Can You Score 6 Out of 6 On This Tax Definitions Quiz?
Less than a month to go until Tax Day! I know many of you out there are feeling the crunch, especially if you’re preparing your taxes on your own.
But even if you do work with a tax professional, it’s important to have a basic understanding of how the IRS determines your taxable income this year, and an understanding of the new laws going into effect next year.
The distinctions between credits, deductions, exemptions, and the various ways of breaking down your income can be confusing. So today I’m going to explain some important tax definitions and provide you with a little clarity on these complex topics.
But before I give you these tax definitions, let’s see how well you know them first. Take a look at the list below and think about your definition of each. Then keep reading and I’ll do my best to fill in the gaps.
- Income
- Deductions
- Tax Exemptions
- Tax Credits
- Tax Bracket
- CPA
Now on to the tax definitions …
Income
There are three different ways to quantify the money you make in a given tax year.
Your gross income is the grand total of all the money you’ve made, pre-tax: wages, tips, investment income from capital gains or dividends, and for some people, things like income from rent, pensions, and alimony.
This sum differs from your taxable income, which is your gross income minus all your deductions and exemptions. This is the number that determines how much you’re going to pay in taxes.
But to get to that taxable income you have to figure your adjusted gross income (AGI) first.
Deductions
The deductions that you subtract from your gross income lower your AGI, which in turn lowers your taxable income and how much you end up paying for taxes.
There are a few ways to look at your deduction picture.
The first is itemized deductions. If you go this route, you add up allowable expenses like charitable contributions, certain medical premiums, property taxes, and, if you’re a small business owner, business expenses like office supplies or vehicle mileage. And you’ll want to keep your receipts!
If, in the past, your itemized deductions have been greater than the standard deduction, this is one part of your tax picture you’ll want to talk to a professional about this year. The new tax laws try to simplify filing for everyone by bumping the standard deduction way up to $12,000 for individuals and to $24,000 for married couples filing jointly for the 2018 tax year. Experts estimate that the majority of people will take the standard deduction for 2018. If you think you might be an exception, then talk to your tax professional before you stop filing away all those receipts.
Finally, there are above-the-line deductions, which are deductions you’re allowed to take even if you don’t itemize. These include qualifying contributions to a traditional IRA, alimony payments, student loan interest, and the taxes that the self-employed pay every quarter. This is an area where people who do their own taxes can be susceptible to expensive slip-ups. I don’t want to sound like a broken record here, but even if you do decide to go the do-it-yourself route, just sitting down with a tax professional to discuss your situation can help you come up with a list of deductions that you might not even know you qualify for.
Tax exemptions
Exemptions are related to your filing status. For tax year 2017, you’re allowed to claim one personal exemption of $4,050, and one for your spouse. In certain circumstances, exemptions can also be claimed for children or relatives that you support. Exemptions get phased out for high earners starting at $261,500 for individuals and $313,800 for married couples filing jointly.
Starting in 2018 these personal exemptions have been eliminated.
Tax credits
What’s the difference between deductions and credits?
All the exemptions listed above reduce your taxable income, which reduce the total amount of your tax bill.
A tax credit reduces what you owe dollar for dollar. If you qualify for a $100 tax credit, then knock $100 off your total payment.
Common tax credits include a credit for first-time homebuyers and credits for dependent children. The new tax bill will expand some of these credits next year to offset the loss of personal exemptions.
Tax bracket
You can check your 2017 taxable income against this chart to find your bracket and the formula that the government uses to calculate the taxes you owe.
Remember, this chart only applies to the 2017 taxes you’ll be paying this April. The new tax laws that affect your 2018 filing in 2019 will be using brackets that are lower across the board and utilize a different method for coping with inflation.
(Source: https://taxfoundation.org/2017-tax-brackets/)
CPA
Of all the tax definitions discussed, this one might be the most important to you. It stands for Certified Public Accountant –a person who can help you sort through your personal situation, especially before you file your taxes!
Now, notice that I am not a CPA. Keen Wealth Advisors has multiple CERTIFIED FINANCIAL PLANNER™ (CFP®) and CHARTERED RETIREMENT PLANNING COUNSELOR℠ (CRPC®) professionals and practitioners on staff. When we recommend to our clients that they talk to a CPA about their taxes, or discuss Medicare transitions with a professional, we’re making recommendations that we believe are in our clients’ best financial interests. We are grateful to quarterback those relationships, and to create a “culture of accountability” between professionals to help our clients achieve their goals. All the apps and online info make it easier than ever for people to try tackling complex financial issues by themselves. That means it’s also easier than ever to make an expensive mistake that could far outweigh the amount you save using only tax software and going it alone.
At the very least, call up a CPA and take a meeting. And if you’re having trouble finding a CPA you can trust, call your fiduciary advisor. We’ll help you organize a team of professionals who can take care of your financial needs. It’s not too late … but for your 2017 taxes, it’s getting there!
About Bill
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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