Tax Terminology

What are "income taxes"?

Income taxes are the price that we pay for living in our civilized society. Every country has income taxes. You have to have income taxes to pay for the government.Your situation, your income and what you do, because of the political nature of any tax system, will determine how much tax you're going to pay.

What is the "IRS"?

The IRS is the Internal Revenue Service. It's a part of the Treasury Department, and is responsible for collecting taxes. Part of it is excise taxes, alcohol and beverage taxes, all kinds of taxes, and income tax is a very large portion of it. They're very closely monitored by the Inspector General of the Treasury Department and by various House and Senate oversight committees that audit the IRS continuously.

What are "tax-favored investments"?

An obvious one is municipal bond interest. The federal government doesn't tax interest paid by cities and states. If you have enough money you can invest it in what they call "munies" and not pay any federal tax on it. If you invest it in bonds from the state where you live in, there won't be any state tax on it either.

What's "total tax"?

The total tax is a combination of the various taxes that you pay, most of which you are not aware of. The obvious is the income tax, that's the tax on your taxable income on your return. The less obvious tax is your social security tax, which is combined employer and employee social security and medicare 15.3%. That goes to the same place that your regular tax does. It doesn't go into any special fund. It's combined with the regular taxes.

What's a "dependent"?

A dependent is someone that you pay over half the support of. A dependent is your child under age 18 unless they're a full time student, then they're classed as a dependent to age 25 unless they're disabled, unless they're your parents. That's an interesting thing; what's a dependent? A close friend that you support- that could be your dependent as long as they don't have income over 80,000 dollars.

What's a "deduction"?

What's a deduction?A deduction reduces your income before arriving at either adjusted gross income or taxable income. It's money that you spend for something that is given tax favored status that you can reduce your income by. For example, let's look at medical expenses. Let's say you had a terrible year. You don't have medical insurance and you incur $10,000 in medical expenses you had to pay yourself, with no insurance. Can you deduct that $10,000? Well, there's a couple of problems with it. Number one, you have to itemize your deductions which means you lose the standard deduction. You don't get both. Then, for medical expenses, you have to reduce them by 7.5 percent of your adjusted gross income. For example, if your adjusted gross income is $100,000 you have to reduce your medical expenses by $7500. You don't get that as a deduction, even though you spent the money. So your net deduction for the medical expenses is only $2500.

What does "tax deductible" mean?

Tax deductible means you've spent money on something that you can rightfully claim a tax deduction for.

What's a "marginal tax rate"?

The marginal tax rate is the rate at which each additional dollar of income will be taxed at; for example, we start off with zero, to the extent that you have standard deduction and your personal exemption. Then you start gradually increasing the tax rate; it's a graduated rate depending upon your income amount, which changes every year, what the range is for each rate, but it's a progressively higher rate. Generally, the more you earn, the higher the rate becomes.

What's the "Death Tax (Estate Tax)"?

The death tax is really a misnomer. There is no tax on death. There is a transfer tax on the passing of estates from one generation to the next, or the next, and the next. The purpose of this was set up years ago to prevent enormously wealthy people from transferring their estates on to future generations. It would've created a class of extremely wealthy people, and that's not really our democratic concept. Now, if someone dies, the first million dollars that they leave is not subject to any tax at all. The idea that small businesses are going to benefit from the repeal of the "death tax" is a foolish analogy. Small businesses aren't going to pay death taxes. It's easy to do succession planning for a business, say that's worth even five or 10 million dollars, to pass it on to the next generation or the very minimum amount of taxes.