Taxing Terms

Here is a glossary of commonly used tax terms.

Adjusted gross income: Gross income, including wages, salaries and tips, minus contributions to certain employee benefit and retirement plans, such as 401(k)s and IRAs.

Alternative minimum tax: A separate, parallel tax system that takes away the benefit of most itemized deductions, but assesses tax at a somewhat lower marginal rate.

Credit: A dollar-for-dollar reduction in the tax you pay. Credits are generally taken after you have determined your taxable income and the tax you owe. If you are eligible for a credit, you may subtract that amount directly from your tax obligation. In other words, if your tax obligation amounts to $2,000 but you are eligible for a $400 credit, you would pay just $1,600.

Deductible IRA: An individual retirement account that allows you to contribute up to $2,000 and deduct that amount from your income. For someone in the 28% tax bracket, a $2,000 deduction saves $560 in federal income tax. In addition, your investment earnings grow on a tax-deferred basis, until the money is pulled out at retirement. (In most cases, money that’s withdrawn prior to retirement is subject to both income taxes and a 10% federal tax penalty. In California, there’s also a 2.5% state tax penalty.)

Deduction: Items such as state taxes and home mortgage interest expenses that reduce income subject to tax. By reducing your income, you reduce your income tax. Deductions are less valuable than credits because the tax savings is the amount of the deduction multiplied by your marginal income tax bracket. For someone in the 28% bracket, a $1,000 deduction saves $280, or $1,000 times 0.28.

Marginal tax bracket: The tax rate that applies to your last dollar of earned income. Singles earning up to $24,650 are in the 15% tax bracket, for instance. But single people earning $25,000 are in the 28% marginal tax bracket because the final $350 of their wages is taxed at a 28% rate, even though the first $24,650 is taxed at a 15% rate.

Nondeductible IRA: This retirement account allows you to grow your savings on a tax-deferred basis. Contributions are not tax-deductible and the investment income is taxed when you pull the money out at retirement. Withdrawals prior to retirement usually are subject to tax penalties just as they are with deductible IRAs.

Personal exemptions: A portion of your income--for 1997 it’s $2,650--multiplied by the number of members in your household, that is not subject to tax. A family of five would multiply $2,650 by five and subtract $13,250 from their adjusted gross income to determine their taxable income.

Phaseouts: Deductions and credits that are limited or eliminated for people whose income exceeds certain levels.

Roth IRA: A new kind of individual retirement account that offers all of its tax breaks on the back end. You get no deductions when you contribute, but if you meet all the restrictions, the money you pull out at retirement is not subject to tax.

Taxable income: Income, after subtracting deductions and personal exemptions, that is subject to federal income tax.