Ad valorem tax
Taxes that are based on the value of the property being taxed (e.g., property taxes). However, most property taxes are not based on the true fair market value of the property. Rather, the ~assessed value~ of the property is used to determine the tax. The assessed value of property is typically 50 to 75% of the estimated market value of the property.
Adjusted gross income (AGI)
Deductions of individuals are broken into two classes—deductions for AGI and deductions from AGI. This difference in deductions results in an intermediate income number called the AGI. It is used to provide limitations on the deductions from AGI of an individual taxpayer. ~Deductions for adjusted gross income~ include trade or business expenses, rental and royalty expenses, capital losses, and certain other expenditures that the tax law specifically allows. Once the allowable amount of an expenditure has been determined, it is not subject to further reduction based on the income of the taxpayer.
Average tax rate
The average rate of tax on each dollar of income that is taxable. The total federal income tax divided by taxable income (tax base). See also ~proportional rate structure~.
Deductions from adjusted gross income
Certain personal expenditures and other specified nonpersonal expenditures are allowed to be deducted by individuals as deductions from AGI. These deductions are commonly referred to as ~itemized deductions~.
An item that does not affect the current period’s taxable income but will affect taxable income in some future tax year.
Effective tax rate
The total federal income tax divided by the taxpayer’s economic income (the tax base plus nontaxable income).
A tax that is paid on the fair market value of the assets of a deceased taxpayer. The tax is paid by the executor of the estate from the assets of the estate.
Increases in a taxpayer’s wealth and recoveries of the taxpayer’s capital investment that Congress has decided should not be subject to income tax. Thus, income exclusions are not counted as gross income. Common income exclusions include inheritances, gifts, and interest on certain municipal bonds.
Individuals, trusts, and estates may subtract predetermined amounts to determine their taxable income. Congress recognizes that people need a minimum amount of income to provide for their basic living expenses. This minimum amount of income is deducted as an exemption and is not subject to tax. See ~personal exemption~.
A current period expenditure that is incurred in order to earn income. Deductions for expenses are limited to those incurred in a trade or business, in an income-producing activity (investment activity), and for certain specifically allowed personal expenses of individuals.
The difference between the selling price of an asset and its basis; the result of disposing of the asset. Gains result in income.
Gross income is income broadly defined, minus income items that are excluded from taxation. Items of gross income are included in the computation of taxable income. Generally, gross income is the starting point for reporting income items on a tax return.
Occurs when an asset is disposed of for a selling price that is less than its basis. Such a loss is referred to as a ~transaction loss~ and represents a loss of capital invested in the asset. An ~annual loss~ results from an excess of allowable deductions for a tax year over the reported income for the year.
Marginal tax rate
The rate of tax that will be paid on the next dollar of income or the rate of tax that will be saved by the next dollar of deduction. Used in tax planning to determine the effect of reporting additional income or deductions during a tax year. See also ~proportional rate structure~.
Recurring income earned by a taxpayer for a tax year; the type of income that people and businesses expect to earn. Ordinary income typically includes business profits, rent from property, interest on investments, and wages. Ordinary income receives no special treatment under the tax laws.
A tax should be collected as close as possible to the time in which the income is earned.
Individuals are allowed to deduct a predetermined amount for each qualifying exemption. The intention is to exempt from tax a minimum amount of income that is used to support the taxpayer and those who are dependent on that taxpayer. Because support costs increase with inflation, the exemption amounts are increased each year to account for the prior year’s inflation. Personal exemptions are allowed for the taxpayer and the taxpayer’s spouse. ~Dependency exemptions~ are granted for individuals who are dependent on the taxpayer for support.
Personal property (personalty)
Any tangible property that is not real property. Personal property includes machines, equipment, furniture, computers, and autos.
Progressive rate structure
A tax in which the average tax rate increases as the tax base increases. The marginal tax rate will be higher than the average tax rate as the tax base increases. The average tax rate, the marginal tax rate, and total tax all increase with increases in the tax base.
Proportional rate structure
A tax for which the average tax rate remains the same as the tax base increases (also referred to as a flat tax). The marginal tax rate and the average tax rate are the same at all levels of the tax base. As the tax base increases, the total tax paid will increase at a constant rate. Examples include sales taxes, real estate and personal property taxes, and certain excise taxes, such as the tax on gasoline.
In general, real property is land and any structures that are permanently attached to land, such as buildings.
Regressive rate structure
A tax in which the average tax rate decreases as the tax base increases. The marginal tax rate will be less than the average tax rate as the tax base increases. Although the average tax rate and the marginal tax rate both decrease as the tax base increases, the total tax paid will increase.
Self-employed individuals pay a Social Security tax equal to the sum of the employer’s and employee’s payments (15.3%). Because employees are not taxed on the Social Security contribution made on their behalf by their employers, self-employed taxpayers are allowed to deduct one-half of their self-employment tax as a business expense to equalize the tax treatments of employees and the self-employed.
Social Security taxes
Under the Federal Insurance Contribution Act (FICA), a tax is levied on wages and salaries earned. Social Security taxes are matched by employers. Employees are not taxed on the Social Security contribution made on their behalf by their employers. In 2010, a tax of 6.2% is levied on the first $106,800 of wages for Old Age, Survivors, and Disability Insurance (OASDI). A tax of 1.45% on all wages and salaries pays for Medical Health Insurance (MHI).
An amount that Congress allows all taxpayers to deduct, regardless of their actual qualifying itemized deductions. Thus, taxpayers itemize their deductions only if their total allowable itemized deductions exceed the standard deduction.
Statute of limitations
The time period within which the IRS or the taxpayer must assert that a tax return is not correct. The general statute of limitations period is three years from the due date of the return. Several exceptions extend the statute of limitations beyond the general three-year period.
The use of legal methods allowed by the tax law to minimize a tax liability. Tax avoidance generally involves planning an intended transaction to obtain a specific tax treatment.
A direct reduction in the income tax liability. In effect, tax credits are treated like tax prepayments.
Occurs when a taxpayer uses fraudulent methods or deceptive behavior to hide the actual tax liability. Tax evasion usually involves three elements: a willfulness on the part of the taxpayer, an underpayment of tax, and an affirmative act by the taxpayer to evade the tax.
The tax base for the federal income tax. The difference between the total income of a taxpayer and the deductions allowed that taxpayer.
Results from a single disposition of property. The loss must be categorized by the activity producing the loss to determine its deductibility: trade or business losses, investment-related losses, and personal use losses. In general, transaction losses must have a business purpose to be deductible. See loss.