Tax Glossary

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AARP – American Association of Retired Persons

This nonprofit organization (technically, a collective of nonprofit entities) serves Americans age 50 and older by providing health and safety guidance, retail discount offers and other benefits. People can join AARP regardless of their status as working or retired. The organization actively lobbies Congress on tax, healthcare and related issues affecting older and retired Americans.

ABLE Account

Named for the Achieving a Better Life Experience Act of 2014, an ABLE account is a tax-advantaged savings plan for a person with a qualifying disability. People with qualifying disabilities may set up these accounts for themselves, or the account may be established by the person’s designated agent, a relative or someone else authorized by the IRS or Social Security Administration. The disabled individual must be the sole beneficiary of the account. Anyone may make after-tax contributions to an ABLE account, as long as the total of all contributions does not exceed the annual contribution limit. Generally, ABLE accounts can grow in value tax-free, and beneficiaries may receive tax-free distributions throughout their lives, as long as the funds are used for qualified disability-related expenses.

Above-the-Line Deductions

Officially called adjustments to income by the IRS, above-the-line deductions are tax deductions that people may claim before figuring their adjusted gross income (AGI) on their tax returns. (Hence, these deductions appear above the AGI line on the return form.) Generally, if you qualify for these deductions, you may claim them regardless of whether you use the standard deduction or itemize deductions.

Accelerated Depreciation – see Bonus Depreciation. Accounting Methods

The IRS allows businesses, including individuals with self-employment income, to track income and expenses in several different ways. The main accounting methods for tax purposes are accrual accounting and cash accounting. Some small businesses and self-employed people may also qualify to use hybrid accounting, which blends the two other methods.

Accrual Accounting

Accrual accounting is one of two major bookkeeping methods (the other being the cash method) that businesses may use for tax purposes. With accrual accounting, a business reports income when it is earned, regardless of when payments are actually received (technically, constructively received). Similarly, expenses are recorded when they are incurred, regardless of the date of payment. The IRS allows many small businesses to choose between accrual and cash accounting, or to use a combination of the two (hybrid accounting). However, businesses in some industries, along with those with sales above a specified threshold, must use accrual bookkeeping methods.

Active Participation (Rental Income)

People are considered to actively participate in rental activities if they make significant business or rental management decisions, such as approving expenditures and projects, or overseeing rental terms and new tenant selection. The IRS guidelines for active participation are not as strict as the business material participation standards. Those who actively participate in rental operations may qualify for an exception to the passive activity loss rule, such as the special $25,000 allowance.

Active Pay, or Active Duty Pay

These terms refer to income that a military service member receives while on active duty, as opposed to retirement income or retainer payments received while the member has Fleet Reserve status. For some federal tax purposes, active duty pay is treated differently than other forms of military service income.

Actual Expense Method (for Business Vehicle Expense Deduction)

The actual expense method is one of two methods that businesses and self-employed people may use to calculate and deduct expenses related to business vehicle use. To use this method, tally up all relevant vehicle expenses, such as fuel and maintenance costs, auto loan interest, and parking fees and tolls. For a vehicle used for both business and personal purposes, prorate all expenses based on the vehicle’s business use percentage (measure by mileage). Alternatively, vehicle expense deductions may be calculated by using the standard mileage rate. Note that enterprises that operate a fleet of five or more vehicles generally must report actual expenses instead of using the standard rate.

Additional Child Tax Credit

People who qualify for the Child Tax Credit (CTC), but cannot claim the full credit amount because it exceeds their tax liability, may be eligible for the Additional Child Tax Credit (ACTC). This refundable credit can allow a person to claim part or all of their unused CTC as a tax refund.

Additional Medicare Tax

People whose earned income for a year exceeds a threshold set by the IRS must pay the Additional Medicare Tax. This tax is assessed on top of the standard Medicare tax component of FICA taxes. The income threshold depends on a person’s filing status. In most cases, an employer automatically withholds Additional Medicare Tax from an employee’s pay once the employee’s earnings for the year cross the threshold. However, people with multiple jobs or self-employment income may need to figure their Additional Medicare Tax on their tax returns, and may need to make quarterly estimated tax payments.

Adjusted Basis

This term can play a key role in calculating capital gains and losses. If you purchase investment property, then your cost basis in the property is typically the amount you paid for it, including commissions and fees. For gifted or inherited property, or property acquired in a trade, your initial basis might be based on the original owner’s basis, or on fair market values (FMVs) at the time of the transfer. Certain activities may subsequently decrease your basis, like claiming depreciation deductions for property used in a trade or business. Meanwhile, making substantial improvements to property may increase your basis. Taking all of these factors into account enables you to calculate your adjusted basis, which in turn must be used to figure a capital gain or loss.

Adjusted Gross Income (AGI)

Adjusted gross income (AGI) is the total of a person’s earned income and unearned income (their gross income), with certain exclusions and above-the-line deductions subtracted away. Your AGI (or the related MAGI) may affect your eligibility for tax benefits, such as the Child Tax Credit (CTC) and Premium Tax Credit (PTC). It may also affect the maximum value of your itemized deductions.

Adjustments to Income – see Above-the-Line Deductions. Adoption Taxpayer Identification Number (ATIN)

An Adoption Taxpayer Identification Number (ATIN) is a temporary, 9-digit ID that the IRS issues for a child in the process of being adopted. Sometimes, a child is placed in a home before the adoption process is finalized, and the adoptive parents cannot immediately obtain a Social Security Number (SSN) for the child. In these circumstances, the adoptive parents may obtain an ATIN, which enables them to claim the child as a dependent and/or qualifying child for certain tax benefits. Adoptive parents may apply for an ATIN by filing Form W-7A.

Advance Premium Tax Credit (APTC)

Many people who qualify for the Premium Tax Credit (PTC) under the Affordable Care Act (ACA) may choose to receive the credit as an adjustment to their health insurance premiums. This adjustment, called the Advance Premium Tax Credit (APTC), can significantly reduce the cost of healthcare coverage for an individual or family. If you receive the APTC, you will need to reconcile your monthly APTC premium reductions with your total PTC for the year when you file your tax return. To avoid issues with incorrect APTC amounts, inform the Health Insurance Marketplace where you purchased your coverage of any changes in your income, family size or other circumstances that may affect your PTC.

Affordable Care Act (ACA)

The Affordable Care Act (ACA) created the official Health Insurance Marketplace, where individuals and families can purchase private health insurance. Those who obtain coverage through the marketplace and have incomes below specified limits may qualify for the Premium Tax Credit (PTC), which is a refundable credit. Eligible people may choose to receive this credit as a reduction in their monthly health insurance premiums, known as the Advance Premium Tax Credit (APTC). The ACA also established minimum standards for health insurance coverage, and increased the number of Americans who qualify for free or very low-cost coverage through the Medicaid Expansion.

After-Tax Contributions

This term refers to contributions to certain tax-advantaged accounts like Roth IRAs and qualified tuition programs that are not tax-deductible. After-tax contributions do not reduce your tax liability for the year when they are made. However, later withdrawals from the account may be shielded from tax, resulting in tax-free growth. Also see pre-tax contributions.

Age Test

Various federal tax benefits, such as the Child Tax Credit (CTC), are only available to people with a qualifying child they can claim as a dependent. The IRS uses a number of tests to determine whether someone is your qualifying child. Age tests set a maximum age for qualifying children, which may depend on whether the child is a full-time student. Note that various IRS programs have their own age tests, so your qualifying child for one tax deduction or tax credit may not meet the test for another tax benefit.

Alimony

Alimony is a payment to a spouse or former spouse under a legal separation or divorce agreement. Depending on when the divorce occurred, alimony payments may or may not be taxable income for the recipient. Similarly, the person paying alimony may or may not be able to claim a tax deduction for the payments.

Allocated Tips

In most cases, employees who receive tips must report those tips to their employers, as well as to the IRS on their tax returns. If you work in a food or beverage establishment and the tips you report add up to less than a percentage of gross revenue specified by the IRS, then your employer may assign additional tips to you, called allocated tips. Generally, you must report the full amount of allocated tips assigned to you on your tax return. However, if you have records proving that your actual tips were less than the amount allocated by your employer, then you can qualify for an exception to this rule.

Alternative Minimum Tax (AMT)

When some people with higher incomes compute their tax using standard IRS formulas, their resulting tax liability falls below a minimum level set by law. For example, a person might qualify for very large tax deductions, resulting in little or no tax. In such cases, the person may have to pay a special tax called alternative minimum tax (AMT), which brings their total tax bill up to the required minimum threshold.

Alternative Fuel Motor Vehicle Credit (Credit for Alternative Fuel Vehicles)

The first version of this federal tax credit was created by Congress in 2006. The original law has since been extended, updated and/or replaced multiple times, most recently in the form of the Qualified Plug-In Electric Drive Motor Vehicle Credit (Electric Vehicle Credit). Generally, all of these programs allow people to claim a tax credit when they purchase certain electric, plug-in hybrid or other alternative fuel vehicles for personal or business use. In some cases, a person may assign the tax credit to the car seller, resulting in an immediate reduction of the vehicle’s purchase price. Alternative fuel vehicle credits are typically subject to income limits and other restrictions.

Amended Return / Amended Tax Return

People who discover that they filed an incorrect tax return, such as a return with errors or omissions that affect their tax liability, may need to file an amended return. Generally, an amended return must show the figures reported on the original return, the corrected figures, and the difference between them. In most cases, IRS Form 1040-X is used for this purpose.

American Opportunity Tax Credit (AOTC)

The IRS offers the American Opportunity Tax Credit (AOTC) for qualifying students for their first four years of higher (post-secondary) education. This partially refundable tax credit for tuition and required school fees may be claimed by either the student or another person (such as a parent) who claims the student as a dependent. To qualify, the student must be pursuing a degree or other recognized credential. In addition, the person taking the credit must have a modified adjusted gross income (MAGI) below the limit set by the IRS. In order to claim the AOTC on your tax return, you will need to obtain IRS Form 1098-T (Tuition Statement) from a qualifying higher education institution.

Amortization

The term amortization generally refers to depreciation expenses related to intangible assets like intellectual property. Tax deductions for amortization are figured in the same way as other depreciation deductions, but determining an intangible asset’s useful life may be a somewhat complicated process.

Amount Realized

When you sell property with the potential result of a capital gain or loss, your “amount realized” is the selling price minus certain expenses necessary for the sale. Those expenses may include commissions, loan charges (such as points), and advertising and legal fees.

Annual Contribution Limits

The IRS sets yearly limits on the amount of money that people may contribute to various tax-advantaged accounts. Savings plans subject to such annual contribution limits include health FSAs, MSAs, ABLE accounts, IRAs and various other qualified retirement plans. Exceeding an annual contribution limit may disqualify a person from receiving the account’s usual tax advantages.

Annual Gift and Estate Tax Exclusion

The annual gift exclusion allows people to give away a certain amount of money or property each year without having gift and estate tax reporting or payment obligations. Gifts below the annual exclusion threshold do not count toward the donor’s lifetime exclusion. Importantly, the annual exclusion applies to the amount given away per beneficiary, and there is no limit on the number of beneficiaries a person may make gifts to during a given year. Note that gifts in excess of the annual exclusion amount generally must be reported to the IRS, but do not necessarily get taxed. In most cases, gifts only become taxable events once the donor has exceeded the lifetime exclusion.

Annuity

An annuity is a contract with an insurance company, trust or other entity that provides a person with long-term income. An annuity may be purchased with either a lump-sum payment or a series of payments specified in the contract. Thereafter, the individual receives regular payments (usually monthly or annually) over the length of the contract. Most commonly, annuity agreements last for 10, 15 or 20 years. Annuity payments are generally taxed as ordinary income.

Archer MSA (Medical Savings Account)

An Archer MSA (named for a congressman who wrote key parts of the legislation) works much the same way as a health savings account (HSA). For that reason, once HSAs came into common use, Congress voted not to allow people to start new Archer MSAs. However, those who already had Archer MSAs could continue contributing to and using their accounts. If you have an Archer MSA and a high-deductible health plan (HDHP), then you or your employer can make pre-tax contributions to the account. However, unlike with an HSA, an employee and employer cannot both contribute to an Archer MSA during the same year. You can withdraw Archer MSA funds tax-free, as long as you use them for qualified medical expenses.

ATIN – see Adoption Taxpayer Identification Number. At-Risk Rule

In many cases, people who engage in business activities and other self-employment pursuits can use business losses to offset other income, reducing their tax liability. However, the IRS limits losses that may be claimed in relation to a passive activity that generates business or rental income. Under the at-risk rule, you cannot claim a passive active loss greater than the amount of investment for which you are personally at risk. In other words, the loss you claim must be no more than the maximum amount of money you stand to lose in the event of a business failure. Also see passive activity rule.

Automatic Filing Extension (6-Month Extension)

All individuals and some businesses may request an automatic six-month extension to file their tax returns. For example, if the standard IRS filing deadline is April 15, then people who request an automatic extension have until October 15 to file their returns. Because the extension is automatic, your request does not require IRS approval. Note, however, that an automatic 6-month extension generally applies only to filing your return, NOT to paying any tax due.

BAH and BAS – Excludable income for Military Members

The IRS allows members of the Armed Services to exclude certain cash benefits from their gross income for tax purposes. These income exclusions include the basic allowance for housing (BAH) and basic allowance for subsistence (BAS). Excludable income is not subject to federal income tax, and usually does not have to be reported on a person’s tax return.

Basis

To determine whether you had a capital gain or loss from the sale of property like a home, stocks, artwork, musical instruments or virtual currency, you need to know your basis in the property. Basis is essentially a measure of your total investment. If you purchase or build property, then your basis is typically the purchase price or building cost, including fees and commissions. If you trade for property, then your basis may be the fair market value (FMV) of either the property you give up or the property you receive. In these scenarios, your basis may be called cost basis. For inherited or gifted property, your initial basis may be determined by its FMV, the previous owner’s basis or other factors. Some activities, such as making improvements to a building or claiming depreciation deductions, can increase or decrease your basis in an asset. In these cases, you may need to determine your adjusted basis.

Before-Tax Contributions – see Pre-Tax Contributions. Bequeath / Bequeathal / Bequest

These terms usually refer to the act of passing property along to heirs, or otherwise giving it away as instructed in a deceased person’s will. For example, if Armon’s last will dictates that $200,000 of his assets are to be given to the local library upon his death, then Armon has bequeathed this money to the library. Similarly, if Armon’s son and daughter receive his house as an inheritance, then Armon bequeathed the home to them. In both cases, the transferred property is called a bequeathal or bequest. Bequests in excess of the donor’s lifetime exclusion may be subject to gift and estate tax.

Blocked income

Generally, U.S. citizens and residents must report and pay tax on their foreign income in U.S. dollars. In some cases, however, foreign income cannot be readily converted into U.S. dollars due to laws or other restrictions imposed by a foreign government. The IRS calls this non-convertible income blocked income. In most cases, people may choose to either report and pay tax on blocked income, or defer reporting and paying tax on the income until it is unblocked. If you choose to defer paying tax on blocked income, then you generally must submit an information return called a Report of Deferrable Foreign Income, to explain the situation to the IRS.

Bona Fide Residence (or Residency) Test

The IRS applies multiple tests to determine whether a person qualifies for the foreign earned income exclusion. The bona fide residence test generally requires people to prove that they have set up a permanent residence in a foreign country and maintained it for an entire, uninterrupted year. Depending on details of their period of stay in a foreign country, people who do not meet this test may still qualify for the exclusion based on the physical presence test.

Bonus Depreciation

Also called accelerated depreciation, bonus depreciation allows businesses and self-employed people to deduct the cost of capital business expenses more quickly than standard depreciation rules would allow. For example, a business that qualifies for bonus depreciation might be able to deduct 50% or more of the cost of new machinery during the year when it was first put into service. The business would then take smaller depreciation deductions throughout the remaining years of the machinery’s useful life.

Book Value (of a Capital Asset)

The book value of capital property is the theoretical remaining value of the asset, as indicated by depreciation deductions. Generally, book value is equal to the owner’s basis minus those deductions. For example, suppose that you purchase business equipment at a total cost of $15,000. You claim a $2,600 depreciation deduction for the equipment in each of the first three years after putting it in service, for a total of $2,600 X 3 = $7,800 in deductions. After those three years, the book value of the equipment would generally be $15,000 – $7,800 = $7,200. At the end of the recovery period for an asset, its book value should equal its salvage value.

Business Entity or Business Entity Type

A business entity (or business structure) is a legal framework for the ownership of an enterprise. The type of entity established affects not only how a business is taxed, but also how well the owners’ personal assets are protected from a business failure or legal action against the company. The most commonly used business entities are sole proprietorships, partnerships, limited liability partnerships (LLPs), limited liability companies (LLCs), S corporations, C corporations and nonprofit organizations. Setting up a business entity other than a sole proprietorship often requires the assistance of both a tax professional and a business attorney.

Business Expenses – Basic IRS Rules

People with business income, including sole proprietors, independent contractors, self-employed freelancers and many gig economy workers, may generally deduct business expenses on their tax returns. These deductions reduce tax liability by lowering the net profit of a person or business. IRS rules state that in order to be deductible, an expense must be “ordinary and necessary” to conduct a trade or business. There is no precise definition of these terms, but the basic ideas are:

Ordinary: Broadly, this term means that the expense is common within a particular trade or industry. For example, purchasing sheet metal would be ordinary for a welder, but not for a freelance writer. The more unusual an expenditure is within your field, the better prepared you should be to show how it contributes to your ability to earn income.

Necessary: To qualify as “necessary,” a business expense does not have to be absolutely indispensable. However, it does need to have a clear connection to the ongoing success of your business or self-employment activities.

Business Income

For tax purposes, this term refers to income not only from formal business ownership, but also from a broad range of self-employment activities. These activities may include freelancing, gig economy work, or work as an independent contractor or artist. Note that if you accept goods, property or services as forms of payment in the course of your business activities, you generally must include the fair market value (FMV) of those payments in your business income. Business income may be subject to both income tax and self-employment tax. People with significant business income may need to make quarterly estimated tax payments to avoid tax penalties.

Business Structure – see Business Entity. Business Use of a Home – see Home Office Deduction. Business Vehicle Expense Deduction

Business owners and self-employed people may generally deduct expenses related to business use of one or more vehicles on their tax returns. This deduction may generally be calculated either by tracking and reporting actual expenses in detail, or by using the IRS standard mileage rate.

Cafeteria Plan / Cafeteria Benefits Plan / Cafeteria 125 Plan

The term cafeteria plan refers to a variety of employer-sponsored benefit packages with optional participation, and rules based on Section 125 of the federal tax code. Cafeteria plans often include tax-advantaged accounts that can be funded with pre-tax contributions, such as flexible spending arrangements (FSAs), health savings accounts (HSAs) and 401(k) plans. Some employers also offer cafeteria plans for term life insurance, adoption costs or dependent care expenses.

Capital Asset / Capital Property (Personal)

The terms capital asset and capital property generally refer to property held as an investment and/or used to generate income. Examples of personal capital property include real estate, artwork, stocks and virtual currency. Selling capital property may result in a capital gain or loss.

Capital Business Asset / Capital Business Property

A capital business asset, or capital business property, is any capital asset that is either held by a business entity (like an LLC or corporation), or used by an individual for business purposes. Common examples of capital business property include financial assets, intangible assets like intellectual property, and fixed assets like buildings, machinery, furniture and computers. Selling capital business property may result in a capital gain or loss, and possibly the need to report a depreciation recapture. Also see Capital Business Expense.

Capital Business Expense

The IRS divides business expenses into two main categories: operating (or ordinary) expenses and capital expenses. The category of capital expenses includes costs associated with acquiring capital business assets, including not only purchase prices but also required taxes, commissions and fees. Under standard IRS rules, a capital expense cannot be deducted all at once. Instead, the cost usually must be recovered gradually, through depreciation deductions. However, some capital assets may qualify for bonus depreciation, or for a one-time Section 179 Expense deduction.

Capital Gain or Capital Loss

The sale of real estate, stocks, antiques, musical instruments, mutual funds, virtual currency, artwork, capital business property or other long-term investment assets may result in a capital gain or capital loss. The amount of gain or loss is the difference between your basis or adjusted basis in the property, and the amount realized in the sale (the selling price minus necessary expenses). If the amount realized is greater than your basis, then you generally must report a capital gain, which may be subject to capital gains tax. If your basis is greater than the amount realized, then you may have a capital loss that can be used to offset capital gains or other income, reducing your tax liability. Capital gains and losses are classified as either short-term or long-term:

Short-term capital gain or loss: This classification generally applies to a gain or loss from the sale of property held for a year or less. Long-term capital gain or loss: This classification generally applies to a gain or loss resulting from the sale of property held for more than a year. Capital Gain Distributions

Certain investment portfolios and packages, such as mutual funds and real estate investment trusts (REITs), distribute capital gains to investors. Recipients of these capital gain distributions generally must report the income on their personal tax returns. Capital gain distributions are usually taxed at the long-term capital gains tax rate. Also see Capital Gains Tax, along with long-term capital gain or loss under Capital Gain or Capital Loss.

Capital Gains Tax

The IRS and many states assess capital gains tax on income derived from the sale of investment or business property. The rules for capital gains tax may differ significantly from the tax rules for other income. To determine whether you owe capital gains tax, first calculate your net capital gain or net capital loss for the year. The tax rate that applies to a net gain will depend on your adjusted gross income (AGI), and on how long you held the property in question. Also see short-term capital gain or loss and long-term capital gain or loss under Capital Gain or Capital Loss, and Capital Gains Tax Rate.

Capital Gains Tax Rate

This term usually refers to special tax rates applied to long-term capital gains. By contrast, short-term capital gains are generally taxed as ordinary income. Also see long-term capital gain or loss under Capital Gain or Capital Loss.

Capital Loss Carryover

The IRS generally limits the dollar value of capital losses that people can use to offset other income, reducing their tax liability. The maximum loss that can be used as an offset during a particular year is referred to as the capital loss deduction limit. In most cases, losses above the limit may be carried forward to future years. You may generally repeat this capital loss carryover process until excess losses get completely used up.

Capital Loss – see Capital Gain or Capital Loss. Capital Loss Deduction Limit

The IRS limits the extent to which people can use capital losses to offset other income, reducing their tax liability. The maximum dollar value of losses that may be used for this purpose is known as the capital loss deduction limit. Also see Capital Loss Carryover.

Capitalization of Expenses

Rather than being claimed on a single tax return, certain deductible expenses must be divided up between multiple tax years. For example, a self-employed person might claim a deduction for 1/4 of a particular business expense in each of four consecutive years. This process is called capitalization of the expense. The most common forms of expense capitalization are depreciation and amortization.

Cash Accounting

Cash accounting is one of two major bookkeeping techniques that businesses may use for tax purposes (the other being accrual accounting). With cash accounting, a business or self-employed person reports income when it is constructively received, regardless of the date of the underlying transaction. Similarly, most expenses are recorded when they are paid, regardless when they are incurred. Many businesses that generally qualify to use cash accounting for tax purposes must use accrual methods for a few specific situations, such as inventory accounting. In such cases, the IRS may allow hybrid accounting, which involves using accrual bookkeeping for limited purposes, and cash accounting for all other transactions.

C Corporation

Also called a traditional or true corporation, a C corporation is a business entity that, for tax and legal purposes, exists separately from its owners or shareholders. C corporations generally must pay corporate income tax, which can lead to double taxation. However, the C corporation structure also provides the highest degree of personal asset protection for shareowners in the event of a business failure, lawsuit or other legal action against the company.

Charitable Contributions / Charitable Donations Deduction

People who itemize deductions may claim a tax deduction for contributions they make to qualifying nonprofit charities. The maximum allowed deduction for charitable donations is typically based on a percentage of a person’s adjusted gross income (AGI). Contributions in excess of the deduction limit may generally be carried over to the next tax year. Generally, people who use the standard deduction cannot deduct charitable contributions, except in years when special IRS rules apply. Corporations may also deduct charitable contributions, up to an annual limit based on the company’s taxable income.

Child and Dependent Care Credit

The IRS offers this credit to people who pay for the care of a qualifying child under the age of 13, or the care of other dependents of any age who cannot care for themselves. To be eligible for this credit, a person must have earned income, and must pay the care expenses to make it possible to work or seek work. Based on a person’s income, the credit may be as high as 50% of qualifying care expenses.

Child Tax Credit (CTC)

People with adjusted gross incomes below a limit set by Congress may claim the Child Tax Credit (CTC) for each of their qualifying children. This credit can reduce an individual or married couple’s tax by thousands of dollars. Depending on current laws, the CTC may be a nonrefundable credit, partially refundable credit, or entirely refundable credit. Also see Additional Child Tax Credit.

Children’s Health Insurance Program (CHIP)

This federal government program provides low-cost healthcare coverage to children in families whose incomes are too high to qualify for Medicaid, but too low to purchase health insurance. Some states also allow families with slightly higher incomes to buy into CHIP coverage for an increased premium amount. Any premiums that a family pays for such a CHIP buy-in program may qualify for the Premium Tax Credit (PTC) under the Affordable Care Act (ACA).

Citizen or Resident Test / Citizenship or Residency Test

Some tax credits and deductions are available only to people who claim a qualifying child or other qualifying relative as a dependent. One of the tests the IRS uses to determine whether a person is a qualifying dependent is the citizenship or residency test. In general, this test requires that the person be a U.S. citizen for some part of the year, and/or live in the U.S., Canada or Mexico for some part of the year.

Clean Vehicle Credit – see Qualified Plug-In Electric Drive Motor Vehicle Credit. Combat Zone (Special Tax Rules for Armed Services Personnel)

Members of the U.S. Armed Forces who serve in a designated combat zone may typically exclude military pay from their taxable income. However, eligible military personnel may instead elect to include combat pay in their reported income for the purpose of qualifying for the Earned Income Tax Credit. In general, a combat zone is any area that (1) the President of the United States designates by Executive Order as an area in which U.S. forces are engaged in combat; (2) the Department of Defense has certified for combat zone tax benefits; or (3) has been established by statute as a Qualified Hazardous Duty Area where service members receive imminent danger pay.

Compensation

For tax purposes, the term compensation refers to a wide range of benefits that a person might receive for work or business activities. Forms of potentially taxable compensation include wages, salaries, commissions, tips, bonuses, royalties, professional fees, earnings from self-employment, and various non-monetary benefits like free housing or free personal use of a company vehicle.

Community Income

This term refers to income received by either spouse in a married couple whose domicile is a community property state.

Community Property State

A community property law holds that any assets or property acquired by either spouse during a marriage belongs equally to both spouses. States that operate under laws of this type are called community property states. Some IRS rules apply differently for married couples in community property states than for couples in other states. These differences may affect both couples who file joint returns and those whose filing status is married filing separately.

Constructively Received

In tax accounting, income and other payments are considered constructively received when they become available to the recipient (or recipient’s agent) without restriction. In other words, you have constructively received income if you have full control over the money or property, even if you have not yet converted it to cash or deposited it into an account. If your business uses cash accounting, you should generally report all income on the date it was constructively received.

Contractor – see Independent Contractor, and also Employee vs. Independent Contractor. Conversion (of Retirement Account) – see IRA Conversion. Contribution Limit – see Annual Contribution Limits. Corporate Income Tax

This term refers to federal or state income tax paid by C corporations. Corporate income taxes have their own tax rates and tax brackets, separate from the rates and brackets for individuals.

Cost basis

Cost basis generally refers to a person’s or company’s initial investment in a capital asset. In most cases, cost basis is the total amount paid to acquire the property, including any required taxes, fees or commissions. However, your cost basis for a particular asset could also be based on the fair market value (FMV) of the property when you took possession of it, the former owner’s basis, or the FMV of any goods, services or property that you exchanged for it. Cost basis plays a critical role in calculating a capital gain or capital loss. Also see Adjusted Basis.

Cost of Goods Sold (COGS)

An important component of inventory accounting, cost of goods sold (COGS) represents the total amount that a business or self-employed person paid to acquire or manufacture the products that they sold in a given year. Generally, COGS is subtracted from gross revenue to compute the gross profit of a business. As a simple example, if you purchase a single item for $350 and then sell it for $525, your COGS is $350, your gross revenue is $525, and your gross profit is $525 – $350 = $175.

Coverdell Education Savings Account (ESA)

A Coverdell ESA is a tax-advantaged account created for the purpose of paying the qualified education expenses of a designated beneficiary. Qualified education expenses typically include tuition and school fees, along with certain other required purchases like books and supplies. Individuals may make after-tax contributions to an ESA if their adjusted gross income (AGI) is below a specified limit, while trusts and corporations may generally contribute to ESAs regardless of their income. The beneficiary of an ESA may subsequently take tax-free withdrawals from the account to pay qualified education expenses. Overall, a Coverdell ESA works similarly to a qualified tuition program plan, also called a Section 529 plan.

Credit – see Tax Credit. Credit for the Elderly or Disabled

This nonrefundable tax credit is available to people who are 65 years old or older, or retired due to permanent disability, and have incomes below a limit set by the IRS. Because the credit is nonrefundable, it can reduce or eliminate a person’s tax bill, but cannot generate an IRS refund.

Credit for Other Dependents

This nonrefundable tax credit is available to people with one or more dependents who do not meet the criteria to be qualifying children for the Child Tax Credit (CTC). The maximum credit amount is significantly lower than the CTC, so always check your eligibility for the CTC before claiming the Credit for Other Dependents.

Cryptocurrency

Like other virtual currencies, cryptocurrencies (“crypto” for short) are digital assets that are not regulated or distributed by a national government. The term cryptocurrency refers to the computer coding that supports the creation and distribution of these currencies. People must report a wide variety of crypto transactions on their tax returns, because those transactions may generate taxable capital gains. Also see Virtual Currency Tax Rules.

Cryptocurrency Tax Rules – see Virtual Currency Tax Rules.

Date of Transaction

IRS rules sometimes require people or businesses to report exactly when a particular transaction occurred. For example, if a transaction is conducted in a foreign currency, then the conversion to U.S. dollars should be based on the exchange rate on the date when the transaction occurs. For individuals, the official date of a transaction is typically either the date when they make a payment, or the date when they constructively receive income. For a business, the correct transaction date for tax purposes may depend on whether the business uses cash accounting or accrual accounting.

Deduction – see Tax Deduction. Deduction for Business Use of a Home / Deduction for Home Office – see Home Office Deduction. Deduction for One Half of Self-Employment Tax

People with self-employment income may generally claim a tax deduction for one-half of the self-employment tax that they owe for a given year. This is an above-the-line deduction, so you do not need to itemize deductions in order to claim it.

Defined Benefit Plan – see Pension. Defined Contribution Plan – see Pension. Department of Veterans Affairs (VA)

This federal government agency manages a wide variety of programs and benefits for U.S. military veterans, including VA disability compensation, military pensions, and free or low-cost medical care. Many VA benefits qualify as excludable income, and so are not subject to federal income tax.

Dependency Tests

This term refers to the various rules that the IRS applies to determine if someone qualifies as a person’s dependent for tax purposes. The main dependency tests are the Support Test, Age Test, Relationship or Member of Household Test, Gross Income Test, Joint Return Test, and Citizen or Resident Test.

Dependent

In general, a person is your dependent if you provide significant financial support for that person (usually more than half of the person’s total support), and the person meets several other dependency tests. Having one or more dependents may make you eligible for tax benefits like the Child Tax Credit (CTC), Earned Income Credit (EITC) or Credit for Other Dependents. If you are unmarried, having dependents may also qualify you to use Head of Household or Qualifying Surviving Spouse as your filing status.

Dependent Exemptions / Dependency Exemptions

Depending on current tax laws, a person may qualify to claim income adjustments called exemptions in addition to tax deductions like the standard deduction or itemized deductions. As the name suggests, dependent exemptions are based on the number of dependents a person has. When they are allowed, exemptions work similarly to deductions, reducing a person’s tax liability by lowering their taxable income. Also see personal exemption.

Dependent Care Benefits

Some workplaces provide dependent care benefit programs for employees. These programs help employees who have qualifying dependents pay for child care or other services that allow the employee to work. In some cases, the employee can make pre-tax contributions to a dependent care flexible spending arrangement (FSA), then withdraw funds from the account tax-free for qualifying care expenses.

Dependent Taxpayer Test

This term may refer to two different IRS rules: (1) If another person can claim you as a dependent for tax purposes (even if they choose not to do so), then you will generally have a reduced standard deduction. You also may not qualify for certain tax benefits. (2) When determining whether a person is your qualifying child or qualifying other relative dependent, you need to know whether anyone else could claim that person as a dependent. In such cases, only one of you may claim the dependent.

Depreciated Asset

This term refers to any property for which a person or business has claimed depreciation deductions.

Depreciable Cost

The depreciable cost of a capital business asset is the portion of its acquisition cost that qualifies for depreciation deductions. In other words, it is the depreciable part of a capital business expense. For most property, the depreciable cost is equal to the acquisition cost minus the property’s salvage value. The total of all depreciation deductions claimed for a particular asset cannot exceed its depreciable cost.

Depreciation / Depreciation Deductions

For tax purposes, depreciation is the process of claiming tax deductions for a capital expense over a series of years. It is the most common example of capitalization of an expense. Depreciation usually involves deducting a portion of the cost of an asset each year throughout a specified depreciation period. However, businesses and self-employed people can sometimes shorten the timeline through the use of bonus depreciation or Section 179 deductions. The two most common methods of calculating depreciation deductions are the straight-line method and the modified accelerated cost recovery system (MACRS). In some cases, the IRS allows alternative depreciation techniques, such as the units of production method. Also see Amortization.

Depreciation Period

Also called a recovery period, a depreciation period is the number of years required to deduct the total depreciable cost of property through annual depreciation deductions. For example, if IRS rules require a business to deduct the cost of new machinery gradually over the course of six years, then the machinery has a 6-year depreciation period. Depending on the date an asset is put into service and the depreciation method used, the asset’s depreciation period may differ slightly from its useful life.

Depreciation Recapture

The process of depreciation is based on the assumption that a capital asset will lose value over time, ultimately retaining only a nominal salvage value or no value at all. The theoretical remaining value of an asset at any point during the depreciation process is known as its book value. However, the true residual value of property may be significantly higher than its book value. If you sell or exchange a depreciated asset for more than its book value (or more than its salvage value after the depreciation period ends), then you may need to report that gain as a depreciation recapture. A depreciation recapture may be taxed as ordinary income, rather than at capital gains tax rates.

Digital Assets

This term refers to not only virtual currencies like cryptocurrency, but also other purely digital commodities like non-fungible tokens (NFTs). Many types of transactions involving digital assets must be reported to the IRS, because those transactions may result in a capital gain or loss.

Direct Expenses – see Home Office Deduction. Disability Income

This term generally refers to payments that a person receives to replace wages or other earned income while the person is unable to work due to a disability. Disability income may come from an employer, Social Security benefits or some other source. Depending on circumstances, disability payments may be either excludable income or taxable income.

Disability Pension

This special type of pension is paid to an employee who retires early due to a permanent disability. Different tax rules may apply for disability pension payments than for other pension benefits. However, once a person receiving disability pension benefits reaches standard retirement age, further benefits from the plan are usually treated as ordinary pension income.

Disaster Tax Relief Programs

The IRS offers a variety of tax relief programs for people and businesses affected by disasters like storms, floods, earthquakes and wildfires. These programs are usually available only in areas covered by major disaster declarations signed by the President. Relief measures may include tax filing and/or payment extensions, special tax deductions, and waivers of tax penalties and IRS interest. People who lose vital records in a disaster may also request free transcripts of their past tax returns from the IRS.

DITY Move or DIY Move (Military) – see Personally Procured Move. Dividends Corporations typically distribute earnings to shareholders in the form of stock dividends, often on a quarterly basis. Like other investment returns, dividends are generally taxable income. Different tax rates may apply for ordinary dividends than for qualified dividends. Domestic Employee – see Household Employee. Domicile

A person’s domicile is the state where they maintain a legal, permanent residence. Note that your domicile might not be the same as the state where you currently reside. For example, if you have a permanent home in Tennessee but live for two years in a rented home in Delaware to complete a work contract, your domicile would generally still be Tennessee. If you regularly use homes in multiple states, then the IRS and state governments will apply a variety of tests to determine which state is your domicile.

Double Taxation

The term double taxation refers to any situation where the IRS or a state revenue department taxes the same income twice. A common example of double taxation occurs with C corporation earnings. The company generally must pay corporate income tax on its net profits. Stockholders then pay individual income tax on any stock dividends they receive, which are distributions from those same profits.

DRIP (Dividend ReInvestment Plan) Accounts

A DRIP account allows stockholders in a company to automatically reinvest dividends to purchase new shares (or in some cases, fractions of shares) of stock. In most cases, the dividends that are reinvested through a DRIP account are still considered taxable income for the stockholder.

Dual Status Alien

The IRS designates a person as a dual-status alien if the person was both a resident alien and a nonresident alien during the same tax year. Such dual status most often occurs during the year when a person arrives in or departs from the U.S. Since different tax rules apply for resident and nonresident aliens, people classified as dual-status aliens must take extra care when preparing their tax returns.

Dual-use Property

This term most often refers to property that a person uses for both personal and business purposes. Common examples include vehicles, computers and cell phones used by independent contractors, freelancers and sole proprietors. When deducting business expenses related to dual-use property, you generally must prorate each expense based on your percentage of business use. For example, if you use your computer for business purposes 40% of the time, then you may claim at most 40% of costs related to the computer (such as repairs and software updates) as business expenses.