Tax Glossary
Please use the "Tax Glossary" below to search out tax terms and their meanings
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Accelerated Cost Recovery System (ACRS)
The system of depreciation that came into effect in 1981, replacing
traditional methods of depreciation based on useful life. Under ACRS, costs
of qualified property are written off over predetermined periods. The
minimum number of years and the applicable percent of cost that may be
deducted each year depends on the class of the property. The Tax Reform Act
of 1986 contained several changes to the ACRS rules. The changes are
generally effective for property placed in service after December 31, 1986.
Accelerated Depreciation
Various methods of depreciation that yield larger deductions in the earlier
years of the life of an asset than does the straight-line method. The
double (or 200 percent) declining balance method is an example of an
accelerated depreciation method.
Accident and Health Benefits
Employee fringe benefits provided by employers through the payment of
health and accident insurance premiums or the establishment of
employer-funded medical reimbursement plans. Employers generally are
entitled to a deduction for such payments. Employees generally exclude the
benefits from gross income.
Accountable Plan
A plan for reimbursing employees for expenses such as meals, entertainment,
travel, and transportation incurred for business purposes on behalf of the
employer. A plan is an accountable plan if the employer requires the
employee to account for all business expenses and to return any excess
reimbursements. For employees under an accountable plan, reimbursements
aren't entered on the tax return as income and the expenses aren't
deductible.
Accounting Method
The method under which income and expenses are determined for tax purposes.
Major accounting methods are the cash method and the accrual method.
Accounting Period
The 12-month period that a taxpayer uses to determine federal income tax
liability. Unless a taxpayer makes a specific choice to the contrary, his
accounting period is the calendar year.
Accrual Method of Accounting
One of the two most common methods of accounting, the other being the
cash method. Under the accrual method of accounting, income is reported
in the tax year earned, whether or not received, and deductions are claimed
in the tax year incurred, whether or not paid.
Accrued Interest
Interest that has been earned but not yet paid or credited; for example,
interest earned on a bond since the last interest payment was made.
Acquisition Debt
Debt incurred to acquire, construct, or improve the taxpayer's principal or
secondary residence.
Active Income
For purposes of the passive loss rules, income must be divided into three
categories: active income,
passive income, and
portfolio income. Active income is income for which the taxpayer
performs services. Examples are wages, salaries, tips, bonuses, and
business and partnership income in which the taxpayer materially
participates in the business or partnership. See
Passive Income and
Portfolio Income.
Active Participant
A taxpayer who is covered by an employer-maintained qualified retirement
plan, or a qualified self-employed retirement plan, if even for only one
day during the year.
Actual Expenses (Regular Method)
The method of deducting automobile expenses based on actual costs incurred.
Additional Child Tax Credit
A refundable credit available to taxpayers with three or more children
qualifying for the child tax credit and whose regular child tax credit
exceeds tax liability minus other nonrefundable credits. The additional
child tax credit is computed on Form 8812. See also
Child Tax Credit.
Adjusted Basis
The cost or other original basis of property reduced by adjustments such as
depreciation allowed or allowable and increased by capital improvements and
other adjustments.
Adjusted Gross Income (AGI)
Adjusted gross income equals gross income less reductions that are
allowable regardless of whether personal deductions are itemized. On the
2001 tax forms, AGI is entered on line 4, Form 1040EZ; line 19, Form 1040A;
and line 33, Form 1040.
Adjustment to Income
An expense that may be deducted even if the taxpayer does not itemize
deductions. Adjustments to income are subtracted from gross income to
arrive at adjusted gross income.
Adoption Credit
A nonrefundable credit for qualified adoption expenses incurred for each
eligible child. The credit cannot exceed $5,000 per child, or $6,000 per
special-needs child. The limit is a per-child limit, not an annual limit,
and can be carried forward for five years or until used. Note: After 2001,
the credit will be available for special needs children only.
Advance Earned Income Credit
Payment by an employer based on an employee's claim to entitlement to the
earned income credit. Advance earned income credit payments are treated as
additional taxes on the tax return.
Advance Payments
Prepayments for services or goods that generally are includable in gross
income upon receipt for both accrual- and cash-basis taxpayers.
Alimony Payments
Payments made by one spouse to the other spouse or former spouse under a
separation or divorce agreement. Qualified alimony and separate maintenance
payments are includable in the gross income of the recipient and are
deductible by the payer. Child support payments, voluntary payments, and
property settlements are not treated as alimony.
Alternate (Straight-Line) ACRS Method (Accelerated Cost Recovery
System)
Under this method, the ACRS deduction is computed using a straight-line
percent and, in some cases, an optional longer recovery period.
Alternative Minimum Tax (AMT)
The alternative minimum tax is designed to prevent taxpayers from escaping
a fair share of tax liability by use of certain tax breaks. A taxpayer is
subject to this tax if he or she has certain minimum tax adjustments or tax
preference items and his or her alternative minimum taxable income exceeds
the exemption allowed for his or her filing status and income level. The
alternative minimum tax is computed on Form 6251.
Alternative Straight-Line Depreciation System
A MACRS (Modified Accelerated Cost Recovery System) system of depreciation
using the straight-line method over an alternative (usually longer)
recovery period.
Amended Return
A tax return filed on Form 1040X after the original return has been filed.
An amended return is used to correct errors or to claim more advantageous
ways of filing the original return. An amended return can also be used to
carry back certain unused credits or a net operating loss.
Amortization
The deduction of certain capital expenses over a fixed period of time.
Amortization is claimed on Form 4562. Amortizable expenses include business
start-up expenses, qualified forestation or reforestation costs, goodwill,
going-concern value, covenants not to compete, franchises, trademarks,
trade names, and section 197 costs.
Amount Realized
The amount received by a taxpayer on the sale or exchange of property. The
amount received is the sum of the cash and the fair market value of any
property or services plus any of the seller's liabilities assumed by the
purchaser. Determining the amount realized is the starting point for
arriving at realized gain or loss.
Annualized Income
The actual income and expenditures for a particular period multiplied by
the ratio of the number of months in the period to 12 months.
Annuitant
A person who receives a pension or an annuity.
Annuity
A fixed sum payable to a person at specified intervals for a specific
period of time or for life. Payments represent a partial return of capital
and a return on the capital investment. Therefore, an exclusion ratio must
generally be used to compute the taxable and nontaxable amounts.
Annuity Starting Date
The first day of the first period for which an amount is due as an annuity
payment under an annuity contract.
Anti-Churning Rules
Regulations designed to prevent taxpayers from bringing their pre-1981
property under the liberalized cost recovery rules of ACRS (Accelerated
Cost Recovery System) instituted in 1981. Additional anti-churning rules
cover the transition from ACRS to MACRS (Modified Accelerated Cost Recovery
System).
Asset
An item of useful or valuable property.
At-Risk Rules
Special rules limiting the taxpayer's deductible business, partnership, S
corporation, or real estate loss to cash invested plus debt he or she is
legally obligated to pay and the adjusted basis of any property
contributed.
Audit
An IRS examination and verification of a taxpayer's return or other
transactions with tax consequences. An office audit is an audit by the IRS
that is conducted in the agent's office. A field audit is conducted by the
IRS on the business premises of the taxpayer or in the office of the tax
practitioner representing the taxpayer.
Automobile Expenses
Automobile expenses are generally deductible to the extent the automobile
is used in business or for the production of income. Personal commuting
expenses are not deductible. The taxpayer may deduct actual expenses
(including depreciation and insurance) or the standard (optional) mileage
rate may be used during any one year. The standard business mileage rate
for 2001 is 34.5 cents per mile. Automobile expenses incurred for
charitable activities, medical purposes, and in connection with job-related
moving expenses are deductible to the extent of actual out-of-pocket
expenses for gas and oil or at the rate of 14 cents per mile for charitable
activities, and 10 cents per mile for medical purposes and job-related
moving expenses. (The standard mileage rates for 2001 are 34.5 cents per
mile for business, 14 cents per mile for charitable activities, and 12
cents per mile for medical or job-related moving expenses.)
Away From Home Overnight
For purposes of deducting travel expenses, a trip away from one's tax home
for a period longer than an ordinary work day, during which time one is
released from duty to obtain rest.
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Bad Debts
Business accounts receivable that have been included in income in a prior
year that are uncollectible, legally binding debts owed to the taxpayer
that are totally worthless and uncollectible, and debts the taxpayer must
pay that he or she guaranteed in connection with his business or for a
profit may be deductible as bad debts.
Bankruptcy
For tax purposes, a formal petition filed in a Bankruptcy Court under
Chapter 7, 11, 12, or 13 of Title 11 of the U.S. Code.
Basis
The amount assigned to an asset from which gain or loss is determined for
income tax purposes when the asset is sold. For assets acquired by
purchase, basis is cost. Special rules govern the basis of property
received by virtue of another's death or by gift, the basis of stock
received on a transfer of property to a controlled corporation, the basis
of the property transferred to the corporation, and the basis of property
received upon the liquidation of a corporation.
Basis of Stock
If purchased, the amount paid for the stock. If the stock is received as a
gift, basis is generally the basis of the previous owner or the fair market
value when received. The basis of inherited stock is usually its fair
market value on the date of the decedent's death.
Bearer Bond
A bond that has no owner's name registered on the books of the issuing
company and is therefore payable to the holder.
Bequest
A gift by will of personal property. A bequest is not includable in the
income of the recipient. Basis is usually the value of the property at the
decedent's death. If a bequest of money is to be paid at intervals, then to
the extent that it is paid out of income from property, it is taxable
income to the recipient.
Bond
A note obliging a corporation or governmental unit to repay, on a specified
date, money loaned to it by the bondholder. The holder receives interest
for the life of the bond. If a bond is backed by collateral, it is called a
mortgage bond. If it is backed only by the good faith and credit rating of
the issuing company, it is called a debenture.
Boot
Cash or property of a type not included in the definition of a nontaxable
exchange. The receipt of boot will cause an otherwise tax-free transfer to
become taxable to the extent of the lesser of the fair market value of the
boot or the realized gain on the transfer. Examples of nontaxable exchanges
that could be partially or completely taxable due to the receipt of boot
include transfers to controlled corporations and like-kind exchanges.
Business Assets
Assets used in a trade or business or used to produce rental or royalty
income.
Business Bad Debts
Business accounts receivable that have been included in income that are
uncollectible, legally binding debts owed to you that are uncollectible,
and debts you must pay that you guaranteed in connection with your business
or for a profit may be deductible as bad debts.
Business Gifts
The cost of qualified business gifts is deductible to a maximum of $25 per
year per client or customer. The $25 limit does not apply to promotional
items costing $4 or less on which the taxpayer's name is clearly imprinted.
Business-Use Property
Property used for the production of income. Examples include rental houses,
machinery, factories, office buildings, and similar items.
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Cafeteria Plan
A plan wherein an employer offers a choice of nontaxable fringe
benefits from which participating employers may select. The plan may be
funded with employer contributions, employee contributions (usually through
salary reduction agreements) or a combination of both. Also called a
section 125 plan or a flexible spending account.
Calendar Year
A year that begins January 1 and ends December 31.
Call
An option to purchase stock at a fixed price within a specified period of
time.
Callable
A bond issue, all or part of which may be redeemed before maturity by the
issuing corporation under specific conditions. The term also applies to
preferred shares of stock, which may be redeemed by the issuing
corporation.
Capital Asset
Broadly speaking, all assets are capital assets except those specifically
excluded by the tax Code. Major categories of non-capital assets include
property held for resale in the normal course of business (inventory),
trade accounts and notes receivable, depreciable property, and real estate
used in a trade or business.
Capital Expenditure
An expenditure made for assets with useful lives of more than one year.
Usually capital expenditures may not be deducted in the year they are paid,
even if they are paid in connection with a trade or business. In other
words, they are capitalized and generally may be depreciated or amortized.
Capital Gain
The gain from the sale or exchange of a capital asset.
Capital Gain Distributions
Amounts paid by mutual funds, regulated investment companies, and real
estate investment trusts. These amounts represent the shareholder's portion
of gain from the sale of capital assets owned by these investment
companies. Capital gain distributions are taxed in the year constructively
received and are always considered to be held long term.
Capital Gain or Loss Holding Period
The length of time a capital asset is owned by the taxpayer. Assets owned
12 months or less are held short term; those owned more than 12 months are
held long term.
Capital Improvement
An improvement made to extend the useful life of a property or add to its
value. Major repairs such as the replacement of a roof are capital
improvements. The costs of capital improvements to business property must
be capitalized and may be depreciated.
Capitalize
To treat the cost of additions and improvements to property as a capital
improvement.
Capital Loss
The loss from the sale or exchange of a capital asset. Up to $3,000 of net
capital loss is deductible annually with the excess carried forward to
future years. Losses on personal-use assets are not deductible.
Capital Stock
Shares of stock that represent ownership of a portion of the corporation.
Carryback/Carryover
Provisions in the tax Code that allow certain losses or credits to be used
in a tax year other than the tax year incurred. A carryover is to a future
year. A carryback is to a prior year.
Cash Equivalent Doctrine
Generally, a cash-basis taxpayer does not report income until cash is
constructively or actually received. Under the cash equivalent doctrine,
cash-basis taxpayers are required to report income if the equivalent of
cash (property, for example) is received in a taxable transaction.
Cash Method of Accounting
One of the two most common methods of accounting, the other being the
accrual method defined elsewhere in this glossary. Under the cash method of
accounting, income is reported in the tax year actually or constructively
received and expenses are deducted in the tax year paid.
Casualty
The complete or partial destruction of property resulting from an
identifiable event of a sudden, unexpected, or unusual nature.
Casualty Loss
A casualty is the complete or partial destruction of property resulting
from an identifiable event of a sudden, unexpected, or unusual nature.
Examples are floods, storms, fires, earthquakes, and auto accidents.
Individuals may deduct a casualty loss only if the loss is incurred in a
trade or business, in a transaction entered into for profit, or is a
personal loss arising from a disaster such as those mentioned above.
Individuals deduct personal casualty losses as itemized deductions on
Schedule A, subject to a $100 nondeductible amount and a reduction of the
loss by 10 percent of the taxpayer's AGI. Use of Form 4684 is required.
Certificate
The actual piece of paper that is evidence of ownership of stock in a
corporation.
Certified Historic Structure
A structure listed on the National Register of Historic Places or located
in a designated historic area. The IRS Code provides tax incentives for the
rehabilitation of such structures.
Change in Accounting Method
A change from one method to another, which usually requires prior approval
from the IRS. A change generally requires adjustments to avoid omissions or
duplications.
Change in Accounting Period
A change from one period to another. Income for the short period created by
the change must be annualized to calculate the tax for that period.
Charitable Contributions
Money or property donated to a qualified charitable organization. Such
donations are deductible on Schedule A as an itemized deduction.
Child and Dependent Care Credit
For 2001, a tax credit of 20-30 percent of employment-related child and
dependent care expenses for amounts of up to $4,800 is available to
individuals who are employed and maintain a household for a dependent child
or disabled spouse or dependent. The credit is computed on Form 2441 for
Form 1040 filers and on Schedule 2 for Form 1040A filers.
Child Support Payments
Payments pursuant to a court order, divorce decree, or other legal
obligation. Payments for child support do not constitute alimony and are
not includable in gross income by the recipient or deductible as alimony by
the payer.
Child Tax Credit
A nonrefundable credit of up to $600 for 2001 per dependent child under
age 17 at the end of the tax year.
CLADR
See Class Life Asset Depreciation Range.
Claim of Right
A term used in the tax Code in connection with money or other property
received as income that the recipient holds, but that he or she is required
to restore to the payer in whole or in part in a later year because it
develops that he or she did not have an unrestricted right to it.
Class Life Asset Depreciation Range (CLADR)
This system of depreciation was used for assets placed in service prior to
January 1, 1981, and must continue to be used for assets whose depreciation
was set up under that system. The CLADR system provided guidelines for
depreciation lives for the assets listed in each guideline class.
Closed Year
A tax year for which the statute of limitations has expired. The taxpayer
can't claim a refund and the IRS can't collect additional taxes (with
certain exceptions).
Commission
(1) The broker's fee for purchasing or selling securities or property for a
client. (2) An allowance paid to a salesperson or agent for services
rendered.
Commodity Futures
Contracts to buy or sell some fixed amount of a commodity (wheat or soy
beans, for example) for a fixed price at a future date.
Common-Law State
A state in which the laws governing property rights are based on British
common law. The property and income of each spouse belongs to him or her
separately.
Common Stock
Shares in the ownership of a corporation that are entitled to residual
dividends, after bonds and preferred stock have first received interest and
dividends. A common stockholder usually has a vote in deciding company
affairs, including the election of a corporation's board of directors.
Community Income
Income of a married couple, living in a community property state, which is
considered to belong equally to each spouse, regardless of which spouse
receives the income.
Community Property
Property considered to belong in equal shares to a husband and wife. This
concept of ownership for property acquired after marriage is followed in
Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas,
Washington, and Wisconsin.
Commuting
Traveling from one's residence to one's regular place of business and back
to the residence.
Compensation
Wages, commissions, tips, professional fees, and net self-employment income
from services rendered; that is, earned income.
Condemnation
The taking of property by a public authority. The property is condemned
as the result of legal action and the owner is compensated by the public
authority. The power to condemn property is known as the right of eminent
domain.
Condemnation Award
Payment in money or replacement property that is received for property
condemned by a government authority.
Constructive Receipt
A cash-basis taxpayer is taxed on income only as it is received. But if the
income was unreservedly subject to his or her demand and he or she could
have received it but chose not to do so, it is regarded as having been
constructively received by him or her and is taxable. For example, interest
credited to a savings account is constructively received even if the
taxpayer hasn't withdrawn it.
Contract Price
An amount payable to the seller and equal to the gross selling price when
no mortgages are involved. If a mortgage is assumed, the contract price is
the gross selling price minus the amount of the mortgage plus the excess
(if any) of the mortgage over the seller's basis and expenses of sale.
Contributions
(1) Gifts to qualified charitable organizations as opposed to gifts to
private individuals. Such contributions are generally deductible on
Schedule A.
Convention Expenses
Travel expenses incurred in attending a convention are deductible if the
meetings are related to a taxpayer's trade or business or job-related
activities. If, however, the convention trip is primarily for pleasure or
for investment purposes, no deduction for travel expenses is permitted.
Limitations may apply to foreign convention expenses.
Convertible
A bond or preferred stock that may, under specified conditions, be
exchanged for common stock or another security, usually of the same
corporation.
Copyright
The exclusive legal right to sell, reproduce, or publish a literary,
musical, or artistic work.
Corporation
For income tax purposes, this term includes associations, trusts that have
a majority of corporate characteristics, joint stock companies, and
insurance companies.
Cost
(1) Cash and/or the value of property given to acquire the property
received.
Cost Depletion
A method for recovering the taxpayer's investment in natural resources or
timber. The cost is recovered ratably as the resource is extracted or the
timber harvested. Total cost depletion cannot be claimed in excess of
basis. Percentage depletion, the other method for computing depletion of
natural resources, is defined elsewhere in this glossary.
Cost Method of Inventory Valuation
Valuing inventory purchased during the year at cost; that is, the invoice
price less any discounts plus transportation or other costs incurred in
acquiring the merchandise.
Cost of Goods Sold
Beginning inventory plus direct purchases, direct labor costs, and overhead
costs less withdrawals for personal use and ending inventory. Sole
proprietors compute their cost of goods sold in Part III of Schedule C.
Cost of Maintaining a Home
Expenses necessary to maintain a taxpayer's residence. These costs include
rent or mortgage interest and real estate taxes, fire and casualty
insurance on the dwelling, upkeep and repairs, utilities, paid domestic
help, and food consumed in the home.
Cost or Market, Whichever Is Lower
This phrase is used in reference to inventory valuations. Most taxpayers
prefer to use "cost or market, whichever is lower" as a basis for valuing
their inventories because this method affords an opportunity to take
advantage of a drop in the market so that profits can be reduced
accordingly before disposition of the goods. If "cost" only is used, a drop
in the market cannot affect the income until the merchandise is sold.
Either method is acceptable, but the one adopted must be followed unless
the IRS grants permission for a change.
Cost Recovery
The writing off of the capital cost of qualified assets over a specified
time period. See also Accelerated Cost Recovery System (ACRS) and Modified
Accelerated Cost Recovery System (MACRS).
Coupon Bond
A bond with interest coupons attached. The coupons are clipped as they come
due and are presented by the bond holder for payment of accrued interest.
Credits
Reductions of tax liability that Congress has decided should be allowed for
various purposes to taxpayers who meet the qualifications. Some credits are
refundable; that is, the IRS will send the taxpayer a check for any amount
in excess of the tax liability. Most credits are not refundable, but some
credits may be carried to other tax years.
Custodial Parent
The parent with whom a child lives for more than half the year.