Tax Terminology Definition
Tax terminology can be a confusing subject for most people, especially those who are unfamiliar with the nuanced terms used within the field. Tax terminology is necessary to understand not just the basic laws surrounding taxation, but the deeper implications of each and part of the taxation system. To truly understand taxation and its effects, it is necessary to understand the specialized language that comes with having an in-depth knowledge of taxes.
Marginal Tax Rate: The term marginal tax rate is used to refer to the rate of tax imposed on an additional unit of income. As income increases, so does the value of tax imposed upon it. The rate of tax increases on a sliding scale or with occasional steps or drops in the rate. This is known as the progressive tax system.
Effective Tax Rate: The effective tax rate is a measure of the average rate of tax imposed on all taxable income. The effective rate considers the combination of all tax brackets the taxpayer is subject to. It is calculated by dividing the total taxes owed by the total income before taxes. This measure is useful for comparing tax deductions and credits.
Tax Exemption: A tax exemption is a deduction from total taxable income. It reduces the amount of taxable income, thus reducing the amount of taxes owed by the taxpayer. Tax exemptions can come in the form of credits or deductions, such as charitable donations or child care expenses. Taxpayers with higher incomes have higher rates of tax exemptions.
Tax Credits: Tax credits are reductions of taxes owing in relation to total taxable income. Unlike deductions, tax credits reduce the amount of taxes owed directly, so a credit of $1,000 translates directly into $1,000 in savings. Tax credits are most often used to offset the tax liabilities of low-income taxpayers.
Capital Gains Taxes: Capital gains taxes are levied on the increase in value of capital investments or assets over time. Generally, the investor incurs taxes on the gain when the asset is sold or exchanged. Tax rates for capital gains taxes vary from jurisdiction to jurisdiction, depending on the type of asset and the circumstances under which it is being sold.
Tax Deductions: Deductions are amount of income that may be subtracted from total taxable income in order to reduce the amount of taxes owed. Deductions are often claimed for the purpose of lowering the effective tax rate. Common deductions include those for charitable donations, business expenses, and educational expenses.
Taxable Income: As the name implies, taxable income is what is liable for taxation under the law. It is the amount of money an individual has earned after all deductions have been taken and any tax credits or exemptions have been applied.
Filing Status: Filing status refers to the individual’s formal declaration as an individual, married couple, head of household, divorced or separated, or qualified widow or widower when filing taxes. Each of the specified statuses carries with it different amounts of taxable income, due to each particular situations unique circumstances and allowances.
Tax Liability: This is the amount of money that is expected to be paid to the government as tax on taxable income. Tax liability is calculated by taking the total income and subtracting all deductions, credits, and exemptions. Tax liability is then multiplied by the applicable tax rate.
Income Tax: Income tax is the type of tax that is most commonly placed on individuals and businesses who are earning income from wages, salaries, and other earnings. Income tax is usually a progressive taxation system, in which the highest-earning individuals and households are subject to a higher rate average tax rate than lower-income individuals.
Estate Tax: Unlike income tax, estate tax is a levy placed on the transfer of property or assets from an individual to another party upon death. The amount of tax is calculated upon the total estate’s worth, not simply the value of specific assets. Estate taxes are typically reserved for the wealthiest individuals as they transfer wealth to heirs with significant assets or assets worth more than the exemption amount.
Property Tax: Property tax is generally levied by local governments upon entities that own real property outside of the owner. Property tax is calculated based on the assessed value, the municipality’s mill rate, and other calculations made by the government. Certain properties, such as those owned by the government or used for charitable purposes, may be exempt from property taxes.
Sales Tax: Sales tax is a tax levy placed on goods and services that are purchased in a particular jurisdiction. These taxes are usually collected at the point of purchase by either charging the customer or by the seller paying the government the amount of the tax. The tax rate is usually fixed in certain jurisdictions, and may differ from one state to another.
Gift Tax: A gift tax is a type of tax imposed on the giver for transferring assets or property to another party. The amount of tax imposed will be dependent on the amount of value being transferred in the gift. Certain gifts, such as those given to charitable organizations, may be exempt from taxation.
Inheritance Tax: Inheritance tax is similar to estate tax, with the key difference being that inheritance tax is due at the time of the transfer of wealth or property as opposed to at the death of the individual. The amount of tax due is based upon the amount of money or property passed on, and the rate of tax may differ from jurisdiction to jurisdiction.
Value-added Tax (VAT): A value-added tax, or VAT, is a type of consumption tax collected by the government or an authorized agent when goods or services are purchased. The amount of tax charged is based on the difference in the value of goods or services between the time of purchase and the time of sale. This type of tax is usually applied at the same rate to most goods and services, and can be passed on to consumers as part of the price of goods and services.
These are just some of the most common tax terms. While there are numerous other technical terms used in taxation, these are the most commonly used and seen. It is important to remember that taxation laws and regulations vary from jurisdiction to jurisdiction, so different terms may also apply depending on where funds or assets are involved.
