Tax Basics: Tax Glossary

Menu item 1

Menu item 2

Menu item 3 »

Menu item 4

Menu item 3a

Menu item 3b

Tax Glossary

- A -

Accelerated cost recovery system (ACRS)
For tax years after 1980, a rapid write-off of the cost of a capital asset is allowed by this system. The minimum number of years over which the asset may be depreciated and the applicable percentage of the asset's cost that may be deducted each year depend on the class of the property.

Accelerated Death Benefits
Early payouts of life insurance, also called accelerated death benefits or viatical settlements, are excluded from gross income for certain terminally or chronically ill taxpayers. The taxpayer may either collect an early payout from the insurance company or sell or assign the policy to a viatical settlement provider.

Accelerated Depreciation

Various methods of depreciation that yield larger deductions in the earlier years of the life of an asset than does the straight-line method. The double (or 200 percent) declining balance method is an example of an accelerated depreciation method.

Accountable Reimbursement Plan

A plan for reimbursing employees for expenses such as meals, entertainment, travel, and transportation incurred for business purposes on behalf of the employer. A plan is an accountable plan if the employer requires the employee to account for all business expenses and to return any excess reimbursements. For employees under an accountable plan, reimbursements aren't entered on the tax return as income and the expenses aren't deductible.

Accural Method of Accounting
A method of accounting that reflects expenses incurred and income earned for any one tax year. In contrast to the cash basis of accounting, expenses do not have to be paid to be deductible, nor does income have to be received to be taxable. Unearned income (e.g., prepaid interest and rent) generally is taxed in the year of receipt, regardless of the method of accounting used by the taxpayer.

Accrued Interest

Interest that has been earned but not yet paid or credited; for example, interest earned on a bond since the last interest payment was made.

Active Income

For purposes of the passive loss rules, income must be divided into three categories: active income, passive income, and portfolio income. Active income is income for which the taxpayer performs services. Examples are wages, salaries, tips, bonuses, a nd business and partnership income in which the taxpayer materially participates in the business or partnership. See Passive Income and Portfolio Income.

Active Participant

A taxpayer who is covered by an employer-maintained qualified retirement plan, or a qualified self-employed retirement plan, if even for only one day during the year.

Actual Expenses (Regular Method)

The method of deducting automobile expenses based on actual costs incurred.

Additional Child Tax Credit

A refundable credit available to taxpayers with three or more children qualifying for the child tax credit and whose regular child tax credit exceeds tax liability minus other nonrefundable credits. The additional child tax credit is computed on Form 8812. See also Child Tax Credit.

Adjusted Basis

The cost or other basis of property reduced by depreciation allowed or allowable and increased by capital improvements. See Basis .

Adjusted Gross Income (AGI)

A determination peculiar to individual taxpayers used to calculate limitations on the amount of certain expenses which may be deductible, including medical expenses, charitable contributions, personal casualty losses and certain miscellaneous deductions. Generally, adjusted gross income represents gross income less certain business expenses, and expenses attributable to the production of rent or royalty income.

Adjustment to Income

An expense that may be deducted even if the taxpayer does not itemize deductions. Adjustments to income are subtracted from gross income to arrive at adjusted gross income.

Adoption Credit

A nonrefundable credit for qualified adoption expenses incurred for each eligible child. The credit cannot exceed $5,000 per child, or $6,000 per special-needs child. The limit is a per-child limit, not an annual limit, and can be carried forward for five years or until used.

Advance Earned Income Credit

Payment by an employer based on an employee's claim to entitlement to the earned income credit. Advance earned income credit payments are treated as additional taxes on the tax return.

Advance Payments

Prepayments for services or goods that generally are includable in gross income upon receipt for both accrual- and cash-basis taxpayers.

Alimony Payments

Payments from one spouse to another, required as a result of a divorce or separation agreement, which meet certain statutory requirements. Alimony and separate maintenance payments are included in the gross income of the receipent and are deducted by the payor.

Alternate (Straight-Line) ACRS Method (Accelerated Cost Recovery System)

Under this method, the ACRS deduction is computed using a straight-line percent and, in some cases, an optional longer recovery period.

Alternative Minimum Tax (AMT)

The alternative minimum tax is designed to prevent taxpayers from escaping a fair share of tax liability by use of certain tax breaks. A taxpayer is subject to this tax if he or she has certain minimum tax adjustments or tax preference items and his or her alternative minimum taxable income exceeds the exemption allowed for his or her filing status and income level. The alternative minimum tax is computed on Form 6251.

Alternative Straight-Line Depreciation System

A MACRS (Modified Accelerated Cost Recovery System) system of depreciation using the straight-line method over an alternative (usually longer) recovery period.

Amended Return

A tax return filed on Form 1040X after the original return has been filed. An amended return is used to correct errors or to claim more advantageous ways of filing the original return. An amended return can also be used to carry back certain unused cr edits or a net operating loss.

Amortization

The allocation (and charge to expense) of the cost or other basis of an intangible asset over its estimated useful life. Some intangible assets which have an indefinite life are amortizable. Examples of amortizable intangibles include patents, copyrights, and goodwill.

Amount Realized

The amount received by a taxpayer on the sale or exchange of property less the cost incurred to transfer the property. The measure of the amount received is the sum of the cash and the fair market value of any property or services. Determining the amount realized is the starting point for arriving at realized gain or loss.

Annualized Income

The actual income and expenditures for a particular period multiplied by the ratio of the number of months in the period to 12 months.

Annuitant

A person who receives a pension or an annuity.

Annuity

A fixed sum payableat specified intervals for a specific period of time or for life. Payments represent a partial return of capital and a return (interest) on the capital investment. An exclusion ratio is generally used to compute the amounts of taxable and nontaxable income.

Annuity Starting Date

The first day of the first period for which an amount is due as an annuity payment under an annuity contract.

Anti-Churning Rules

Regulations designed to prevent taxpayers from bringing their pre-1981 property under the liberalized cost recovery rules of ACRS (Accelerated Cost Recovery System) instituted in 1981. Additional anti-churning rules cover the transition from ACRS to MACRS (Modified Accelerated Cost Recovery System).

Asset

An item of useful or valuable property.

At-Risk Rules

Special rules limiting the taxpayer's deductible business, partnership, S corporation, or real estate loss to cash invested plus debt he or she is legally obligated to pay and the adjusted basis of any property contributed.

Audit

An IRS examination and verification of a taxpayer's return or other transactions with tax consequences. An office audit is an audit by the IRS that is conducted in the agent's office. A field audit is conducted by the IRS on the business premises of the taxpayer or in the office of the tax practitioner representing the taxpayer.

Automobile Expenses

Automobile expenses are generally deductible only to the extent the automobile is used in business or for the production of income. Personal commuting expenses are not deductible. The taxpayer may deduct actual expenses (including depreciation and insurance) or the standard (automatic) mileage rate may be used.

- B -

Bad Debts

Business accounts receivable that have been included in income in a prior year that are uncollectible, legally binding debts owed to the taxpayer that are totally worthless and uncollectible, and debts the taxpayer must pay that he or she guaranteed in connection with his business or for a profit may be deductible as bad debts.

Bankruptcy

For tax purposes, a formal petition filed in a Bankruptcy Court under Chapter 7, 11, 12, or 13 of Title 11 of the U.S. Code.

Basis

The amount assigned to an asset from which gain or loss is determined for income tax purposes when the asset is sold. For assets acquired by purchase, basis is cost. Special rules govern the basis of property received by virtue of another's death or by gift, the basis of stock received on a transfer of property to a controlled corporation, the basis of the property transferred to the corporation, and the basis of property received upon the liquidation of a corporation.

Basis of Stock

If purchased, the amount paid for the stock. If the stock is received as a gift, basis is generally the basis of the previous owner or the fair market value when received. The basis of inherited stock is usually its fair market value on the date of the decedent's death.

Bearer Bond

A bond that has no owner's name registered on the books of the issuing company and is therefore payable to the holder.

Bequest

A gift by will of personal property. A bequest is not includable in the income of the recipient. Basis is usually the value of the property at the decedent's death. If a bequest of money is to be paid at intervals, then to the extent that it is paid out of income from property, it is taxable income to the recipient.

Bond

A note obliging a corporation or governmental unit to repay, on a specified date, money loaned to it by the bondholder. The holder receives interest for the life of the bond. If a bond is backed by collateral, it is called a mortgage bond. If it is backed only by the good faith and credit rating of the issuing company, it is called a debenture.

Boot

Cash or property of a type not included in the definition of a nontaxable exchange. The receipt of boot will cause an otherwise tax-free transfer to become taxable to the extent of the lesser of the fair market value of the boot or the realized gain on the transfer. Examples of nontaxable exchanges that could be partially or completely taxable due to the receipt of boot include transfers to controlled corporations and like-kind exchanges.

Business Assets

Assets used in a trade or business or used to produce rental or royalty income.

Business Bad Debts

Business accounts receivable that have been included in income that are uncollectible, legally binding debts owed to you that are uncollectible, and debts you must pay that you guaranteed in connection with your business or for a profit may be deductible as bad debts.

Business Gifts

The cost of qualified business gifts is deductible to a maximum of $25 per year per client or customer. The $25 limit does not apply to promotional items costing $4 or less on which the taxpayer's name is clearly imprinted.

Business-Use Property

Property used for the production of income. Examples include rental houses, machinery, factories, office buildings, and similar items.

- C -

Callable

A bond issue, all or part of which may be redeemed before maturity by the issuing corporation under specific conditions. The term also applies to preferred shares of stock, which may be redeemed by the issuing corporation.

Capital Asset

Broadly speaking, all assets are capital assets except those specifically excluded by the tax Code. Major categories of noncapital assets include property held for resale in the normal course of business (inventory), trade accounts and notes receivable, depreciable property, and real estate used in a trade or business.

Capital Expenditure

An expenditure made for assets with useful lives of more than one year. Usually capital expenditures may not be deducted in the year they are paid, even if they are paid in connection with a trade or business. In other words, they are capitalized and generally may be depreciated or amortized.

Capital Gain

The gain from the sale or exchange of a capital asset.

Capital Gain Distributions

Amounts paid by mutual funds, regulated investment companies, and real estate investment trusts. These amounts represent the shareholder's portion of gain from the sale of capital assets owned by these investment companies. Capital gain distributions are taxed in the year constructively received and are always considered to be held long term.

Capital Gain or Loss Holding Period

The length of time a capital asset is owned by the taxpayer. Assets owned 12 months or less are held short term; those owned more than 12 months are held long term.

Capital Improvement

An improvement made to extend the useful life of a property or add to its value. Major repairs such as the replacement of a roof are capital improvements. The costs of capital improvements to business property must be capitalized and may be depreciated.

Capitalize

To treat the cost of additions and improvements to property as a capital improvement.

Capital Loss

The loss from the sale or exchange of a capital asset. Up to $3,000 of net capital loss is deductible annually with the excess carried forward to future years. Losses on personal-use assets are not deductible.

Capital Stock

Shares of stock that represent ownership of a portion of the corporation.

Carryback/Carryover

Provisions in the tax Code that allow certain losses or credits to be used in a tax year other than the tax year incurred. A carryover is to a future year. A carryback is to a prior year.

Cash Equivalent Doctrine

Generally, a cash-basis taxpayer does not report income until cash is constructively or actually received. Under the cash equivalent doctrine, cash-basis taxpayers are required to report income if the equivalent of cash (property, for example) is received in a taxable transaction.

Cash Method of Accounting

One of the two most common methods of accounting, the other being the accrual method defined elsewhere in this glossary. Under the cash method of accounting, income is reported in the tax year actually or constructively received and expenses are deducted in the tax year paid.

Casualty

The complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature.

Casualty Loss

A casualty is the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature. Examples are floods, storms, fires, earthquakes, and auto accidents. Individuals may deduct a casualty loss only if the loss is incurred in a trade or business, in a transaction entered into for profit, or is a personal loss arising from a disaster such as those mentioned above. Individuals deduct personal casualty losses as itemized deductions on Schedule A, subject to a $100 nondeductible amount and a reduction of the loss by 10 percent of the taxpayer's AGI. Use of Form 4684 is required.

Certificate

The actual piece of paper that is evidence of ownership of stock in a corporation.

Certified Historic Structure

A structure listed on the National Register of Historic Places or located in a designated historic area. The IRS Code provides tax incentives for the rehabilitation of such structures.

Change in Accounting Method

A change from one method to another, which usually requires prior approval from the IRS. A change generally requires adjustments to avoid omissions or duplications.

Change in Accounting Period

A change from one period to another. Income for the short period created by the change must be annualized to calculate the tax for that period.

Charitable Contributions

Money or property donated to a qualified charitable organization. Such donations are deductible on Schedule A as an itemized deduction.

Child and Dependent Care Credit

A tax credit of 20-30 percent of employment-related child and dependent care expenses for amounts of up to $4,800 is available to individuals who are employed and maintain a household for a dependent child or disabled spouse or dependent. The credit is computed on Form 2441 for Form 1040 filers and on Schedule 2 for Form 1040A filers.

Child Support Payments

Payments pursuant to a court order, divorce decree, or other legal obligation. Payments for child support do not constitute alimony and are not includable in gross income by the recipient or deductible as alimony by the payer.

Child Tax Credit

A nonrefundable credit of up to $1000 per dependent child under age 17 at the end of the tax year.

Claim of Right

A term used in the tax Code in connection with money or other property received as income that the recipient holds, but that he or she is required to restore to the payer in whole or in part in a later year because it develops that he or she did not have an unrestricted right to it.

Class Life Asset Depreciation Range (CLADR)

This system of depreciation was used for assets placed in service prior to January 1, 1981, and must continue to be used for assets whose depreciation was set up under that system. The CLADR system provided guidelines for depreciation lives for the assets listed in each guideline class.

Closed Year

A tax year for which the statute of limitations has expired. The taxpayer can't claim a refund and the IRS can't collect additional taxes (with certain exceptions).

Commission

(1) The broker's fee for purchasing or selling securities or property for a client. (2) An allowance paid to a salesperson or agent for services rendered.

Commodity Futures

Contracts to buy or sell some fixed amount of a commodity (wheat or soy beans, for example) for a fixed price at a future date.

Common-Law State

A state in which the laws governing property rights are based on British common law. The property and income of each spouse belongs to him or her separately.

Common Stock

Shares in the ownership of a corporation that are entitled to residual dividends, after bonds and preferred stock have first received interest and dividends. A common stockholder usually has a vote in deciding company affairs, including the election of a corporation's board of directors.

Community Income

Income of a married couple, living in a community property state, which is considered to belong equally to each spouse, regardless of which spouse receives the income.

Community Property

Property considered to belong in equal shares to a husband and wife. This concept of ownership for property acquired after marriage is followed in Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin.

Commuting

Traveling from one's residence to one's regular place of business and back to the residence.

Compensation

Wages, commissions, tips, professional fees, and net self-employment income from services rendered; that is, earned income.

Condemnation

The taking of property by a public authority. The property is condemned as the result of legal action and the owner is compensated by the public authority. The power to condemn property is known as the right of eminent domain.

Condemnation Award

Payment in money or replacement property that is received for property condemned by a government authority.

Constructive Receipt

A cash-basis taxpayer is taxed on income only as it is received. But if the income was unreservedly subject to his or her demand and he or she could have received it but chose not to do so, it is regarded as having been constructively received by him or her and is taxable. For example, interest credited to a savings account is constructively received even if the taxpayer hasn't withdrawn it.

Contract Price

An amount payable to the seller and equal to the gross selling price when no mortgages are involved. If a mortgage is assumed, the contract price is the gross selling price minus the amount of the mortgage plus the excess (if any) of the mortgage over the seller's basis and expenses of sale.

Contributions

(1) Gifts to qualified charitable organizations as opposed to gifts to private individuals. Such contributions are generally deductible on Schedule A.

Convention Expenses

Travel expenses incurred in attending a convention are deductible if the meetings are related to a taxpayer's trade or business or job-related activities. If, however, the convention trip is primarily for pleasure or for investment purposes, no deduction for travel expenses is permitted. Limitations may apply to foreign convention expenses.

Convertible

A bond or preferred stock that may, under specified conditions, be exchanged for common stock or another security, usually of the same corporation.

Copyright

The exclusive legal right to sell, reproduce, or publish a literary, musical, or artistic work.

Corporation

For income tax purposes, this term includes associations, trusts that have a majority of corporate characteristics, joint stock companies, and insurance companies.

Cost

(1) Cash and/or the value of property given to acquire the property received.

Cost Depletion

A method for recovering the taxpayer's investment in natural resources or timber. The cost is recovered ratably as the resource is extracted or the timber harvested. Total cost depletion cannot be claimed in excess of basis. Percentage depletion, the other method for computing depletion of natural resources, is defined elsewhere in this glossary.

Cost Method of Inventory Valuation

Valuing inventory purchased during the year at cost; that is, the invoice price less any discounts plus transportation or other costs incurred in acquiring the merchandise.

Cost of Goods Sold

Beginning inventory plus direct purchases, direct labor costs, and overhead costs less withdrawals for personal use and ending inventory. Sole proprietors compute their cost of goods sold in Part III of Schedule C.

Cost of Maintaining a Home

Expenses necessary to maintain a taxpayer's residence. These costs include rent or mortgage interest and real estate taxes, fire and casualty insurance on the dwelling, upkeep and repairs, utilities, paid domestic help, and food consumed in the home.

Cost or Market, Whichever Is Lower

This phrase is used in reference to inventory valuations. Most taxpayers prefer to use "cost or market, whichever is lower" as a basis for valuing their inventories because this method affords an opportunity to take advantage of a drop in the market so that profits can be reduced accordingly before disposition of the goods. If "cost" only is used, a drop in the market cannot affect the income until the merchandise is sold. Either method is acceptable, but the one adopted must be followed unless the IRS grants permission for a change.

Cost Recovery

The writing off of the capital cost of qualified assets over a specified time period. See also Accelerated Cost Recovery System (ACRS) and Modified Accelerated Cost Recovery System (MACRS).

Coupon Bond

A bond with interest coupons attached. The coupons are clipped as they come due and are presented by the bond holder for payment of accrued interest.

Credits

Reductions of tax liability that Congress has decided should be allowed for various purposes to taxpayers who meet the qualifications. Some credits are refundable; that is, the IRS will send the taxpayer a check for any amount in excess of the tax liability. Most credits are not refundable, but some credits may be carried to other tax years.

Custodial Parent

The parent with whom a child lives for more than half the year.

- D -

Dealer

A person or firm that regularly buys and sells property. A person is classified as a dealer if at the time of the sale, that person held the property primarily for sale to customers in the ordinary course of business. Gains from the sale of such property are ordinary gains not capital gains.

Declining Balance Method of Depreciation

An accelerated method of depreciation. The percent is determined by the type of property. The depreciable basis for the next year is reduced by the depreciation deduction taken in the current year.

Deduction

An amount that may be subtracted from income that is otherwise taxable.

Deferred Compensation

Compensation that will be taxed when received or upon the removal of certain restrictions on receipt and not when earned. For example, contributions by an employer to a qualified pension or profit-sharing plan on behalf of an employee is considered deferred compensation. Such contributions will not be taxed to the employee until the funds are made available or distributed to the employee, usually upon retirement.

Deferred Gain

Nonrecognition of realized gain at the time of a tax-deferred exchange. Deferred gain on the sale of a principal residence generally applies only to those sales made before May 7, 1997.

Defined Benefit Plan

An employee benefit plan that provides determinable benefits not based on employer profits.

Defined Contribution Plan

An employee benefit plan that provides a separate account for each person covered and pays benefits on amounts allocated to each account.

Dependency Exemption

An exemption for an individual who qualifies as the taxpayer's dependent ($2,750 for 1999).

Dependent

An individual who qualifies to be claimed as a dependent exemption on another person's income tax return.

Dependent Care Credit

A nonrefundable credit based on expenses paid for a dependent's care. Such care must enable the taxpayer to be gainfully employed or to look for gainful employment. The credit is computed on Form 2441 for Form 1040 filers and on Schedule 2 for Form 1040A filers.

Depletion

The process by which the cost or other basis of a natural resource (for example, an oil and gas interest) is recovered upon extraction and sale of the resource. The two ways to determine the depletion allowance are the cost and percentage methods, both of which are defined elsewhere in this glossary.

Depreciable Asset

Tangible personal property or real property used in business or held for the production of income with a determinable useful life of more than one year.

Depreciation

The deduction of a reasonable allowance for the wear and tear of assets (excluding inventory) used in a trade or business or held for the production of income. In a more narrow sense, the term depreciation refers to the method used to write off the cost or other basis of assets placed in service before 1981 over their estimated useful lives.

Devise

A transfer of real property to a beneficiary under the terms of a decedent's will. For income tax purposes, the term is used mainly in connection with determining the basis of property so acquired. Basis is the value of the property at the date of death of the decedent, or the later alternate valuation date if chosen for estate tax purposes. Receipt of property by devise is not a taxable event.

Disability Pension

A taxable pension from an employer-funded disability plan or a disability provision of a retirement plan.

Disaster Loss

If a casualty is sustained in an area designated as a disaster area by the President of the United States, the casualty is designated a disaster loss. A disaster loss may be treated as having occurred in the taxable year immediately preceding the year in which the disaster actually occurred. Thus, immediate tax benefits are provided to victims of the disaster.

Distribution

Money a taxpayer withdraws from a retirement plan such as an individual retirement arrangement or an employer-maintained pension plan. See also Distributions by Corporations.

Distributions by Corporations

As used in the tax Code, this term refers to any amounts paid by a corporation to its shareholders, or any property distributed, other than for value received in goods or services. It is a broader term than dividends, for a distribution may be a divid end, and therefore taxable income, or it may be a return of capital. See also Returns of Capital.

Dividend

A stockholder's share of the profits of a corporation. An insurance dividend is not a true dividend but a return of premium. Dividends from a savings and loan association or credit union are interest, not dividends.

Divorce Decree (Final)

A decree issued after a divorce is declared final by the court. This action dissolves the marriage and returns the spouses to unmarried status. Alimony payments made as a result of this decree are deductible by the payer and income to the recipient, if requirements are met.

Divorce Decree (Interlocutory)

A divorce decree that is not yet final. Alimony paid under an interlocutory decree is deductible by the payer and income to the recipient, if requirements are met.

Dollar Amount Paid

Cash plus the principal amount of a loan on the property that the taxpayer is legally obligated to pay.

Drought Sale

The sale of more animals in a particular year than is the farmer's usual practice because of drought conditions. If certain conditions are met, the farmer may elect to report the proceeds from such sales either in the year of the sale or in the following year.

- E -

Earned Income

Income from personal services as distinguished from income generated by property or other sources. Earned income includes all amounts received as wages, tips, bonuses, other employee compensation, and self-employment income, whether in the form of money, services, or property.

Earned Income Credit

A refundable tax credit for qualified taxpayers based on earned income and modified adjusted gross income.

Education Expense

Employees may deduct education expenses if the expenses are incurred either to maintain or improve existing job-related skills or to meet the express requirements of the employer or legal requirements to retain current employment status. Such expenses are not deductible if the education is required to meet the minimum educational requirements for the taxpayer's job or if the education qualifies the taxpayer for a new trade or business. Education expenses may also qualify the taxpayer for the Hope scholarship credit or the lifetime learning credit, both of which are defined elsewhere in this glossary.

Education IRA

A tax-favored savings plan under which the taxpayer may contribute up to $500 per year per eligible beneficiary. Contributions are nondeductible. Earnings are tax free and withdrawals are also tax free if used to pay for qualified higher education expenses.

Eminent Domain

The right of a government authority to take private property for public use and paying fair compensation to the owner.

Employee

For income tax purposes, an employee is to be distinguished from an independent contractor. This is important, because the withholding of income taxes on wages applies only to employees. Also, employee status will affect the manner and extent of some deductions and credits. The regulations state that an employee is one who is subject to the will and control of the employer not only as to what shall be done but also as to how it shall be done.

Employee Stock Option

An option granted to an employee to purchase the employer's stock. Employee stock options to which special income tax treatment is accorded are known as statutory options.

Employer-Funded Retirement Plan

A pension plan funded in full or in part by employer contributions on behalf of employees.

Employment Expenses

Ordinary and necessary expenses required to perform the duties for which the taxpayer was hired.

Energy Tax Credit--Business Property

An energy tax credit allowed for the purchase of certain business-use property utilizing solar, geothermal, or biomass energy.

Energy Tax Credit--Residential Property

Prior to 1986, taxpayers were eligible for a credit against the cost of energy-saving devices or renewable energy source property installed in their principal residences. Residential energy credits claimed in prior years must be subtracted from the basis of the residence.

Entertainment Expenses

Such expenses are deductible by employees and self-employed taxpayers only if the expenses are directly related to or associated with a trade, business, or profession. To prevent abuses, various restrictions and documentation requirements have been imposed on the deductibility of entertainment expenses. The deduction for qualified business entertainment is limited to 50 percent of cost.

Estate

A taxable entity that is established upon the death of a taxpayer. It consists of all the decedent's property and personal effects. The estate exists until the final distribution of its assets to the heirs and other beneficiaries. During the period of administration, the executor must usually file a return.

Estimated Tax

The amount of tax a taxpayer expects to owe for the year after subtracting expected amounts withheld and the amount of any expected credits.

Estimated Tax Voucher

A statement by an individual of (1) the amount of income tax he or she estimates he or she will incur during the current taxable year on income that is not subject to withholding, (2) the excess amount over that withheld on income that is subject to withholding, and (3) his or her estimated self-employment tax. Advance payment of tax may be required (on as many as four payment dates) unless estimated tax due after withholding and credits is less than $1,000.

Estimated (Useful) Life

The period of time over which an asset will be used by a particular taxpayer. Although that period cannot be longer than the estimated physical life of an asset, it can be shorter if the taxpayer does not intend to keep the asset until it wears out. The estimated useful life of an asset is essential to determining the annual tax deduction for depreciation and amortization.

Excess Social Security Tax Withheld

If a taxpayer worked for more than one employer during 1999, and more than $4,501.20 was withheld for social security tax, the excess over the maximum is included in the Payments section of the return. The excess amount has the same character as withholding tax.

Exchange

A transfer of property for other property or services. Exchanges of like-kind property are a popular method for deferring taxes.

Excludable Amount of Pension

The portion of pension distributions that is not taxable.

Excluded Gain

Generally applies to gains realized on the sale of a principal residence. For sales after May 6, 1997, a taxpayer may exclude up to $250,000 ($500,000 MFJ) of gain on the sale if he or she owned and occupied the residence for at least two of the five years prior to the sale.

Exclusion

An amount of income that is not included in adjusted gross income because the tax Code excludes it.

Exclusion Percentage

Used to establish the excludable amount of a pension under the general rule. This percentage is determined by dividing the taxpayer's total contribution by the expected return.

Exemption

An amount ($2,750 for 1999) allowed by law as a reduction of income that would otherwise be taxed. There are two kinds of exemptions: personal and dependency.

Expected Return

For a lifetime pension, this is determined by multiplying the annual pension by the taxpayer's expected life multiple from government actuarial tables.

Expenses

For federal income tax purposes, expenses are divided into four categories: (1) trade or business expenses, (2) expenses in connection with production of income, in connection with management, conservation, or maintenance of property held for production of income, (3) expenses in connection with the determination, collection, or refund of any tax, and (4) personal, family, or living expenses. Expenses in the first three categories are generally deductible in determining taxable income. Expenses in the fourth category are not deductible, except in a few cases (medical expenses, charitable contributions, etc.) in which they are specifically allowed by law. Expenses are to be distinguished from "capital expenditures," defined elsewhere in this glossary.

Expenses of Sale

When paid by the seller, these expenses reduce the sale price of property. Examples are commissions to a broker or real estate agent, title search, title insurance, legal fees, and transfer taxes.

Expensing

A term used to refer to the section 179 expense deduction, defined elsewhere in this glossary.

- F -

Fair market value

The amount at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

First-in, first-out (FIFO)

An accounting method for determining the cost of inventories. Under this method the cost of inventory on hand is deemed to be the cost of the most recently acquired units.

Foreign tax credit or deduction

Both individual taxpayers and corporations may claim a foreign tax credit on income earned and subject to tax in a foreign country or U.S. possession. As an alternative to the credit, a deduction may be taken for the foreign taxes paid.

- G -

Gift

A transfer of property for less than adequate consideration. Gifts usually occur in a personal setting (such as between members of the same family).

Goodwill

The ability of a business to generate income in excess of a normal rate on assets due to superior managerial skills, market position, new product technology, etc. In the purchase of a business, goodwill is the difference between the purchase price and the value of the net assets. Goodwill is an intangible asset which possesses an indefinite life; however, it is amortized over fifteen years for federal income tax purposes.

Gross income

Income subject to the Federal income tax. Gross income does not include income such as interest on municipal bonds. In the case of a manufacturing or merchandising business, gross income means gross profit (i.e., gross sales or gross receipts less cost of goods sold).

- H -

Head of household

An unmarried individual who maintains a household for another and satisfies certain conditions. Such status enables the taxpayer to use income tax rates lower than those applicable to other unmarried individuals but higher than those applicable to surviving spouses and married persons filing a joint return.

Hobby loss

A nondeductible loss arising from a personal hobby as contrasted with an activity engaged in for profit. Generally, the law provides a presumption that an activity is engaged in for profit if profits are earned during any three or more years during a five year period.

Holding period

The period of time property has been held by the taxpayer. The holding period is of significance in determining whether gains or losses from the sale or exchange of capital assets are long-term or short-term.

"Hope" tax credit

A HOPE Scholarship tax credit is available for the first two years of post-secondary education expenses.

- I -

Installment method

A method of accounting enabling a taxpayer to spread the recognition of gain on the sale of property over the payment period. Under this procedure, the seller computes the gross profit percentage from the sale (i.e., the gain divided by the contract price) and applies the percentage to each payment received to arrive at the gain to be recognized.

Involuntary conversion

The loss or destruction of property through theft, casualty, or condemnation. If the owner reinvests any proceeds within a prescribed period of time in property that is similar or related in service or use, any gain realized on an involuntary conversion can, at the taxpayer�s election, be deferred for Federal income tax purposes.

Itemized deductions

Personal expenditures allowed by the Code as deductions from adjusted gross income. Itemized deductions include certain medical expenses, interest on home mortgages, real and personal property taxes, charitable contributions, personal casualty losses and other miscellaneous expenses.

- J -

- K -

- L -

Life insurance proceeds

Generally, life insurance proceeds paid to a beneficiary upon the death of the insured are exempt from Federal income tax. An exception exists when a life insurance contract has been transferred for valuable consideration to another individual who assumes ownership rights. In such a case, the proceeds are income to the assignee to the extent that the proceeds exceed the amount paid for the policy (cash surrender value at the time of transfer) plus any subsequent premiums paid.

Lifetime learning credit

The Lifetime Learning credit may be used in any tax year the HOPE credit is not used, for expenses paid and education furnished after June 30, 1998. Unlike the HOPE credit, the Lifetime Learning credit may be claimed for an unlimited number of tax years.

Like-kind exchange

An exchange of property held for productive use in a trade or business or for investment (except inventory and stocks and bonds) for property of the same type. Unless different property is received (i.e., "boot"), the exchange will be completely nontaxable.

Limited Liability Company (LLC)

Business organizations usually treated as partnerships for tax purposes but offering the limited liability of a corporate stockholder to all members.

Listed property

Listed property includes computer and peripheral equipment, unless used exclusively at a regular business establishment, passenger automobiles, cellular telephones, property used for transportation, and property used for entertainment, recreation, or amusement. The depreciation of listed property is subject to certain limitations where the property is not used over 50 percent in a qualified business use.

- M -

Medical expenses

Medical expenses of an individual, spouse, and dependents are allowed as an itemized deduction to the extent that total medical expenses, less insurance reimbursements, exceed limitations based on the taxpayer�s AGI.

Medical Savings Accounts (MSAs)

An MSA is a savings account coupled with a high-deductible health insurance plan used for medical expenses. Personal contributions to MSAs are deductible and employer contributions to MSAs are excludible from income within certain limits.

Modified Accelerated Cost Recover System (MACRS)

See Accelerated Cost Recovery System (ACRS)

Moving expenses

A deduction in arriving at adjusted gross income is permitted to employees and self employed individuals providing certain tests are met (e.g., the taxpayer�s new job must be at least fifty miles farther from the old residence than the old residence was from the former place of work). Ceiling limitations are placed on indirect expenses (e.g., house-hunting trips and temporary living expenses, and certain disposition and acquisition expenses of personal residences).

- N -

Necessary

Appropriate and helpful in furthering the taxpayer�s business or income producing activity. See Ordinary.

Net operating loss

To mitigate the affect of the annual accounting period, taxpayers are allowed to use a loss of one year as a deduction from income in past or future years. A carryback period of two years and a carryforward period of twenty years is allowed.

Nonbusiness bad debts

A bad debt loss not incurred in connection with a creditor�s trade or business. Such loss is deductible as a short-term capital loss and will only be allowed in the year the debt becomes entirely worthless. In addition to family loans, many investor losses fall into the classification of nonbusiness bad debts.

Nonrecourse debt

An obligation on which the endorser is not personally liable. An example of a non-recourse debt is a mortgage on real estate acquired by a partnership without the assumption of any liability on the mortgage by the partnership or any of the partners. The acquired property generally is pledged as collateral for the loan.

- O -

Office-in-the-home expenses

Employment and business-related expenses attributable to the use of a residence (e.g., den or office) are allowed only if the portion of the residence is used exclusively and on a regular basis as the taxpayer�s place of business or as a place of business which is used by patients, clients, or customers. If the expenses are employment related, the use must be for the convenience of the employer as opposed to being merely appropriate and helpful.

Ordinary

Common and accepted in the general industry or type of activity in which the taxpayer is engaged. It comprises one of the tests for the deductibility of expenses incurred or paid in connection with a trade or business; for the production or collection of income; for the management, conservation, or maintenance of property held for the production of income; or in connection with the determination, collection, or refund of any tax. See Necessary.

Organization expenses

Organizational expenses are associated with the formation of a business prior to the beginning of operations. A corporation may elect to amortize organizational expenses over a period of sixty months or more. Certain expenses related to starting a company do not qualify for amortization (e.g., expenses connected with issuing or selling stock or other securities).

- P -

Partnerships

Partnerships are conduit entities and are not subject to taxation. Various items of partnership income, expenses, gains and losses flow through to the partners and are reported on their income tax returns.

Passive losses

Passive losses are deductible only to the extent of passive income. Unused passive losses carry forward indefinitely (until the activity which generated the losses is disposed of) and can be used by taxpayers to offset passive income in future years.

Patents

A patent is an intangible asset which may be amortized over its life. The sale of a patent usually results in long-term capital gain treatment.

Personal expenses

Expenses of an individual incurred for personal reasons which are not deductible unless specifically allowed under the tax law.

Personal property

Generally, all property other than real estate. It is sometimes designated as �personalty� while real estate is termed �realty.� Personal property can also refer to property not used in a taxpayer�s trade or business or held for the production or collection of income. When used in this sense, personal property could include both realty (e.g., a personal residence) and personalty (e.g., personal effects such as clothing and furniture).

Personal residence

The sale of a personal residence may result in the recognition of capital gain (but not loss). Taxpayers may permanently exclude $250,000 ($500,000 if married) of gain on the sale of their personal residence from income providing certain requirements are met.

Points

Loan origination fees generally deductible as interest by a buyer of property. A seller of property who pays points is required to reduce the selling price and, therefore, does not receive an interest deduction.

Portfolio income

Portfolio income includes dividends, interest, royalties, annuities, and realized gains or losses on the sale of assets producing portfolio income.

Prizes and awards

The fair market value of a prize or award generally is included in gross income.

- Q -

Qualified pension or profit-sharing plan

An employer-sponsored plan that meets certain requirements. If these requirements are met, none of the employer�s contributions to the plan will be taxed to the employee until distributed to him or her. The employer will be allowed a deduction in the year the contributions are made.

- R -

Realized gain or loss

The difference between the amount realized upon the sale or other disposition of property and the adjusted basis of such property.

Recognized gain or loss

The portion of realized gain or loss that is subject to income taxation. See Realized gain or loss.

Reserve for bad debts

An allowance permitted for estimated uncollectible accounts. Actual write-offs are charged to the reserve, and recoveries of amounts previously written-off are credited to the reserve. This method is not generally allowed for tax purposes.

Rollover

Transfer of pension funds from one plan or trustee to another. The transfer may be a direct transfer or a rollover distribution.

Roth IRAs

The Roth IRA allows nondeductible contributions. Although the contributions to the Roth IRA are not deductible, income accumulates tax free, and qualified distributions are not included in income when received.

- S -

S Corporation

A small business corporation whose shareholders have filed an election permitting the corporation to be treated in a manner similar to partnerships for income tax purposes. Of major significance is the fact that S Corporations usually avoid the corporate income tax and corporate losses can be claimed by the shareholders.

Scholarships

Scholarships are generally taxable income to the recipient except for amounts received for tuition, books, and supplies.

Section 401(k) plan

A section 401 (k) plan is a qualified retirement plan which grants employee participants a deferral of income for employer contributions to the plan. The plan allows taxpayers to elect to receive compensation or have the employer make a contribution to the retirement plan. The plan may be structured as a salary reduction plan. There is a maximum annual dollar limitation, as well as a limitation based on the employee�s compensation.

Section 1231 assets

Section 1231 assets include depreciable assets and real estate used in a trade or business, held for the long-term holding period. Under certain circumstances, the classification also includes timer, coal, domestic iron ore, livestock (held for draft, breeding, dairy, or sporting purposes), and unharvested crops.

Self-employment income

Self-employment income is the taxpayer�s net earnings from self-employment which includes gross income from a taxpayer�s trade or business, less trade or business deductions. Self -employment income also includes the taxpayer�s share of income from a partnership trade or business.

Self-employment tax

The self-employment tax consists of two components: the Social Security portion and the Medicare portion. The Social Security portion of the self-employment tax consists of a tax of 12.4 percent imposed on an individual�s net earnings from self-employment, up to a maximum, which changes yearly. The Medicare portion of the tax consists of a tax of 2.9 percent imposed on the individual�s net earnings from self-employment, with no maximum. In calculating the self-employment tax, a deduction is allowed for one-half of the otherwise applicable self-employment tax. This deduction is calculated by multiplying the taxpayer�s self-employment income, before the self-employment tax deduction, by one-half of the total self-employment tax rate. If a self -employed individual also receives wages subject to FICA, the maximum Social Security tax base on the self-employed earnings is reduced.

Separate property

Separate property is property, other than community property, acquired by the spouse before marriage or after marriage as a gift or inheritance.

Standard deduction

Taxpayers can deduct the larger of the standard deduction or their itemized deductions in calculating taxable income. An extra standard deduction amount is allowed for elderly and blind taxpayers (see text for amounts).

Simple plans

Retirement plans for small business with no more than 100 employees called the Savings Incentive Match Plan for Employees, or simple plans.

- T -

Tax credit for elderly

Elderly taxpayers (age 65 and over) may receive a tax credit. The amount of the credit is dependent on the filing status of the taxpayer and the amount of the taxpayer�s adjusted gross income and nontaxable Social Security and pension benefits.

Tax home

Since travel expenses of a taxpayer are deductible only if the taxpayer is away from home, the deductibility of such expenses rests upon the definition of "tax home." The IRS position is that the "tax home" is the business location, post or station of the taxpayer. If the taxpayer is temporarily reassigned to a new post for a period of one year or less, the taxpayer�s home should be his or her personal residence and the travel expenses should be deductible.

Trade or business expenses

Deductions for AGI, which are attributable to a taxpayer�s business or profession.

Transportation expenses

Transportation expenses for a taxpayer include only the costs of transportation (taxi fares, automobile expenses, etc.) in the course of employment where the taxpayer is not "away from home" in a travel status. Commuting expenses are not deductible.

Travel expenses

Travel expenses include meals (50 percent deductible), lodging, and transportation expenses while away from home in the pursuit of a trade or business (including that as an employee).

- U -

Unearned income

For tax purposes, unearned income (e.g., rent) is taxable in the year of receipt. In certain cases involving advance payments for goods and services, income may be deferred.

- V -

Vacation home

The Code places restrictions upon taxpayers who rent their residence or vacation home for part of the tax year. The restrictions may result in the limitation of certain expenses related to the vacation home.

- W -

Welfare-to-work credit

A welfare-to Work credit is allowed for 35 percent of the first $10,000 of wages of qualified new hires to encourage employers to provide work for former welfare recipients. In the second year of employment, 50 percent of wages up to $10,000 will be allowed for each qualified employee. To qualify, employees must be certified by designated agencies as long-term family assistance recipients.

Work Opportunity credit

Employers who hire from specified groups with high unemployment rates receive credits equal to 40 percent of the first $6,000 of wages per employee.

- X -

- Y -

- Z -