February 2000 February 2000
Tax 101
Jamie H. Thompson, thompsonja@missouri.eduWhether we have our taxpreparer complete our taxes or we do them ourselves, we face taxese (the tax language only the IRS knows). This article is called Tax 101, a simple primer of taxese and basic facts.
Ability to Pay – The concept of tax fairness. People with different amounts of wealth or different amounts of income should pay different rates of taxes.
Adjusted Gross Income – Our total income is reduced by certain adjustments such as the IRA deduction, student loan interest deduction, and the deduction for alimony paid.
Dependent – A person who relies on someone else for support. A dependent generally may not be the taxpayer or their spouse.
Earned Income – Includes wages, salaries, tips, net earnings from self-employment, and other income received for personal services.
Earned Income Credit – A refundable credit for low-income workers. This credit may be paid to the worker even if no income tax was withheld from the work’s pay. To receive the earned income credit, the taxpayer must file a tax return.
Filing Status – Based on a taxpayer’s marital status and other factors. The filing status determines the tax bracket and rate at which income is taxed.
Form W-4 – A form that helps an employer determine how much to withhold from an employee’s paycheck for federal income tax purposes.
Gross Income – Money, goods, and property received that must be reported on a tax return and may be included in taxable income.
Income Taxes – Taxes on income, both earned (salaries, wages, tips, commissions) and unearned (interest, dividends).
Progressive Tax – A tax that takes a larger percentage of income from high-income groups than from low-income groups.
Standard Deduction – An amount fixed by law and based on filing status, age, blindness, and dependency that taxpayers may deduct from their adjusted gross income before tax is determined.
Tax Credits – Amounts that can be deducted directly from taxes owed. Credits may be allowed for child and dependent care expenses, the elderly and disabled, higher education costs, and the earned income credit for low-income taxpayers.
Tax Deductions – A part of a taxpayer’s total expenses that can be deducted in determining taxable income.
Tax Exemptions – A set amount that taxpayers can claim for themselves, their spouses, and eligible dependents that is subtracted from adjusted gross income before any tax is figured on the remaining income.
Tax Withholding – Money that an employer takes from an employee’s paycheck to pay part or all of the employee’s taxes. The amount is determined from the employee’s W-4.
Do we have to file a tax return and pay taxes? The U.S. income tax system is built on the idea of voluntary compliance. This means that it is left to the taxpayer to keep the necessary records, file a return on time, pay any required taxes, and meet the requirements of the tax law. The system is built on trust in citizens to know their responsibilities and to do what needs to be done.
Most taxpayers withhold money monthly to cover their tax liability. What is the advantage of withholding for taxpayers? For the Government? Without tax withholding many people would find it difficult to save enough money to pay their income taxes all at once. The government depends on an uninterrupted flow of revenues to avoid a possible disruption in government services.
As taxpayers, it is important for all of us to understand that we are responsible for paying income taxes by withholding income as it is earned, and we voluntarily report our income to the IRS by filing a tax return.
Understanding Tax Forms, IRS
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