Glossary of Tax Terms

Ability to Pay

A principle of taxation. Individuals who earn more income pay more tax, not because they use more government goods and services but because taxpayers who earn more have the ability to pay more. The progressive tax, or higher tax rates for people with higher incomes, is based on this principle.

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Accelerated Cost Recovery System (ACRS)

A depreciation method used for most property placed into service from 1981 to 1986. This method allowed assets to be depreciated at a faster rate than had been allowed previously. The modified accelerated cost recovery system (MACRS) replaced ACRS for assets placed into service after 1986.

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Accelerated Depreciation

A depreciation method that allows you to deduct a greater portion of the cost of depreciable property in the first years after purchase, rather than spreading the cost evenly over the life of the asset, as with the straight-line depreciation method.

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Accountable Reimbursement Plan

A reimbursement plan set up so that employees can receive business expense reimbursements and not be required to include them in their income. The plan must require the employees to keep records of their expenses and return any excess reimbursement within a reasonable period of time.

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Accounting Method

The method used by a business or individual to keep its records. Most individuals and small businesses use the cash method, although businesses that maintain inventory are required to use the accrual method.

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Accrual Method

The form of business accounting in which you report income in the year you earned it and you report expenses in the year you incur them, rather than reporting income and expenses when you receive payment or when you pay the expenses. If you own a business that maintains an inventory, you are required to use the accrual method for purchases and sales

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Accrued Interest Adjustment

An adjustment that reduces your taxable interest income by any interest that you reported and paid tax on as it was earned.

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Acquisition Debt

A home mortgage; a loan used to buy or build your primary residence or second home. You can deduct the interest you pay on your loan up to a maximum loan amount of $1,000,000.

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Active Income

Income from wages, tips, salaries, commissions, and your trade or business in which you materially participate.

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Active Participation

A term the IRS uses to determine if an investor in rental real estate takes an active role in its management. The rules for active participation are much easier to meet than the material participation rules. An active participant may generally deduct up to $25,000 of rental real estate losses against other income. An active participant must not be a limited partner or own 10 percent or less of the property.

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Adjusted Basis

The amount you use to determine your profit or loss from a sale or exchange of property. To determine your adjusted basis for an asset, start with the original cost. Add your cost of improvements and assessments to the asset, and subtract deductions you have taken, such as depreciation and depletion.

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Adjusted Gross Income (AGI)

Your income after certain allowable adjustments from your total income, such as IRA contributions, alimony paid, moving expenses, and Keogh account contributions. You use your AGI amount as a basis for various calculations, including determining the limitations on your itemized deductions.

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Adjustment

A reduction of your income for expenses, such as IRA contributions, alimony, moving expenses, and Keogh deductions. Your gross income less adjustments equals your adjusted gross income (AGI).

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Adoption Credit

A tax credit for qualifying expenses of adopting a child under 18 or adopting a person who is physically and mentally unable to care for himself or herself. The limit on the credit is higher if a state determination has been made that the adopted child is a "special needs" child.

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Adoption Taxpayer Identification Number (ATIN)

The taxpayer identification number used for a taxpayer's child if the child's adoption is pending. If an authorized adoption agency places a child in your home, you may be able to claim the child as your dependent and also claim the child and dependent care credit.

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Adverse Living Conditions

As relating to the waiver of time requirements for the foreign earned income exclusion, adverse living conditions are war, civil unrest, and similar conditions that prevented you from staying in a country. You must show that you would have otherwise stayed in the country long enough to meet the time requirements. The IRS has a strict definition of adverse living conditions, and it publishes a list of qualifying countries.

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Alien

A person who is not a citizen of the country in which that person lives.

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Alimony

Money paid to a spouse or former spouse as a result of a written separation agreement or a court order in a separate maintenance agreement or divorce decree. Alimony and separate maintenance payments are taxable income to the receiver and deductible before adjusted gross income for the payer.

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Alternative Minimum Tax (AMT)

A tax that primarily affects high-income taxpayers who shelter some of their income from tax through certain tax preference items or deductions.

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Amended Return

A return filed to make a correction to your individual tax return from a prior year. An amended return is filed on Form 1040X.

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Amortizable Bond Premium

The amount you paid over the face value of the bond. You reduce your taxable bond interest by your bond premium amortization amount each year until the bond matures.

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Amortization

Deductible expense allowed as a means of spreading the cost of an intangible asset over a period of years. For instance, if you pay points to take out a home equity loan and the loan proceeds are not used for home improvements, you cannot deduct all the points in the year paid. Instead, you divide the cost of the points by the length of the loan and deduct only the amount that applies to the current year.

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Amount Realized

The amount received in the sale or other disposition of property. This amount includes cash, the fair market value of property and services received, and debt assumed by the buyer.

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Annualized Income Installment Method

A method you can use to figure your required estimated tax payment when you do not receive income evenly throughout the year. Using this method, you base each quarter's estimated tax payment on what your income would be for the entire year if you continued to earn at the rate you have thus far.

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Annuity

A contract, sold by a commercial insurance company, that pays benefits to you on a regular basis for the rest of your life or for another specified period of time. The payments you receive include the return of your investment in the contract plus interest or other return on your invested capital.

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Applicable Federal Rate

If you are receiving or making payments for a loan or installment sale, but little or no interest is stated on the contract, the IRS assumes a rate of interest based on the published applicable federal rate. For instance, if you sold some land on an installment sale and agreed to receive the payments over a 10-year period interest free, the IRS would determine that part of your sales price was actually interest and calculate the interest amount based on the applicable federal rate.

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Appreciation in Value

The amount your property increases in value due to market conditions. If you sell appreciated property, the appreciation will generally be taxable gain; if you donate appreciated property, you can usually deduct the fair market value of the property, including appreciation.

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Asset

An item you own that has cash or exchange value.

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Assignment

The transfer of your rights, property, or interest to another person or business. You cannot avoid taxes on your income by assigning the income to someone else.

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At-Risk Rules

Tax laws limiting the amount of losses you can claim on a business investment to the amount you actually have at risk to lose.

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Attorneys' Fee Awards

An attorney and litigation expense settlement paid to taxpayers who win their cases in tax court and show that the IRS position on their cases was unreasonable.

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Audit

An examination of your tax return by the IRS.

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Away from Home

The IRS definition of being away from your tax home substantially longer than a normal workday, for a period of time that would require sleep or rest. If you meet the requirements for being away from home, you can deduct meals and lodging expenses.

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