Taxes Made Simple

Differences between lifetime learning credit and American opportunity credit

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How does a standard deduction differ from a below the line deduction?

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How is above the line deduction different that below the line deduction?

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Describe each of the 5 categories of taxable income

1. Earned income-money derived from paid work. 2. Interest income-usually taxable; the ordinary income tax rate applies to this form of income. In a bank, the excess amount of interest earned on investments over the amount paid out for deposits is referred to as net interest income. 3. Dividend income-Mutual funds pay out interest and dividend income received from their portfolio holdings as dividends to fund shareholders. In addition, realized capital gains from the portfolio's trading activities are generally paid out (capital gains distribution) as a year-end dividend. 4. Passive income (such as rental income)-income received on a regular basis, with little effort required to maintain it. It is closely related to the concept of "unearned income". 5. Capital gains (from things such as the sale of stock)-a profit from the sale of property or of an investment.

Describe each of the 4 categories of "other" important deductions?

1. Home mortgage interest-allows taxpayers who own their homes to reduce their taxable income by the amount of interest paid on the loan which is secured by their principal residence (or, sometimes, a second home). 2. State and local taxes 3. Charitable contributions 4. Medical expenses

Standard deduction

A fixed amount that reduces your taxable income. Think of it as tax-free income that you get to keep before the remainder of your income is taxed.

Progressive tax

A tax for which the percentage of income paid in taxes increases as income increases

Deduction

Arises from expenses and reduces your taxable income

How is an exemption different from a credit?

Exemption reduces taxable income, credit reduces your tax.

Lifetime learning credit

For the tax year, you may be able to claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all eligible students. There is no limit on the number of years the lifetime learning credit can be claimed for each student. A tax credit reduces the amount of income tax you may have to pay.

American opportunity credit

For the tax year, you may be able to claim an American opportunity credit of up to $2,500 for qualified education expenses paid for each eligible student. A tax credit reduces the amount of income tax you may have to pay.

Above the line deduction

Preferred because they can be taken by ALL taxpayers regardless of whether they take standard or itemized deductions (see attached tax ladder). Moreover, they are desirable because they reduce adjusted gross income (AGI).

Credit

Reduces tax directly and more valuable than a deduction of the same amount

Pre-tax money

Spent before gov't gets its cut. The money you pay towards the cost of coverage comes out of your salary before you pay any taxes on it.

Earned income credit

Tax break for people whom Congress determined lower-income taxpayers.

Marginal tax rate

The extra taxes paid on an additional dollar of income

Effective tax rate

Total amount of income tax you pay divided by your taxable income

Difference between 401K and Roth 401K

Traditional 401(k) = income taxes on distributions Roth 401(k) = income taxes on contributions

Difference between IRA and Roth IRA

Traditional IRA contributions are tax deductible on both state and federal tax returns for the year you make the contribution, while withdrawals in retirement are taxed at ordinary income tax rates. Roth IRAs provide no tax break for contributions, but earnings and withdrawals are generally tax-free.

Capital gain/loss

When a capital asset is sold, the difference between the amount you paid for the asset and the amount you sold it for is a capital gain or capital loss.

Student loan interest deduction

You may be able to deduct interest you pay on a qualified student loan. Generally, the amount you may deduct is the lesser of $2,500 or the amount of interest you actually paid. The deduction is claimed as an adjustment to income so you do not need to itemize your deductions on Form 1040, Schedule A (PDF).

What is the standard deduction?

Your age and filing status, along with several other factors, determines your standard deduction amount.

How is an exemption different from a deduction?

exemption -- like other deductions -- reduces your taxable income, whereas tax credits directly reduce your tax bill dollar for dollar

Exemption

the process of freeing or state of being free from an obligation or liability imposed on others.