(CNN) – Paying taxes can be a chore. But it’s all the more true when you wonder what exactly you are asked, how income tax really works and what some common tax terms mean.
To help you out, here’s a guide to some of the more common tax terms and questions you might have, with brief explanations for each.
What is gross income? The sum of all your income before taxes, including your work, investments and related activities.
Gross income includes many different forms of income, such as your wages, dividends, taxable interest, capital gains, alimony, rent received, Unemployment benefits and distributions from your retirement accounts.
What is adjusted gross income? Your AGI is your gross income minus a number of expenses you incurred and contributions you made during the tax year, such as education expenses, student loan interest, alimony payments, and contributions to a tax-advantaged retirement account like a 401 (k) or IRA.
Your AGI will determine your eligibility for a host of tax breaks.
What is taxable income? It is the part of all your income that is subject to tax. For most people, it’s your AGI minus your deductions (or the standard deduction if you don’t itemize).
What is income tax? It is the tax that the federal, state and local governments assess on your income.
The federal tax system is progressive, which means the more you earn, the higher your tax rate on the last dollar you earn.
Here’s what it looks like: There are seven tax rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Each rate applies to a different portion of your income.
For example, for single tax filers, the 10% bracket applies to the first $ 9,950 of income you earn in 2021. The 12% rate applies to $ 9,951 to $ 40,125. The 22% rate applies to dollars from $ 40,526 to $ 86,375, and so on up the scale. So if you only earned $ 40,000, you are in the 12% bracket, while someone who earned $ 70,000 is in the 22% bracket. (See here for all 2021 income tax brackets depending on filing status.)
What is the payroll tax? It is the tax you pay to support federal welfare programs, Medicare and Social Security. It is also called the FICA tax.
The Medicare tax rate is 2.9% of all your earned income, while the Social Security Tax the rate is 12.4% and applies to the first $ 142,800 of your salary in 2021. (Base salary increases by a few thousand dollars each year.)
Typically, however, if you are an employee of an organization, you pay half of the FICA taxes owed and your employer pays the other half. So you would pay 1.45% for Medicare on all your wages plus 6.2% on the first $ 142,800 for Social Security, while your business would pay the same amounts.
Note: People who earn more than $ 200,000 – or $ 250,000 if married and file jointly – will pay an additional 0.9 percentage point to Medicare on salary income above the $ 200,000 / 250 threshold. $ 000. In addition, they may owe 3.8% Medicare taxes (2.9% + 0.9%) on some of their investment income, including taxable capital gains, dividends, interest, investment income. rentals and annuities.
What is capital gains tax? When you invest in a stock, mutual fund, house, work of art or any other fixed asset that is likely to appreciate, you usually have to pay a capital gains tax on how much the asset has appreciated over time, but only when you sell that asset.
So if you buy a stock for $ 100 and sell it for $ 125, you’ll have to pay tax on the $ 25 gain.
The amount of tax you pay depends on three things: your taxable income, how long you have held the asset, and whether special rules apply to a given asset, for example, the first $ 250,000 of gain for individuals who sell a home ($ 500,000 for married couples) are exempt from capital gains tax.
Gains on assets held for less than one year will be taxed at your regular tax rate.
Gains on assets held for more than one year are taxed at 0% if your taxable income is less than $ 80,000; at 15% if your taxable income is at least $ 80,000 but less than $ 441,450 if you are single, or $ 496,600 if you are married. If you earn more than this amount, you will pay 20%.
What is a capital loss? Investments can lose value. When you sell an asset for less than what you paid for, you incur capital loss.
This loss can make up a dollar for taxable capital gains you realized in any given year. But if your loss exceeds your gains that year, you can carry over $ 3,000 in losses to the next tax year to offset future gains.
But you are not allowed to use the loss from the sale of a house or a car to offset any gains you may have on other assets.
What is a tax deduction? A tax deduction reduces your taxable income and it will reduce the taxes you owe by a percentage equal to your highest tax rate.
So, for example, if your top tax rate is 22% and you claim a deduction of $ 1,000, that will reduce your final tax bill by $ 220.
Therefore, the higher your maximum tax rate, the more valuable a deduction will be to you.
What is the standard deduction? This is a standard deduction subtracted from your adjusted gross income. In 2021, the standard deduction is $ 12,550 for individuals and $ 25,100 for joint filers.
Most tax filers take advantage of the standard deduction because it gives them a greater tax advantage than if they itemized all the individual deductions to which they are entitled.
What is a tax credit? It’s a dollar for dollar reduction in the taxes you owe.
Some tax credits, like the earned income tax credit, are also refundable, which means you can get a larger refund if the credit alone or in combination with other tax credits reduces your income tax. income below zero. You would be paid the amount less than zero.
What is tax liability? Quite simply, it’s what you owe the taxman, whether it’s the IRS or your state and local tax departments. When you complete your tax return, you will be guided through a series of questions and calculations to determine the amount, if any, of the remaining tax you owe when you file your return. Or, these calculations may show that you have paid too much tax and that you are owed a refund.
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