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Abandoned Spouse
A married taxpayer, living separate and apart from the spouse during the entire year, who did not file a joint return with the spouse; also, none of the earned income of the couple was transferred between the spouses either directly or indirectly.
Above The Line
In general, amounts on a tax return that are deductible from gross income before arriving at adjusted gross income, such as IRA contributions, half of the self-employment tax, and self employed health insurance deduction.
Accelerated Depreciation
Depreciation as determined by methods, chosen for income tax or accounting purposes, that offer greater deductions in early years.
Accounting Records
All documents and books used in the preparation of the tax return and all financial statements, including general ledger, subsidiary ledgers, sales slips, and invoices.
Accounts Payable
A list of the debts currently owed by a person or business, mainly for the purchase of services, inventory, and supplies.
Accounts Receivable
A list of money owed on current accounts to a creditor, which is kept in the normal course of the creditor's business and represents unsettled claims and transactions.
Accrual Basis (Accrual Method)
An accounting method whereby income and expense items are included in taxable income or expense as they are earned or incurred, even though they may not yet have been received or actually paid in cash.
Acquisition Cost
The price of all fees required to obtain a property.
Acquisition Indebtedness
1) For home mortgage loans, a limit is placed on the amount of debt that can generate tax-deductible interest expense.
2) For determining unrelated debt-financed income, acquisition indebtedness is debt incurred to purchase or improve a property.
Adjusted Basis (Adjusted Tax Basis)
The original cost of other basis of property, reduced by depreciation deductions and increased by capital expenditures.
Adjusted Sales Price
The selling price of a home less the expenses of the sale, less fixing-up expenses.
Administrator
A court-appointed individual or bank charged with carrying out the court's decisions with respect to a decedent's estate until it is fully distributed to all claimants.
After-Tax Cash Flow
The cash flow from income-producing property, less income taxes, if any, attributable to the property's income.
Alimony
Payment for the support of one's estranged spouse in the course of divorce or separation. Alimony and separate maintenance payments are taxable to the receiver and deductible by the payor.
Alternative Minimum Tax
A flat tax to ensure that corporate and high-income non-corporate taxpayers pay at least some tax, regardless of their deductions. A two-tier 26% or 28% rate applies to broadly based income of an individual; a 20% rate, to broadly based income of a corporation. If the alternative minimum tax exceeds the regular income tax.
Amortization
1) The systematic write-off of cots incurred to acquire an intangible asset, such as patents, copyrights, and organization expenses, IRC §197.
2) reduction of a debt by periodic charges to assets or liabilities, such as payments or mortgage or amortization of bond premiums.
Annual Exclusion
The amount up to $10,000 per donee per year, that a donor may exclude from the gift tax. IRS §2503(b).
Appreciation
The excess of the fair market value of property over the taxpayer's cost or tax basis in such property.
Attorney-At-Law
A person admitted to practice law in a jurisdiction, authorized to perform both civil and criminal legal functions for clients. These functions include drafting legal documents, giving legal advise, and representing clients before courts, administrative agencies, boards, and other bodies.
Attorney-In-Fact
A person who is authorized to act for another under a power of attorney, which may be general or limited in scope. A person need not be an attorney-at-law to be an attorney-in-fact.
Audit
An examination of a taxpayer's books and records by the Internal Revenue Service. The examination can be conducted by correspondence, at the taxpayer's home or place of business or at an IRS field office.
Avoidance Of Tax
A method by which a taxpayer legally reduces his or her tax liability, for example, by investing in a tax shelter. Contrast tax evasion.
Avoiding Probate
The use of certain techniques to eliminate assets from the legal probate process. Jointly held property, living trusts, and lifetime giving are some ways to avoid probate. Avoiding probate does not enable a person to avoid the federal estate or gift tax.
Away From Home
A term used in reference to travel expenses. Sleeping arrangements are necessary for at least one night before returning home in order to deduct "ordinary and necessary" travel expenses on a business trip.
Bank Deposit Method
An indirect method of calculating a taxpayer's income, used by IRS agents when records are suspect or unavailable. Under this method, the taxpayer's bank deposits and cash expenditures are totaled, non-income deposits, redeposits, and transfers are eliminated, and any excess of deposits, as adjusted, over reported income as assumed to be unreported income.
Bargain Prices
The purchase, by the shareholder of a corporation, of property owned by the corporation for less than fair market value; the difference is treated as a distribution.
Barter
The trade of goods and services without the use of money. Income from a barter transaction is taxable income.
Basis
An amount usually representing the taxpayer's cost in acquiring an asset. It is used for a variety of tax purposes, including computation of gain or loss on the sale or exchange of the asset and depreciation with respect to the asset.
Beneficial Interest
The equitable interest in a trust held by the beneficiary of the trust, as distinguished from the interest of the trustee, who holds legal title. Any person who, under the terms of the trust instrument, has the right to the income or principal of the trust fund has a beneficial interest in the trust.
Blindness
To qualify for the blindness standard deduction (or to receive benefits under the Social Security disability program), vision that cannot be corrected to better than 20/200 in the better eye, or a visual field of 20 degrees or less, even with corrective lenses. Vision is determined as of the last day of the taxable year, or as of the date of death (in the case of a deceased taxpayer).
Book Inventory
Stock in hand according to recorded figures.
Bunching
T he concentration of gross income in one or more taxable years.
Burden Of Proof
The duty of a plaintiff, at the beginning of a tax trial, to make a prima facie showing of each fact necessary to establish the existence of a cause of action. In general, the burden of proof is on the taxpayer in a civil tax case and on the Internal Revenue Service in a criminal or fraud case.
Business Gift
A deduction limited to $25 per recipient per year. Advertising items such as pencils, pens, and calendars embossed with a business name and costing $4 or less apiece do not figure into the $25 limitation.
Buy-And-Sell Agreement
An estate planning approach used for sole proprietorships, partnerships, and closely held corporations in which the business interests of a deceased or disabled proprietor, partner, or shareholder are sold according to a predetermined formula to the remaining owner(s) of the business.
Bypass Trust
An agreement allowing parents to pass assets on to their children to reduce estate taxes. The trust must be made irrevocable, meaning that the terms can never be changed.
Capital Assets
All property held for investment by a taxpayer that, when sold, is subject to special tax treatment (as capital gains or capital losses).
Capital Gain Dividend
An distribution that is designated as such by a regulated investment company in a written notice mailed to its shareholders not later than 60-days after the close of its taxable year. A capital gain dividend is treated as a capital gain by the shareholders.
Capital Loss
The loss from the sale of a capital asset. Individuals are limited to $3,000 of loss that can be used annually to offset ordinary income; corporations may offset capital losses against capital gains but not against ordinary income. An individual may carry a capital loss forward until it is completely exhausted. A corporation may carry a capital loss back 3-years and forward 5-years.
Cash Basis (Cash Method)
The accounting method used by most individual taxpayers; also called the cash receipts and disbursements method. The cash method recognizes income and deductions when money is received or paid.
Casualty Loss
A loss of property, due to fire, storm, shipwreck, theft, or other casualty, that is allowable, net of insurance reimbursement, as a deduction is computing taxable income. To qualify as a casualty loss, a loss must be due to a sudden, unexpected, or unusual event.
Charitable Remainder Annuity Trust
A trust that is to pay its income beneficiary (or beneficiaries) a specific sum that is not less than 5% of the initial fair market value of all property placed in the trust. No contributions can be made to a charitable remainder annuity trust after the initial contribution. Contrast charitable annuity unitrust.
Charitable Remainder Unitrust
A trust that is to pay its income beneficiary (or beneficiaries) a fixed percentage that is not less than 5% of the net fair market value of its assets (as valued annually). Additional contributions may be made to a charitable remainder unitrust after the initial contribution; contrast charitable remainder annuity trust.
Child Support
Payment specifically designated for the purpose of child support (or treatment as such) under a divorce or separation agreement. Such payments are neither deductible by the payer nor taxable to the payee.
Closely Held Corporation
A corporation in which five or fewer individuals owned more than 50% of the value of all outstanding stock during the last half of the year.
Closing Agreement
A written agreement between a tax payer and the Internal Revenue Service that conclusively settles a tax liability for the taxable year ending before the agreement date or settles one or more issues affecting a tax liability.
Commuting
Travel between a taxpayer's residence and his or her regular place of business. Commuting expenses are not deductible regardless of the distance traveled or whether work is performed during the trip.
Complex Trust
1. A trust that under the instrument of its creation or under state law may either distribute or retain income
2. A trust with a charitable beneficiary. A complex trust is allowed only 1 $100 exemption.
Compound Interest
The interest earned on principal plus interest that was earned earlier. If $100 is deposited in a bank account at 10%, compounded yearly, the depositor will be credited with $110 at the end of the first year and $121 at the end of the second year. The extra $1, which was earned on the $10 from the first year is the compound interest.
Conservator
A court-appointed custodian of assets belonging to a person determined by the court to be unable to manage his or her own property.
Consideration
Under contract law, anything of value exchanged for a promise or for performance that is needed to make an instrument binding on the contracting parties.
Contractor
A person who contracts to do work for another. An independent contractor agrees to do a specific piece of work, retaining control of the means and method of doing the job; neither party has the right to terminate the contract at will. Examples of independent contractors are physicians, lawyers, construction contractors, and others engaged in professions in which they offer their services to the public. Federal income taxes and Social Security taxes are not withheld by employers of independent contractors, who are subject to the self-employment tax.
Cost Basis
The original price of an asset, used in determining depreciation and capital gains or capital losses. The cost basis is usually the purchase price, but in the case of an inheritance it is the market value of the asset at the time of the decedent's death.
Crummey Power
The beneficiaries' non-cumulative power to invade a trust's corpus during a brief period of each year, to the extent often limited to $10,000 or to 5% of the corpus (whichever is greater).
Date of Gift
The date on which the donor's dominion and control over the property ceases.
Decedent
A person who has died.
Deduction
An amount allowed to taxpayers under the Internal Revenue Code as an offset against gross income or adjusted gross income.
Deferral of Taxes
The postponement of tax payments from the current year to a later year. For example, delaying the receipt of income to a subsequent year can postpone payment of taxes, or like-kind exchanges may postpone taxes on a gain until the new property is sold.
Deferred Compensation
A plan under whose terms an employee defers payment of a portion of salary in return for the employer's promise to pay the employee the salary at some time in the future.
Deficiency
The excess of a taxpayer's correct tax liability for the taxable year over the amount of taxes previously paid for that year. The Internal Revenue Service is authorized to assess deficiencies during an audit of the taxpayer's return, and a deficiency may be used as the basis for penalties for the underpayment of tax, on such grounds as negligence or fraud in filing the return.
Delinquent Return
A tax return not filed within the time prescribed by the Internal Revenue Code (the due date). A delinquent return may be subject to a flat penalty or to penalties based on any unpaid tax liability.
De Minimis
Of insufficient significance to warrant judicial or tax attention, as in the case of nontaxable de minimis fringe benefits. De minimis reflects the judicial principle of de minimis non curat lex ("the law does not concern itself with trifles").
Depletion:
The process whereby the cost or other basis of a natural resource (such as a coal interest) is recovered upon the extraction and sale of the deposit.
Depreciate
To systematically write off the cost of an asset over a period of time allowed by tax law.
Diary
A daily, written record of occurrences, experiences, observations, or thoughts. For example, a taxpayer should keep a diary of the miles driven for business purposes.
Disaster Loss
The loss from a disaster in an area declared by the President as warranting federal assistance. A taxpayer may elect to claim a casualty loss on the tax return for the previous year anytime on or before the later of (1) the due date of the tax return for the year of the disaster or (2) the due date of the return considering any extension for filing the previous tax year's return.
Disclaimer
A provision that allows a person to postpone decisions based upon asset values and estate composition until such values are fixed at death. In essence, a disclaimer, or renunciation, is an unequivocal refusal to accept an interest or power in property to which a person is otherwise entitled by will, gift, or operation of law. Quite often the disclaimed property is passed to another person.
Dissolution
In corporation law, the end of the legal existence of a corporation, whether by expiration of charter, decree of court, act of legislature, vote of shareholders, or other means. A corporation can be liquidated under any one of a number of IRC sections.
Divorce or Separation Instrument
1. a decree of divorce or separate maintenance, or a written instrument incident to that decree.
2. a written separation instrument.
3. a decree of any other type of court order requiring a spouse (or former spouse) to make payments for the support or maintenance of the other spouse.
Domicile
The permanent home or principal establishment of an individual. Residence is not the same as domicile, since a person can have many transient residences but only one legal domicile, which is the home address to which he or she always intends to return for prolonged periods.
Double Declining Balance
A method of depreciation for tax purposes whereby twice the straight-line rate is applied to the remaining depreciable balance of an asset.
Double Taxation
An effect of federal tax law whereby a corporation's earnings are taxed at the corporate level, then taxed again as dividends of shareholders.
Durable Power of Attorney
A power of attorney that remains in effect even if the principal becomes incompetent.
Earned Income
A tax term describing "sweat of the brow" income, which requires obvious effort on the part of the recipient. This includes all income generated by providing goods or services, especially wages and salaries but also not profit from a trade or business; it is contrasted with income received as dividends, for instance.
Earnings and Profits
A term referring to the economic capacity of a corporation to make a distribution to shareholders that is not a return of capital.
Effective Date
The date on which a new tax provision takes effect; often the date when the provision was first submitted to the House Ways and Means Committee, or when it was signed into law by the president.
EIN
See employer identification number.
Employee
A person who works for compensation, whether direct or indirect, for another in return for stipulated services. An employee may work on an hourly, daily, or annual wage basis. For tax purposes, there are two types of employees: (a) common-law and (b) statutory. All workers who have a legal relationship with those for whom they perform services as employees are common-law employees for payroll tax purposes. The employer has the right to control the work to be performed as well as the timing and means of accomplishing the work. Statutory employees are specifically identified as employees by federal tax law and include agent or commission drivers, life insurance salespeople, home-workers, and outside salespersons.
Employee-Owner
Any employee who on any day of the year owns more than 10% of the outstanding stock of a personal service corporation. For purposes of constructive ownership of stock, 5% is substituted for 50% in the attribution rules for stock owned by a corporation.
Employee Stock Option
An opportunity for employees to purchase stock in the company they work for, often at a discount from fair market value. The two categories of employee stock options for tax purposes are statutory (incentive) stock options and nonstatutory options. Options may be granted under an employee stock ownership plan or a restricted stock plan.
Employer Identification Number (EIN)
A taxpayer identification number for an entity other than an individual, such as a partnership, corporation, estate, or trust.
Enrolled Agent
A person other than a certified public accountant or an attorney who is qualified to practice before the Internal Revenue Service. Enrolled agents have passed a 2-day examination or have worked in a technical area at the Internal Revenue Service for at least 5 years.
Entertainment Expenses
Expenses incurred for entertaining a client, customer, or employee. Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; or at sporting events. As a result of the 1993 tax act, only 50% of entertainment expenses and business meals is deductible.
Estate
Broadly, all that a person owns, whether real property or personal property, for instance, the estate one leaves at death.
Estate Planning
Planning for the orderly handling, disposition, and administration of an estate when the owner dies. Estate planning includes drawing up a will, settling up trusts, and minimizing estate, income, and trust taxes. In a broad sense, it is the art of designing a program for the effective enjoyment, management, and disposition of property at the minimum possible tax cost.
Estimated Tax Payment
A quarterly tax payment by a taxpayer on income that is not subject to withholding taxes in an amount that represents a projection of the ultimate tax liability for the taxable period.
Exchange
A provision under Section 1031 of the Internal Revenue Code, that like-kind property used in a trade or business or held as an investment can be exchanged tax-free.
Exclusion
An amount that would otherwise consitute a part of gross income, but is excluded under a specific provision of the Internal Revenue Code. Some major exclusions are gifts, inheritance, life insurance proceeds, scholarships, and lodging or meals furnished for the convenience of the employer.
Executor (Executrix)
A person designated to carry out the wishes expressed in a will as to the administration of a decedent's estate and the distribution of the assets in it. An executor may be a bank trust officer, a family member, or a trusted friend.. Executrix is a term for a woman who fills these shoes.
Expense
Costs that are currently deductible, as opposed to capital expenditures, which may not be currently deducted but must be depreciated or amortized over the useful life of the property.
Extension Of Time For Filing
An additional period of time to file a tax return. For example, an automatic 4-month extension of time to file an individual tax return (Form 1040) is obtained by filing Form 4868 by April 15. An additional 2-month extension to file may be obtained by filing Form 2688. This request may, however, be denied by the Internal Revenue Service. An extension of more than 6 months will not be granted if the taxpayer is in the United States.
Failure-To-Pay Penalty
A penalty assessed at 0.5% of unpaid taxes for each month, or part of a month, after the due date when the tax is not paid, up to a maximum of 25%.
Fair Market Value
The price at which an item would be sold at retail by a willing seller to a willing buyer.
Federal Tax Lien
A lien of the United States on all property and rights to property of a taxpayer who fails to pay a tax for which he or she is liable to the federal government.
Fiduciary
A person, company, or association holding assets in trust for a beneficiary. The fiduciary is charged with the responsibility of investing the money wisely for the beneficiary's benefit.
Field Audit
An examination of a tax return by a revenue agent at a taxpayer's place of business.
Filing Status
For tax purposes, a category that governs the form of return used by the taxpayer. Forms include the following:
- Single Individual;
- Married Persons Filing Jointly and Surviving Spouse;
- Married Persons Filing Separately;
- Head of Households
Forgery
Preparing or altering writings or paintings with the intention of prejudicing the rights of others. Forgery can be considered fraud under the tax laws.
Fraud
The willful intent of a taxpayer to evade a tax. The Internal Revenue Service bears the burden of proof of intentional wrongdoing, and the intent required is the specific purpose of evading a tax believed to be owed.
Full-Time Student
For purposes of the dependence exemption, a person who is enrolled for the number of hours or courses that the school attended considers full-time attendance.
General Partner
Iin a partnership, a partner whose liability is not limited. All partners in an ordinary partnership are general partners. A limited partnership must have at least one general partner and at least one limited partner. As a general rule, partners include on their personal tax returns their share of partnership income, loss and deductions.
Gift Tax Exclusion
An annual exclusion of $10,000 per donee allowed for present-interest gifts; also called annual exclusion.
Gross Estate
The total value of a person's assets before liabilities such as debts and taxes are deducted. After someone dies, the executor of the will makes an assessment of the stocks, bonds, real estate, and personal possessions that comprise the gross estate.
Gross Income
The total of a taxpayer's income from any source, except items specifically excluded by the Internal Revenue Code and other items not subject to tax.
Guarantor
A person who guarantees, endorses, or provides indemnity agreements with respect to debts owed to others. Any losses are deductible when sustained.
Heirs
Strictly, persons whom statute law would appoint to inherit an estate should their ancestor die without a will (intestate). The term is often applied indiscriminately to persons who inherit by will or deed, as well as by operation of law.
Historical Cost
An accounting principle requiring assets to be based on original cost or a substituted basis. A stepped-up basis to fair market value is provided to the heirs upon death of the former owner.
Hobby Loss
A loss incurred by a taxpayer in an activity not pursued for profit. In general, hobby losses are deductible only to the extent of income generated by the hobby. If an activity generates a loss in 3 of 5 years, there is a rebuttable presumption that it is not operated for profit.
Holding Period
The length of time that an investment is owned or expected to be owned. The holding period is important in determining whether a gain or loss from the sale or exchange of a capital asset is long-term or short-term. For tax purposes, the holding period generally begins and ends on the trade date of the purchase and sale transactions.
Illegal Income
The proceeds of theft, for example, or embezzled funds, which are taxable income. For IRS purposes, income is taxable irrespective of the legitimacy or illegitimacy of its source. Taxpayers have illegal income are often reluctant to report it because in so doing they expose their crimes. However, failure to report such income is itself a crime for tax purposes.
Incentive Stock Option (ISO)
An equity-type compensation plan under which qualifying stock options are free of tax at the date of grant and the date of exercise but are taxed when sold.
Income Beneficiary
A beneficiary of a trust or estate who is entitled to income from property rather than the corpus or principal.
Independent Contractor
A contractor who is self-employed. The contracting party need not withhold Social Security taxes and federal income tax; the independent contractor is subject to the self-employment tax. Rev. Rul. 87-41 provides a 20-factor common-law test to classify a worker as an employee or an independent contractor.
Inherit
To acquire property from one who has dies, either by devise (will) or by descent (from an ancestor by operation of law).
Inheritance
Real property or personal property that is received by heirs. A non-technical meaning of inheritance includes property passed by will. Although the federal estate tax may have to be paid on the estate itself, the recipient is not subject to federal income tax on the inheritance.
Inter Vivos Transfer
A transfer of property during a person's lifetime.
Inter Vivos Trust
A trust established between living persons, for instance, between father and child; also called a living trust. In contrast, a testamentary trust goes into effect when the person who establishes the trust dies.
Investment Interest Expense
Interest paid to carry portfolio investments such as bonds, stocks, and underdeveloped land. Tax deductions by non-corporate tax payers for investment interest expense are limited to the income received from the investment, such as dividends, interest, and capital gains.
Itemized Deductions
Specific individualized tax deductions, allowed under provisions of the Internal Revenue Code and state of municipal tax codes for specific expenses incurred by the taxpayer during the taxable year (e.g., unreimbursed medical expenses, qualified residence interest expense, casualty loss, charitable contributions). These deductions are allowed in computing taxable income. There is an overall limitation on certain itemized deductions. An alternative is to claim the standard deduction.
Job Hunting Expenses
The expenses of looking for a new job in the same line of work, whether or not a new job is found; these are miscellaneous itemized deductions, subject to the 2% adjusted gross income floor. Expenses incurred in searching for one's first job after completing school are not deductible.
Jointly and Severally
Together or individually, separately; a legal phrase used in definitions of liability, meaning that an obligation may be enforced against all obligators jointly or against any one of them separately.
Joint Return
A tax return filed by a husband and wife, setting forth tax information concerning each of them, and computing a combined tax liability.
Joint Tenancy
Joint control over property or interest only during the lifetime of the tenants, recognized in most states. Upon the death of a joint tenant, the property or interest passes automatically to the surviving joint tenant.
Joint Venture
An agreement by two or more parties to work on a project together. A joint venture, which is usually limited to one project, differs from a partnership, which forms the basis for cooperation on many projects. A joint venture may, however, be required to file a partnership tax return.
Lease
A contract in which, in return for the payment of rent, the one entitled to the possession of real property (the lessor) transfers those rights to another (the lessee) for a specified period of time.
Lease with Option to Purchase
A lease that gives the lessee (tenant) the right to purchase property at an agreed-upon price under certain conditions. If a lease bears characteristics similar to those of a financing device, the arrangement will be treated as financing, not a lease. An option to purchase at fair market value would appear to be a lease; by contrast, an option at a bargain price would indicate equity build-up through the "rent" and would be an indication of financing.
Life Beneficiary
A person entitled to the use of or income from property during his or her lifetime.
Life Estate
An estate whose duration is limited by the life of the person holding it or by that of some other person.
Like-Kind Property
A tax term defining property having the same nature or character, without reference to grade or quality. One kind or class of property may not be exchanged tax free for property of a different kind or class (e.g., real estate may be exchanged for other real estate, an automobile for another automobile, but not real estate for an automobile).
Limited Liability
The restriction of a person's potential losses to the amount invested; the absence of personal liability. Generally, a taxpayer cannot deduct tax losses in excess of the amount he or she stands to lose.
Limited Liability Company (LLC)
In some states, a form of organization that may be treated as a partnership for federal tax purposes and that has limited liability protection for the owners at the state level.
Limited Partnership
An entity in which one or more persons, with unlimited liability, called general partners, manage the partnership, while one or more other persons contribute only capital. The latter group of partners, called limited partners, have no right to participate in the management and operation of the business and assume no liability beyond the capital contributed.
Living Trust
A trust that was established and was in operation during the grantor's life; an inter vivos trust.
Lottery
A contest that requires a purchase in order to qualify for a random drawing. Whether legal or illegal, lottery income is taxable.
Majority Shareholder
One of the shareholders who controls more than half the outstanding shares of a corporation.
Marital Deduction
A federal estate tax deduction permitting a spouse to take, tax free, the decedent spouse's total estate. The marital deduction thus permits property to pass to the surviving spouse without being depleted by the federal estate tax.
Member of Household
For purposes of the dependency exemption, a person who has lived with the taxpayer for the entire tax year.
Minimum Tax Credit
A credit allowed for the adjusted jet minimum tax paid in a prior year, against the regular tax liability for the current year.
For individuals, the adjusted net minimum tax is the alternative minimum tax reduced by the tax on exclusion-type preferences and adjustments. Exclusion-type preferences include depletion, and tax-exempt interest on private activity bonds. Exclusion-type adjustments include the standard deduction, itemized deductions, and personal exemptions.
Multiple Support Agreement
An agreement made by two or more taxpayers regarding the dependency exemption. When two or more taxpayers provide more than half of a person's support, but no one person provides more than half the support, an agreement can be made allowing one of the taxpayers to claim the dependent. Form 2120, Multiple Support Agreement, must be attached to the tax return of the individual claiming the dependency exemption. IRC §152.
Negligence
A lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the given circumstances. The term covers (1) omission of something that a reasonable person, guided by the considerations that ordinarily regulate the conduct of human beings, would do, and (2) doing something that a prudent, reasonable person would not do.
Net Operating Loss (NOL)
The excess of allowable deductions over gross income with certain specific adjustments set forth in the Internal Revenue Code, which are generally designed to limit the net operating loss deductions of individual taxpayers to business losses.
90-Day Letter
A formal notice after an audit indicating that a proposed deficiency will be assessed unless the taxpayer files a petition with the U.S. Tax Court.
Non-business Bad Debt
A bad debt in which the obligation was not generated by activities involving a trade or business, but perhaps by a personal loan. No deduction is allowed unless the debt is totally worthless, and then the deduction is treated as a short-term capital loss no matter how old the debt.
Nonresident Alien
An alien who is not a lawful permanent resident of the United States during the calendar year, does not meet the requirements of the substantial presence test, and does not elect to be treated as a resident alien. A nonresident alien is taxed on all effectively connected income as though he or she were a U.S. Citizen. Other U.S.-source income is taxed at a flat 30% rate. IRC §871.
Not for Profit Organization
An organization in which no stockholder or trustee shares in profits or losses and that usually exists to accomplish some charitable, humanitarian, or educational purpose: also called nonprofit organization.
Office Audit
An examination at an IRS office, generally of an uncomplicated tax matter.
Options
Warrants, convertible debt instruments, instruments other than debt that are convertible into stock, put options, stock interests subject to risk of forfeiture, and contracts to acquire or sell stock, Also included are certain buy-sell agreements, certain rights of first refusal, binding letters of intent to acquire stock, pledges of stock as security on debt from non-qualified lenders, and merger agreements.
Ordinary and Necessary Business Expenses
A tax provision that allows a current deduction for business expenses; contrasted with capital expenditure and unreasonable expense. An ordinary and necessary business expense of a sole proprietor would appear on Schedule C of Form 1040.
Ordinary Income
That is fully subject to ordinary income tax rates (e.g., interest income, dividend income, salary income), as distinguished from income that can benefit from the special tax rates for capital gain (loss). The tax rate for capital gains is less than the ordinary income rate.
Organization Cost
The amounts spent to begin a business enterprise, such as legal fees, business filing fees, and franchise acquisition. Expenditures by a corporation related to issuing or selling shares of stock or other securities are capitalized and not deductible.
Owner-Employee
A sole proprietor or partner who owns more than 10% of either the capital interest or the profits interest of the partnership. With an owner-employee, a Keogh retirement plan is subject to more stringent rules. IRC §401(c)(3).
Paid-In Capital
The capital received by a corporation from investors for stock, as distinguished from capital generated by earnings or donated. Paid-in capital may be important when determining whether a dividend is ordinary income or a nontaxable return of capital.
Partnership
An organization of two or more persons who pool some or all of their resources, abilities, and skills in a business and divide the profit or loss in predetermined proportions. A partnership may be a syndicate, group, pool, joint venture, or other unincorporated organization. Partnerships are generally not taxed but serve as conduits through which partnership income, losses, and other tax related items are passed to the partners, who include them on their personal tax returns. Partners are individually responsible for the debts of the partnership. In a limited partnership, however, the limited partners generally assume no monetary responsibility beyond the capital originally contributed. Generally, partners cannot deduct tax losses beyond their tax basis in their partnership interest. They may add their pro-rata share of mortgage debt to their investment contributed to determine basis. The death of a general partner or the sale or exchange of 50% or more of the total interest in capital and profits normally terminate the partnership.
Part-Time
Referring to employment that represents less than a full-time organizational commitment on the part of the employee. Part-time employees usually do not receive the same health insurance, retirement, and other benefits that full-time employees receive. For qualified retirement plan vesting purposes, part-time refers to an employee with less than 1,000 hours of service during a 12-month period.
Passive Activity
A term introduced by the Tax Reform Act of 1986; generally, any rental activity is considered passive, as is any other activity in which the investor does not materially participate. With certain exceptions, losses generated by passive activities may not be used to offset active income or portfolio income. Losses from passive activities are suspended until passive income is generated. IRC §469.
Pass-through Entity
A nontaxable entity such as a partnership, limited partnership, S corporation, simple trust, estate, regulated investment company, or real estate investment trust. Generally, the income or expense is passed to the underlying owner and retains its character as, for example, ordinary income, capital gain (loss), or charitable contribution.
Personal Injury Exclusion
An exclusion from income that is available for amounts received for personal injuries or sickness.
Placed In Service
Ready for use. A depreciable asset is deemed to be placed in service, when it is first placed in a condition or state or readiness and availability for a specifically assigned function; this date which fixes the beginning of the depreciation period. Reg. §1.167(a)-11(e)(1).
Prenuptial Agreement
A contract that limits, restricts, or eliminates the economic benefits that one spouse would otherwise have in the event of divorce or death. Such agreements are often entered into by spouses who have previously been married.
Principal Place of Business
The place where a person does business most of the time. Two primary considerations in deciding whether a home office is a person's principal place of business, and therefore deductible, are (1) the relative importance of the activities performed at each business location and (2) the amount of time spent at each place. Recent tax law changes have expanded the availability of a home office deduction to circumstances beyond the classification of such as the principle place of business.
Probate
1. Act of proving that an instrument purporting to be a will was signed and otherwise executed in accordance with the legal requirements for a will, and not determining its validity.
2. Combined results of all procedures necessary to establish the validity of a will.
Punitive Damages
Compensation in excess of actual damages that is a form of punishment to the wrongdoer and of reparation to the injured. Punitive damages are awarded only in rate instances of malicious and willful misconduct. They are taxable unless the damages arise from physical injury or sickness; such damages are excludable under IRC §104(a)(2).
Qualified Charity
An organization that has applied for and received tax-exempt status under IRC §501. Cumulative List of Organization, IRS Publication 78, lists many, but not all, of these qualified charities. A charitable contribution deduction may be available for contributions to states, universities, churches, veteran's organizations, cemetery companies, fraternal organizations, and community chests.
Qualified Scholarship
Any amount received for:
1. Tuition and fees to enroll at or attend an educational institution, or
2. Fees, books, supplies, and equipment required for courses at the educational institution.
Amounts used for room and board do not qualify. A candidate for a degree can exclude from income amounts received as a qualified scholarship. Exclusions for qualified scholarships or qualified tuition reductions do not apply to payments for teaching, research, or other services that the student is required to perform.
Relationship Test
For purposes of the dependency exemption, the following persons qualify as related to the taxpayer:
- child, grandchild, great-grandchild, or other lineal descendant
- stepchild
- brother, sister, half-brother, half-sister, stepbrother, or stepsister
- parent, grandparent, or other direct ancestor (but not foster parent)
- stepfather or stepmother
- brother or sister of the taxpayer's father or mother (i.e., uncle or aunt)
- son or daughter of the taxpayer's brother or sister (i.e., nephew or niece)
- father-in-law, mother-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law
Repairs
The work performed to return property to a former condition without extending its useful life, as distinguished from capital improvements. In income property, repairs are an operating expense for tax purposes. For example, patching a hole in a roof (but not replacing the roof) and mending (but not rebuilding) a fence are repairs.
Retirement Plan
A plan provided by an employer for an employee's retirement or by a self-employed individual for his or her own retirement. Because of the tax advantages, most qualified retirement plans are designed to ensure a present deduction to the employer, while the employee is permitted to avoid recognizing the income until he or she has actually or constructively received it.
Revenue Agent
A member of the Examination Division of the Internal Revenue Service. Revenue agents audit complicated and problematic individual and business returns, usually at the taxpayer's home or office. They set the scope of the examination and have authority to expand or restrict audits as circumstances warrant. A revenue agent has a college degree in accounting.
S Corporation
A corporation with a limited number of stockholders (75 or fewer) that elects not to be taxed as a regular a (C) corporation and meets certain other requirements. Shareholders include in their personal tax returns their pro rata shares of capital gains, ordinary income, tax preference items, and so on. This form avoids corporate double taxation while providing legal liability protection to the shareholders of the corporation.
Second Home
A residence that is not the principal residence. A taxpayer may deduct interest on two personal residences provided certain residence requirements are met.
Section 1031
The part of the Internal Revenue Code that deals with tax-free exchanges of certain property. The general rules for a tax-free exchange of real estate are that the properties must (1) be exchanged, (2) be like-kind property (real estate for real estate, e.g.), and (3) be held for use in a trade or business or held as an investment. The Tax Reform Act of 1984 allows delayed exchanges within certain limits.
Self-employed
Referring to persons who work for themselves and are not employed by another. The owner-operator of a sole proprietorship or a partner in a partnership is considered self-employed. Self-employed persons assume all the risk and responsibilities of a business enterprise and are subject to the self-employment tax, in addition to the income tax, on net income from self-employment activities. The self-employment tax is paid in lieu of the Social Security payments that are deducted from the wages of employees.
Simple Trust
A trust that is required, by the terms of its creation or under state law, to distribute all of its income currently. A simple trust is allowed a $300 standard deduction.
Start-up Firms
Companies for which, under the 1993 tax act, investors who hold qualified small business stock for at least 5 years are permitted to exclude 50% of the gains realized on the disposition of their stock. A qualified small business is a C corporation with less than $25 million of aggregate capitalization from January 1, 1993, through the date on which the taxpayer acquires stock in the corporation, that uses substantially all of its assets in the active conduct of a trade or business during substantially all of the taxpayer's holding period. Firms engaged in certain activities, including personal service, banking, leasing, real estate, farming, mineral extraction, and hospitality, cannot be qualified small businesses. Qualified small business tock must be acquired directly by an individual taxpayer (or indirectly by an individual taxpayer through an investment partnership or other pass-through entity) after December 31, 1992, and at its original issue price (either directly from the corporation or through an underwriter). A corporation that holds stock in a qualified small business does not qualify for the exclusion.
Individuals are allowed to exclude 50% of capital gains realized upon the disposition of qualified small business stock held over 5 years, and they apply their current statutory rate on capital gains (either 15% or 28%) to the reduced amount of taxable gain. Gain eligible for the exclusion is limited to the greater or ten times the investor's basis in the stock or $1 million for each qualified small business. One-half of any exclusion claimed is treated as a tax preference item under the individual alternative minimum tax
Statute of Limitations (SOL)
The time period during which the Internal Revenue Service may assess an additional tax or collect a tax or the taxpayer can file an amended return claim for refund. The statute of limitations is generally 3 years from the due date of the return or the date of its filing or, if later, 2 years from the date the tax was paid. The period can be extended by agreement between the taxpayer and the IRS. It is also extended for material omissions, and the statute does not apply if a required return is not filed or is fraudulent.
Stepped-Up Basis
A process by which a person's tax basis is increased to a certain level (usually the fair market value) as of a certain date. A stepped-up basis generally applies to property received by an heir from a decedent.
Tax Avoidance
Tax reduction through methods permitted by law, such as the deferral of income into the following year.
Tax Haven
A jurisdiction that allows transactions to take place in conditions of extreme secrecy that may allow taxpayers to avoid taxation. Some well-known tax havens are the British Virgin Islands, the Cayman Islands, Liechtenstein, the Netherlands Antilles, and Panama.
Tax Home
A taxpayer's regular place of business or post of duty, regardless of where the taxpayer maintains a family home. A tax home includes the entire city or general area in which the taxpayer's business or work is located.
Tax Planning
The systematic analysis of differing tax options aimed at the minimization of tax liability in current and future tax periods. Decisions on whether to file jointly or separately, when to sell an asset, when to withdraw retirement funds, when to pay expenditures, who is to receive income, the timing and amounts of gifts to be made, and estate planning are examples of tax planning.
Travel and Entertainment (T&E)
Expenses ordinary and necessary business expenses paid while traveling away from home for business, profession, or job. An ordinary expense is one that is common and accepted in a given business, trade, or profession. A necessary expense is one that is helpful and appropriate to the business. Lavish or extravagant expenses are not deductible. See also commuting expenses.
Wash Sale
A sale or other disposition of stock or securities at a loss accompanied by a purchase of substantially identical stock or securities during a period beginning 30 days before the date of sale or other disposition and ending 30 days after that date -- a total of 61 days. The taxpayer is denied a tax deduction for any loss incurred on a wash sale. If the disposition during the 61-day period is at a gain, it is not a wash sale, and the gain will be taxable. This rule does not apply to individuals who are traders or dealers in securities or to corporations that are dealers in securities if the sale or other disposition is made in the ordinary course of their businesses. When a loss is disallowed because of its being a wash sale, the basis of the substantially identical stock or securities acquired during the 61-day period is the cost thereof plus the amount of the loss disallowed.
Zero-Coupon Bond a security that makes no periodic interest payments but instead is sold at a deep discount from its face value. The buyer of such a bond receives the rate of return by the gradual appreciation of the security, which is redeemable at face value on a specified maturity date. Accrued interest is taxable annually.
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