tax Counseling for the Elderly (TCE), which is often run by the American Association for Retired Persons (AARP; https://www.irs.gov/Individuals/Free-Tax-Return-Preparation-for-You-by-Volunteers). They also include the Tax Clinics, also known as the Low Income Taxpayer Clinics (LITC; https://www.irs.gov/Advocate/Low-Income-Taxpayer-Clinics), which are often run by colleges or universities with student volunteers. There are sites all over the country. They all provide free services to taxpayers who need them. The primary targets are people whose incomes fall below specified amounts and seniors.