10 must-know tax terms

One of the hardest things about taxes is learning the language. You've got all the
forms and instructions, but it seems they're harder to decipher than your VCR user
manual.

Here are 10 common tax terms to help you start talking taxes.

Tax terms

1. AGI 6. Exemption
2. Credits 7. Progressive taxation
3. Deductions 8. Taxable income
4. Standard deduction 9. Voluntary compliance
5. Itemized deduction 10. Withholding

1. AGI -- Adjusted gross income, or AGI, is all the income you receive over the course of the
year such as wages, interest, dividends and capital gains minus items, such as contributions to
a qualified IRA, some business expenses, moving costs and alimony payments. The adjusted
gross income is the first step in calculating your final federal income tax bill.

2. Credits -- Tax credits are much like credits you get from a store. After you calculate your
tax bill, you can use the credit to reduce the amount of the check you must write to Uncle
Sam. Tax credits are more valuable than deductions because they directly cut the amount of
tax you owe, rather than reducing the amount of taxed income. A $200 credit, for example,
will turn a $1,000 tax bill into only $800. A few could even give you a refund you weren't
expecting.

3. Deductions -- Deductions are expenses that the Internal Revenue Service allows you to
subtract from your AGI to arrive at your taxable income. In most cases, the lower your
income, the lower your tax bill. If, for example, a single filer has income of $38,000 and
$8,000 in deductions, then he would pay taxes only on $30,000. The IRS offers all filers a
standard deduction amount (more on this later). Some other deductions, such as student loan
interest, moving expenses, deductible IRA contributions and alimony payments, are also listed
directly on Form 1040A or long Form 1040. The term is most commonly associated with the
itemized deductions (more on this later, too) that are claimed by taxpayers who file Schedule
A.

4. Standard deduction -- This is a fixed dollar amount that a taxpayer can subtract from his
or her income. The standard deduction is available to all filers and is determined by the
taxpayer's filing status. The amounts change each year because of inflation adjustments; you
can find the current standard deduction levels listed on each of the three individual tax forms.
This deduction method is used by most taxpayers and eliminates the need for them to itemize
actual deductions such as medical expenses, charitable contributions or state and local taxes.
5. Itemized deductions -- These are expenses that can be deducted from your AGI to help
you reach a smaller income amount upon which you must calculate your tax bill. Itemized
deductions include medical expenses, other taxes (state, local and property tax), mortgage
interest, charitable contributions, casualty and theft losses, unreimbursed employee expenses
and miscellaneous deductions, such as gambling losses. Some itemized deductions must meet
IRS limits before they can be claimed. When you itemize, you must file Form 1040 and detail
your deductions on Schedule A.

6. Exemption -- This is an amount that the IRS lets you subtract from your income to reflect
all the people who count on your income. Exemptions can be claimed for yourself, your spouse
and your dependents. The IRS allows a set amount for each exemption and, as with
deductions, this total is subtracted from your adjusted gross income to come up with your
final, lower earnings amount upon which you must figure your tax bill. Your personal
exemption amount is in addition to any deductions, either standard or itemized, that you
claim.

7. Progressive taxation -- This is the system in which higher tax rates are applied as income
levels increase. The U.S. tax system uses progressive taxation with tax brackets starting at 10
percent and rising to 35 percent for the wealthiest taxpayers.

8. Taxable income -- Your overall, or gross, income reduced by all allowable adjustments,
deductions and exemptions. It is the final amount of income you use to figure just how much
tax you owe.

9. Voluntary compliance -- This describes the philosophy upon which our tax system is
based: that U.S. taxpayers voluntarily comply with the tax laws and report their income and
other tax items honestly.

10. Withholding -- Also known as pay-as-you-earn taxation, this method enables taxes to be
taken out of your wages or other income as you earn it and before you receive your paycheck.
These withheld taxes are deposited in an IRS account and you are credited for the amount
when you file your return. In some cases, taxes also may be withheld from other income such
as dividends and interest.