To go to the definition, click the first letter of the term. The CFP Board topic is referenced in parentheses following each term.
A
Accountable Plan: A method of accounting for employee business expenses in which employee reimbursements are not reported as employee income. Employee expenses must have a business connection, employees must adequately account for these expenses to the employer within a reasonable time, and employees must return any excess reimbursement or allowance within a reasonable time.
Accrual Method: A method of tax accounting in which income is reported for the year in which the taxpayer's right to receive it becomes fixed (not contingent on the occurrence of a future event). Expenses are deductible in the year in which all events have occurred, establishing the fact of the liability for such payments so that the amount can be estimated with a reasonable degree of accuracy.
Adjusted Basis: The original tax basis of an asset, plus such items as property improvements or additions, and minus depreciation.
Adjusted Gross Income (AGI): Gross income, including all items of income required to be included, reduced by deductions for adjustments to gross income, such as alimony paid, deductible IRA contributions, 50 percent of self-employment tax paid, etc. AGI is a crucial number in determining the deductibility of various expenditures and certain credits against the income tax.
Adjustments to Gross Income: Deductions permissible in arriving at adjusted gross income, including deductible IRA contributions, one-half of self-employment tax, self-employed health insurance deduction, qualified job-related moving expenses, alimony paid, penalty on early withdrawal of savings, educator expenses, student loan interest paid, higher education tuition and fees deduction, Archer MSA deduction, and self-employed SEP, SIMPLE, and qualified plans deductions.
Administrative Interpretations: Interpretation, clarification, definition, and analysis of the Internal Revenue Code by the U.S. Treasury Department in order to ensure that the intention of the law can be applied to the specific facts of a taxpayer's situation. This process results in numerous administrative releases, including regulations, revenue rulings, revenue procedures, letter rulings, and technical advice memoranda.
Alternative Minimum Tax (AMT): A second federal income tax system parallel to the regular income tax system. Congress enacted the AMT to ensure that every individual and corporation pays at least a minimum tax every year.
Assignment-of-Income Doctrine: An income tax doctrine that holds that as long as a taxpayer retains control over the source of income ("the tree"), he or she will be taxed on the receipt of that income ("the fruit"), even though he or she has assigned all the rights to the income to someone else.
At-Risk Rules: A set of income tax rules limiting the deductibility of losses in an activity to the amount that a taxpayer has at risk in the activity. These rules are intended to prevent the utilization of losses in situations where the taxpayer is not economically at risk due to nonrecourse loans for which he or she is not personally liable, stop-loss agreements, and similar arrangements. Loss deductions are limited to the amount of the taxpayer's cash contribution, the adjusted basis of other property that he or she contributed to the activity, and any amount borrowed for use related to the activity if the taxpayer has personal liability for repayment or the taxpayer pledges property (other than property used in the activity) as security for repayment of the amounts borrowed.
Average Tax Rate: The effective rate of tax that a taxpayer is paying on taxable income calculated by dividing the total taxes payable by the taxable income. The terms "average tax rate" and "effective tax rate" are synonymous.
B
Basis: The value of an asset for income tax purposes used in computing gain or loss upon disposition of the asset and in calculating depreciation, depletion, or amortization, if applicable.
Bonus Depreciation: An additional first-year depreciation allowance of 30 percent of the adjusted basis of depreciable property enacted by the Job Creation and Worker Assistance Act in March 2002. This provision applies to qualified property, the first use of which began with the taxpayer, and which is acquired within the period generally running from September 11, 2001 to September 11, 2004.
Book vs. Tax Differences: Differences in the treatment of income and expense items between tax rules and financial statement rules. These differences can be either permanent or temporary. An example of a permanent difference is when income or gain is realized for book purposes but never recognized for tax purposes (e.g.: tax-exempt interest income). A temporary difference arises when an item of income, gain, expense, or loss is taken into account in a different year for book purposes than for tax purposes, such as with depreciation. Temporary differences will reverse in later years, resulting in the same total amount of income being reported over a period of years
Brother-Sister Controlled Group of Corporations: A brother-sister controlled group exists if (1) five or fewer persons (individuals, estates, or trusts) own at least 80 percent of the voting stock or value of shares of each of two or more corporations and (2) these five or fewer persons own more than 50 percent of the voting power or value of shares of each corporation, considering a particular person's stock only to the extent that it is owned identically with regard to each corporation.
Business Purpose Doctrine: An income tax doctrine holding that a transaction will not be effective for income tax purposes unless it is intended to achieve a genuine business purpose other than tax avoidance.
C
C Corporation: An incorporated entity organized under state law that has not elected S Corporation income tax status. It offers limited personal liability for the owners, perpetual life, free transferability of ownership interests, and the ability to raise capital more easily than other types of entities, but must observe certain formalities, is less flexible and is subject to double taxation, an accumulated earnings tax, and a personal holding company tax.
Capital Asset: Every asset except those falling into one of eight specific categories: (1) inventory or property held primarily for sale to customers in the ordinary course of business; (2) accounts or notes receivable acquired in the ordinary course of business; (3) supplies used or consumed in the ordinary course of business; (4) Section 1231 assets; (5) a copyright, literary, musical, or artistic composition, a letter or memorandum, or similar property held by a taxpayer whose personal efforts created the property or a person to whom the property was gifted by the creator; (6) certain publications of the U.S. government; (7) commodities-derivative financial instruments held by a dealer; and (8) hedging transaction properties.
Capital Expenditure: A cash disbursement, because of its long-term benefit, that is required to be recorded, for tax accounting purposes, as an asset on the balance sheet rather than as a current expense. Certain capital expenditures are subject to depreciation, depletion, or amortization. IRC Section 263(a) prohibits a current deduction for "permanent improvements or betterments made to increase the value of any property," but the tax law does permit deductions in future years.
Capital Gain or Loss: Gain or loss realized on the sale or exchange of a capital asset or an asset receiving such treatment. A net long-term capital gain may be eligible for a preferential income tax rate, while net capital losses are deductible only against other income up to $3,000 per year (subject to an indefinite capital loss carryforward).
Cash Method: A method of tax accounting requiring the taxpayer to report as income all cash and property actually or constructively received during the tax year and, as deductions, all cash disbursements actually made during the tax year (except for payments that will benefit the taxpayer for a period longer than 12 months, such as prepaid rent).
Charitable Bargain Sale: Sale of property to a qualifying charity at less than fair market value, resulting in the allocation of the basis of the property sold between the portion of the property considered "sold" and the portion "given" to the charity, based on the fair market value of each portion. The result is that the donor-seller realizes some taxable gain on the "sale" even if the selling price did not exceed the donor-seller's basis for the entire property.
Charitable Deduction: A limited income tax deduction allowed in computing an individual taxpayer's income tax liability for qualifying transfers of property to a qualified charity made during the donor's lifetime. An unlimited deduction is permitted in computing both federal-gift and estate tax.
Child and Dependent Care Credit: A nonrefundable credit, computed on Form 2441, permitted for a portion of qualifying child or dependent care expense paid for the purpose of allowing the taxpayer to be gainfully employed.
Child Tax Credit: A credit available to taxpayers having qualifying children (a child, descendant, stepchild, eligible foster child who is a U.S. citizen or resident alien for whom the taxpayer may claim a dependency exemption and who is less than 17 years old as of the close of the tax year).
Complex Trust: A trust that is not a simple trust that, accordingly, is permitted to have charitable beneficiaries (e.g.: a charitable remainder annuity or unitrust), to accumulate trust income, and to distribute corpus or accumulated income during the year.
Constructive Receipt: When a taxpayer has an unrestricted right to receive items of income, regardless of whether actually received by the taxpayer.
Controlled Corporate Group: One of two types of groups of corporations allowed only one set of graduated income tax brackets, one $250,000 accumulated earnings tax credit, and one $40,000 exemption amount for AMT purposes.
Corpus: The assets of a trust or estate. Also called res or principal.
Correspondence Examination: The lowest level of IRS audit, which is handled entirely by telephone or through the mail and focuses on only a few items on the tax return.
Cost Basis: The purchase price of an asset including any sales tax paid by the purchaser and any incidental costs related to getting the asset in place and into use.
Cost Recovery: Writing off the capitalized cost of "wasting assets" (those that lose value over time because of wear and tear, physical deterioration, or obsolescence, and that have a reasonably ascertainable useful life) over their estimated useful lives. This has the effect of deducting the total cost of an asset over the years in which it is used to help generate revenue for the taxpayer. Land and works of art acquired for display are not subject to such income tax treatment.
D
Deductible IRA: An individual retirement account for which the owner qualifies to take an income tax deduction, as an adjustment for gross income, for the contributions made.
Deductions for Adjusted Gross Income: Income tax deductions permitted by the Internal Revenue Code in arriving at adjusted gross income. Also known as above-the-line deductions. See Adjustments to Gross Income.
Deductions from Adjusted Gross Income: Income tax deductions permitted by the Internal Revenue Code from adjusted gross income in arriving at taxable income. These deductions include the various itemized deductions, the standard deduction, and the personal and dependency exemptions. Also known as below-the-line deductions.
Dependency Exemption: An amount deductible from adjusted gross income in arriving at taxable income for each dependent claimed by an individual taxpayer.
Depletion: An annual allowance for the exhaustion of natural resources as the result of production and sale based upon the taxpayer's economic interest in the property. Cost depletion involves the amortization of the cost of the property based upon the units produced and sold during the year divided by the estimated reserves in the ground. Percentage depletion allows the deduction of a flat percentage of the gross income (subject to limitation) from the property as a depletion allowance. In any year, a taxpayer is allowed to deduct the greater of cost depletion or percentage depletion attributable to its properties.
Depreciation: The systematic method of ratably deducting the cost of tangible property having a useful life or more than one year, used in a trade or business or held for the production of income, over its assumed useful life. Currently, the IRS requires use of the modified accelerated cost recovery (MACRS) system for this purpose.
Depreciation Recapture: The full or partial recharacterization of capital gain income as ordinary income upon the disposition of depreciable property to the extent of depreciation deducted through the date of disposition.
Discriminate Functions System (DIF) Program: An IRS audit program that compares the information on each tax return filed with a pre-formulated set of norms, or averages; pre-formulated information (with taxpayers organized in classes by geographic location, occupation, and earnings range) is derived from the Taxpayer Compliance Measurement Program (TCMP).
Distributable Net Income (DNI): An amount that sets the upper limit on the taxability to the beneficiaries of current financial income received from a trust and on the amount deductible by the trust. Distributions in excess of DNI are neither taxable nor deductible by the trust. If distributions are less than DNI, only the amount actually distributed is taxable to the beneficiaries and deductible by the trust.
E
Earned Income Credit: A refundable tax credit enacted for the purpose of financially assisting low-income working families.
Economic Growth and Tax Relief Reconciliation Act (EGTRRA): A major piece of federal income tax legislation enacted in 2001 that made significant changes to the federal income tax law.
Economic Performance: Pertaining to property, when the property is received or used by the taxpayer; pertaining to services, when the services are provided to the taxpayer.
Effective Tax Rate: The average rate of tax that a taxpayer is paying on taxable income, calculated by dividing the total taxes payable by the taxable income. The terms "average tax rate" and "effective tax rate" are synonymous.
Equitable Interest: A beneficial interest, as opposed to legal title, in property. For example, a trust beneficiary has a beneficial interest in the trust property, while the trustee has a legal title to the trust property.
Exclusion (Income Tax): Any amounts excluded from gross income, such as municipal bond interest, gifts and inheritances, life insurance proceeds after death, and the gain from sale of one's principal residence (without applicable limits).
F
Field Examination: The highest level of IRS audit where a revenue agent comes to the taxpayer's place of business. A field examination is generally broad in scope and may involve a complete analysis of the taxpayer's books and records for the year or years under investigation.
First In, First Out (FIFO) Method: An inventory valuation method (or inventory costing assumption) under which the taxpayer takes the cost of the oldest inventory into cost-of-goods sold first, and leaves the newest inventory costs in ending inventory. During periods of escalating inventory prices, this method takes the least expensive items into cost-of-goods sold first and leaves the highest-priced items in ending inventory, resulting in a relatively lower cost-of-goods sold, correspondingly higher taxable income, and higher tax liability.
Filing Status: Pertaining to federal individual income tax returns, the manner in which individual taxpayers are classified for purposes of the income tax laws, such as single, married filing jointly, married filing separately, head of household, etc. Standard deduction amounts and applicable tax rates vary depending upon the taxpayer's filing status.
Fiscal Year: An accounting and tax reporting period consisting of 12 months.
Funded Trust: A trust to which the title of assets has been transferred.
G
Gain: The amount by which the amount realized on the sale of exchange of an asset exceeds its adjusted tax basis upon disposition.
General Partnership: An association of two or more owners to carry on a business, for a valid business purpose, for profit. The owners, who do not necessarily have to be individuals, are jointly and severally liable for the debts, tort claims, and other obligations of the partnership. Accordingly, they have unlimited personal liability for any claims against the business, including those arising from the actions of other partners or other persons when acting for the business. A partnership is a pass-through entity for federal income tax purposes and pays no tax itself, acting only as a conduit in passing all items of partnership income, gain, losses, deductions, and credits through to the partners.
Going-Concern Value: The additional element of value of a trade or business that attaches to property by reason of its existence as an integral part of a going concern. Also known as the synergism-of-business assets, it includes the value attributable to the ability of a trade or business to continue to function and generate income without interruption, even with a change of ownership, and the use or availability of an acquired trade or business.
Goodwill: The value of a trade or business attributable to the expectancy of continued customer patronage, due to a trade or business name or reputation, or to other factors.
Grantor: Pertaining to a trust, the person who creates and usually provides initial funding to a trust for the benefit of the trust beneficiaries.
Grantor Trust: A trust in which part or all of the trust's income is taxed to the grantor under the provisions of the grantor trust rules.
Grantor Trust Rules: Federal income tax rules under which, when a grantor retains certain powers of dominion and control over trust property and income, the grantor is treated as the substantial owner of that property and is taxed on its income. Typical powers of dominion and control include the right to revoke the trust, maintenance of a reversionary interest, maintaining the power to control the beneficial enjoyment of the trust, retention of certain administrative powers, or the availability of trust income to the grantor.
Gross Income: Pertaining to federal income taxation, the starting point in calculating income taxes payable, including all income from whatever source minus certain items of income the IRC specifically excludes.
H
Half-Year Convention: A uniform method of determining the depreciation allowable in the year of an asset's acquisition and the year of its disposal, under which assets with recovery periods from 3 to 20 years are assumed to be placed in service or disposed of exactly halfway through the tax year. This means that six months of depreciation is allowed in both the year of acquisition and the year of disposal, unless more than 40 percent of the depreciable personalty acquired during a tax year is placed in service during the last three months of the year (in which case, the mid-quarter convention must be used).
Holding Period: The length of time an asset is owned. A holding period of one year or less is considered short term, while one of more than one year is considered long term. The length of the holding period affects the treatment of any gain or loss upon disposition of the asset.
Hybrid Method: A method of tax accounting representing a combination of the cash method and the accrual method.
I
Income Beneficiary: The beneficiary of a trust who has the right to the beneficial enjoyment of the trust corpus for the term of the trust.
Income in Respect of a Decedent (IRD): Income to which a decedent was entitled at the date of his or her death, but, because of death, had not yet received. Examples include unpaid salary or commissions, collection of the proceeds on the closing of a sale completed before the taxpayer-decedent's death, the acceleration of recognition of gain resulting from the forgiveness of any debt at death on a self-canceling installment note (SCIN), accrued but unpaid rents or royalties, and distributions from a qualified plan or an IRA made after the decedent participant's death.
Inherit: To receive property through intestate succession, rather than under the terms of a decedent's will.
Installment Sale: A sale of property in which the purchase price is paid in a fixed number of installments (together with specified interest) over a period of more than one tax year, usually evidenced by a promissory note. This treatment permits the seller to report a portion of any gain on sale as the payments are actually received.
Inter Vivos Trust: A trust created by a grantor during his or her lifetime. Also known as a living trust.
Investment Income: Gross income from securities or property held for investment. Net investment income represents investment income minus applicable investment expenses.
Investment Interest Deduction: The deductible amount of interest paid or accrued on debt applicable to "property held for investment", but then limited to the amount of net investment income from that property.
Involuntary Conversion: A condemnation of private property by a government agency that takes the property for public use by the agency employing its right of "eminent domain" for fair value.
Irrevocable Trust: A trust that, once having been created by the grantor, cannot be revoked by the grantor.
Itemized Deduction: Specific statutory income tax deductions permitted as adjustments from AGI, or below-the-line deductions, subtracted from AGI in arriving at an individual taxpayer's taxable income. Itemized deductions include medical and dental expenses (in excess of 7 ½ percent of AGI), certain taxes paid, certain types of interest paid, charitable gifts, casualty and theft losses (in excess of 10 percent of AGI), and miscellaneous deductions, some of which are subject to a 2 percent of AGI floor and some of which are not. If the total of the itemized deductions exceeds the allowable standard deduction, this total is the amount deducted from AGI. The itemized deductions are subject to phaseout, or partial elimination, for high-income taxpayers with AGI in excess of a threshold amount.
Kiddie Tax: The tax on a child's unearned income based on the child's parents' marginal income tax rate. In 2002, a child under age 14 at the end of the tax year who has unearned income in excess of $1,500 is taxed on this excess at the top marginal income tax rate of the parent(s).
L
Legal Interest: The interest held by the legal owner of a property, such as a trustee of a trust, as contrasted with an equitable (or beneficial) interest enjoyed by a beneficiary of a trust.
Letter Rulings: Issued by the IRS in response to a taxpayer's request for an advance ruling on the income tax consequences of a contemplated transaction. These rulings apply only to the particular taxpayer asking for the ruling and are not applicable to all taxpayers. The IRS has the option of not ruling on a particular question posed by a taxpayer.
Last In, First Out (LIFO) Method: An inventory valuation method (or inventory costing assumption) under which the taxpayer takes the cost of the newest inventory into cost-of-goods sold first, and leaves the oldest inventory costs in ending inventory. During periods of escalating inventory prices, this method takes the most expensive items into cost-of-goods sold first and leaves the lowest priced items in ending inventory, resulting in a relatively higher cost-of-goods sold, correspondingly lower taxable income, and lower tax liability.
Like-Kind Exchange: A transaction involving the exchange of business or investment property of a "like-kind," on which no gain or loss is recognized. This provision allows individuals and businesses to convert one asset to another asset with the same purpose at no immediate tax cost. Only certain types of property qualify for this tax treatment. Such transactions are only nontaxable in the current year; gain or loss is deferred until the qualifying property is disposed of in a taxable exchange.
Limited Liability Company (LLC): A form of business entity that includes the beneficial tax attributes of both S Corporations and partnerships, but offers the limited liability of corporations. LLC members (owners) may participate in management without risking personal liability. There is no limit on the number of owners or on the type of owners, as with S Corporations. It is a statutory entity and must be formed under a specific state law.
Limited Liability Partnership (LLP): Basically a general partnership in which each individual partner remains liable for his or her own malpractice and the liabilities arising out of the wrongful acts or omissions of those they supervise, but has a liability shield (varying by state) for claims against partners that arise from obligations of the partnership. Typically used by professionals such as accountants or attorneys.
Limited Partnership: A partnership in which there are two classes of investors: limited partners and general partners. Normally, the general partners promote, build, develop, or manage the partnership, while the limited partners are primarily investors. Earnings and losses are not taxed to the partnership as an entity; rather, they are passed through to the partners and taxed accordingly. Limited partners have limited liability for partnership debts.
Living Trust: A trust created by a grantor during his or her lifetime. Also called Inter Vivos Trust.
M
Marginal Tax Rate: The tax rate applicable to the next dollar of taxable income. It is calculated by adding a specific amount of gross income and determining the additional income taxes payable as a result of this additional income; then the total of the additional income taxes payable is divided by the additional gross income to determine the marginal tax rate.
Marriage Penalty: The difference between the combined tax liability of a married couple filing a joint return and the sum of the tax on each individual computed as if they filed returns as single individuals. This penalty is gradually being phased out over several years under the provisions of EGTRRA.
Mid-Month Convention: A uniform method of determining the depreciation allowable in the year of an asset's acquisition and the year of its disposal, under which depreciable realty (assets with recovery periods of 25, 27.5, 39, or 50 years) placed in service or disposed of during any month are considered to be placed in service or disposed of midway through the month.
Mid-Quarter Convention: A uniform method of determining the depreciation allowable in the year of an asset's acquisition and the year of its disposal, under which assets either placed in service or disposed of during any quarter (three months) of the year are assumed to be placed in service at the midpoint (one and one-half months) of that quarter.
Miscellaneous Itemized Deductions: Personal below-the-line deductions that are not specifically deductible as (a) above-the-line deductions or (b) specified below-the-line deductions. Generally they are subject to a 2 percent AGI floor, except for certain specific items. They include expenses for: (1) producing or collecting income; (2) determining one's tax liability; (3) an activity for which a deduction is otherwise allowable under the "hobby loss rules;" and (4) unreimbursed employee business expenses.
Modified Accelerated Cost Recovery System (MACRS): An IRS system used to calculate the amount of annual depreciation allowable for income tax purposes on depreciable assets, including depreciable realty (buildings, improvements, and other structures permanently attached to the land) and personalty (any tangible asset not part of a building or other permanent structure (used in a trade, business, or income-producing activity.
Mortgage "Points": Loan origination fees usually incurred when obtaining a home mortgage calculated as a percentage of the amount of the mortgage loan. If incurred in connection with a home mortgage loan for the purchase or improvement of a principal residence, and if the mortgage is secured by that principal residence, they are deductible in the year paid, subject to certain restrictions. Points paid on the refinance of a mortgage on a personal residence must be amortized over the life of the new mortgage, or until the loan is paid off.
N
Net Tax Liability: Pertaining to income taxation, the total tax due for the tax year.
Nonaccountable Plan: A method of accounting for employee business expenses in which the entire advance or reasonable compensation reimbursement is taxable income to the employee and deductible by the employer. The employer must withhold income and payroll taxes on the amount paid and the advance or reimbursement must be reported on the employee's W-2 Form. If proper records are kept, the employee may claim an offsetting itemized deduction (subject to a 2 percent floor) for expenses. However, a 50 percent deductible limit applies on business-related entertainment or meals consumed on overnight business trips.
Nondeductible IRA: An individual retirement account in which contributions do not qualify for deduction from current gross income.
Nonrefundable Tax Credits: Those tax credits taken fully or partially against tax liability, with a carryover or carryback of any unused credit to years in which there is an offsetting tax liability. They include the foreign tax credit, the credit for child and dependent care services, the credit for the elderly or the disabled, the credit for adoption expenses, the basic child tax credit, the Hope and Lifetime Learning credits, and the retirement savings contributions credit (Saver's Credit).
O
Office Examination: An intermediate level of IRS audit where the taxpayer is requested to come to a district office of the IRS to meet with a tax auditor to discuss a few questionable items on the tax return as filed.
P
Parent-Subsidiary Control Group: A parent-subsidiary controlled group exists if (1) one or more chains of corporations are connected through stock ownership with a common parent corporation; (2) 80 percent or more of the voting power or value of the stock of each corporation in the group other than the parent is owned by one or more corporations in the group; and (3) the common parent owns at least 80 percent of the voting power or value of the stock of one of the other corporations in the group (not counting stock owned directly by other members).
Passive Activity: An activity involving the conduct of any trade or business in which the taxpayer does not "materially participate" on a regular, continuous, and substantial basis, as defined in the IRC. Generally, real estate activities are considered passive except for residential real estate where the taxpayer "actively participates", as defined in the IRC. Net losses from passive activities may not be offset against a taxpayer's other income, such as salary or portfolio income.
Personal Exemption: Generally, an annually adjusted dollar amount deductible by each taxpayer filing a tax return. For example, a single taxpayer may claim one personal exemption on his or her tax return, while a married couple may claim two personal exemptions (one for each spouse). The personal exemption is to be distinguished from the dependency exemption, which applies only to persons qualifying as the taxpayer's dependent for income tax purposes. For high-income taxpayers, the personal and dependency exemptions are subject to phaseout when AGI exceeds a specified threshold amount.
Personal Interest: Interest incurred by an individual that is other than trade or business interest, investment interest, interest related to a passive activity, qualified personal residence interest, or student loan interest. Personal interest includes interest paid on personal credit card debt and personal auto loans.
Postponing Taxation: A tax planning technique involving delay in the taxation of income until a future tax year. The technique may accomplish the joint purposes of deferring taxation until the taxpayer is in a lower tax bracket (such as after retirement) and taking advantage of the time value of money (money not paid currently in taxes can be invested until required).
Q
Qualified Residence Interest: Interest paid or accrued during the tax year on acquisition or home equity indebtedness with respect to any qualified residence (includes the taxpayer's principal residence and one other residence, such as a vacation home, that is used by the taxpayer for a number of days exceeding the greater of 14 days or 10 percent of the number of days during the tax year that it is rented out at a fair market rental value). Acquisition indebtedness (limited to $1 million) is debt incurred in acquiring, constructing, or substantially improving a qualified residence and secured by such residence. Home equity indebtedness (limited to $100,000) is all nonacquisition debt that is secured by a qualified residence to the extent it does not exceed the fair market value of the residence minus any acquisition indebtedness.
R
Realized Gain: The excess of the amount realized (ordinarily the sales price, subject to certain adjustments) over the property's adjusted basis. Normally, the realized gain is recognized (included in gross income) except where a specific IRC section permits the nonrecognition or deferral of the gain for income tax purposes. If the adjusted basis exceeds the adjusted sales price, the resulting loss on disposition is deductible only in certain situations.
Recognized Gain: A gain included in gross income for the current tax year. Normally, a realized gain is recognized in the same tax year, but certain types of transactions may result in either nonrecognition or deferral of the gain for income tax purposes.
Refundable Tax Credits: Tax credits available even if the taxpayer has no tax liability, including withholding on wages, the earned income credit, the alternative child tax credit, the gasoline and special fuels credit, and the health insurance credit.
Regulations: U.S. Treasury documents published to explain and interpret a particular IRC (the Code) section. The Secretary of the Treasury is authorized by Congress to prescribe and issue all rules and regulations needed to enforce the Code. Regulations are usually first published in proposed form (Proposed Regs), which have no force or effect until the Treasury Department issues them in final form. Sometimes Temporary Regs are issued soon after the enactment of a major change in the tax law to provide guidance while Final Regs are being developed. Temporary Regs, until withdrawn or replaced, have the same binding effect as Final Regs.
Revenue Procedures: Statements reflecting the internal management practices of the IRS that affect the rights and duties of taxpayers. Sometimes they are used to announce procedures to guide the public in dealing with the IRS, or to make public something that the IRS believes should be brought to taxpayers' attention.
Revenue Rulings: Official interpretations of the federal tax laws issued by the national office of the IRS that do not have quite the authority of regulations. They are an application of the administrative powers of the IRS, and are limited to a given set of facts.
Reverse Gift: Gifting of appreciated property to a terminally ill person (usually a relative) just prior to the donee's death, with the property then bequeathed back to the donor or the donor's spouse at the donee's death, thus receiving a stepped-up basis for the property, permitting immediate sale at little or no taxable gain. Under IRC Section 1014(e), the "rubber band rule", the donee must own the property for one year or more in order for the original donor to receive a step-up in basis. Also known as a "rubber band" gift.
Revocable Trust: A trust that, once having been created by the grantor, can be revoked by the grantor.
S
S Corporation: A corporation that meets the requirements to make the S Corporation election and whose shareholders have consented to do so. In general, an S Corporation does not pay income tax, but rather passes through to its shareholders its income and deductions. Only small business corporations may become S Corporations, and their shareholders, which are limited in number to 75, must be individuals, estates, certain types of trusts, or certain tax-exempt organizations. An S Corporation can have only one class of stock, which is usually common voting stock. However, this stock may vary in terms of voting rights without being classified as a second class of stock.
Section 179 Limited Expensing Election: An option permitted under the IRC to deduct either partially or in full (subject to dollar limitation), in the year paid or incurred, expenditures that would ordinarily be required to be capitalized and depreciated over their estimated useful life. This election is available for tangible personal property purchased for use in the active conduct of a trade or business, and the amount of the deduction is reduced dollar for dollar for qualifying capital expenditures in excess of $200,000 during the tax year. In addition, the deduction is limited to the taxable income from the active conduct of any trade or business during the year, before the Section 179 deduction.
Section 1231 Property: Generally, operating assets consisting of real or depreciable property used in a business (including rental real estate) and intangible business assets subject to amortization. If gains from the disposition of such property exceed any losses during a tax year, then each gain or loss is treated as though it were derived from the disposition of a long-term capital asset. If losses exceed the gains, all gains and losses are treated as though they were ordinary gains and losses.
Section 1245 Property: Property that is or has been depreciable (or subject to amortization under IRC Section 197) and that is either (1) tangible or intangible personal property or (2) other tangible property (not including a building or its structural components) used as an integral part of manufacturing, production, extraction, or the furnishing of transportation, communications, electrical energy, gas, water, or sewage disposal services. It also includes livestock. A leasehold of Section 1245 property is also treated as Section 1245 property. Such property is subject to depreciation recapture upon disposition.
Section 1250 Property: Any real property that is or has been depreciable but is not subject to recapture under Section 1245. It includes any intangible real property (such as leases of land or other realty), buildings and their structural components, and all tangible real property (except those treated as Section 1245 property).
Self-Employment Tax: A combined Social Security and Medicare tax imposed on income earned by individual taxpayers who are considered to be self-employed, rather than employees.
Settlor: A person who creates a trust. Also known as a grantor or trustor.
Shifting the Tax Burden to Others: A tax-planning strategy that involves transferring assets producing taxable income from an individual in a high tax bracket to an individual in a lower tax bracket to reduce the tax burden of such income.
Simple Trust: A trust that, by the terms of the trust document, is required to distribute all income at least annually and that is prohibited from paying or setting aside amounts for charitable purposes and from making distributions from corpus.
Sole Proprietorship: An unincorporated business activity owned by one individual under which the sole proprietor owns the business assets in his or her name and is personally liable for the business debts. The business has no existence apart from the owner.
Standard Deduction: A below-the-line deduction that any individual taxpayer may take from AGI. The deductible amount is determined by the taxpayer's filing status. This deduction is used in place of itemized deductions if the standard deduction amount exceeds the total itemized deductions available.
Statute of Limitations: The period of time during which an income tax return is still open to examination by the IRS and assessment of additional tax, if appropriate. Typically, this is three years from the later of the statutory due date of the return or the date on which the return was actually filed. This period is extended to six years where a taxpayer files a return and omits an amount of gross income exceeding 25 percent of the gross income reported on the return. In the case of fraud, the return remains subject to audit indefinitely.
Step Transaction Doctrine: An income tax doctrine permitting the IRS to collapse a series of apparently unrelated transactions into one transaction to determine the tax consequences.
Stepped-Up Basis: The usual basis of property received by an estate beneficiary from the estate. The value of the property for estate tax purposes is the fair market value on the date of death of the decedent or, alternatively, the value six months after the date of death (the alternate valuation date), if elected. Such a basis is not necessarily stepped-up if this value is less than the property's basis in the hands of the decedent.
Substance-Over-Form Doctrine: The income tax doctrine that holds that the IRS can look through the legal formalities to determine the economic substance (if any) of a transaction. If the substance differs from the form, the IRS bases the tax consequences of the transaction on the reality rather than the illusion.
Substituted Basis Rule: Under a nontaxable exchange, the basis of the property surrendered is equal to the basis of the qualifying property acquired, except where "boot" is received or paid.
T
Tax Accounting Methods: A set of rules used to determine when and how income and expenses are reported. It includes not only a taxpayer's overall method of accounting but also the accounting treatment used for any material item. A change of method requires IRS approval.
Tax Credit: Amounts permitted, under various tax law provisions, to be deducted from the income tax calculated on taxable income and otherwise payable on a tax return, in determining the taxpayer's net tax liability. For this reason, they are of much greater value than income tax deductions.
Tax-Deductible: Amounts that may be deducted by a taxpayer in arriving at his or her taxable income.
Tax-Deferred: Income not subject to federal income tax in the current tax year but taxed in some future tax year or years. For example, earnings within an IRA are not taxed in the year or years earned, but only upon distribution to the account owner or his or her heir.
Tax Elimination or Reduction: A tax planning technique that employs tax deductions, exemptions, and credits to either reduce otherwise taxable income (or the tax otherwise payable) or to convert taxable income to nontaxable income or provide a nontaxable economic benefit.
Tax-Preference Item: Items specified by income tax law that must be added to regular taxable income in determining alternative minimum taxable income, such as accelerated depreciation in excess of straight-line depreciation for property placed in service before 1987, percentage depletion deductions to the extent in excess of the adjusted basis of the property at year's end, tax-exempt interest on specified private activity bonds, intangible drilling costs to the extent they exceed 65 percent of the net income from the applicable properties, and a specific percentage of the amount of gain excluded from the sale or disposition of Section 1202-qualified small business stock held for more than five years.
Tax Research Process: The process used to ascertain the optimal answer to a question with tax implications. It normally includes (1) understanding the client's transaction and obtaining the facts; (2) formulating specific research questions; (3) locating relevant tax law authority; (4) evaluating the authority and answering the research questions; (5) repeating the previous steps as required; and (6) documenting and communicating the conclusions to the client.
Tax Service: A set of books used in tax research that contains a vast quantity of tax-related information, normally including a compilation of the Code, regulations, court decisions, and IRS releases, with explanations of these primary authorities by the editors.
Tax Year: The annual accounting period is 12 consecutive months, beginning with the first day of the first month and ending on the last day of the twelfth month. Alternatively, taxpayers may select a 52- to 53-week tax year (a fiscal year that varies from 52 to 53 weeks but may not end on the last day of a month). A short tax year is one of less than 12 months usually occurring in the first and final year of a tax entity's existence or when changing the tax year. A change of tax year requires IRS approval.
Taxable Income: The amount upon which income tax is calculated after subtracting allowable deductions for AGI, deductions from AGI, and the personal and dependency exemptions.
Technical Advice Memoranda: Advice from the National Office of the IRS as to the Code, regulations, and statutes and their impact upon a specific set of facts. Generally, such requests are made during an audit or the audit appeals process, and they give both the taxpayer and the IRS agent the opportunity to resolve a dispute over a technical question.
Testamentary Trust: A trust, created under the terms of a will or an inter vivos trust provision that becomes effective only on the death of the grantor.
Trust: A fiduciary arrangement established by a grantor whereby property is held and managed for the benefit of a named beneficiary or beneficiaries by a third party known as a trustee.
Trust Corpus: The assets owned by a trust, as distinguished from the income those assets generate.
Trustee: A person or entity that holds legal title to trust assets and manages the property in a fiduciary capacity for the benefit of the trust beneficiary or beneficiaries.
Trustor: The creator, settlor, or grantor of a trust.
U
Unearned Income Rules: Also known as the kiddie tax rules, a set of rules applicable to the taxation of unearned income of a child under 14 years of age, which taxes such income in excess of a periodically adjusted dollar amount at the marginal income tax bracket of the child's parent or parents.
W
Wash Sale: A sale in which a taxpayer acquires substantially identical stock or securities within a period beginning 30 days before the date of the sale and ending 30 days after that date. In this situation, a loss sustained on the sale or other disposition of the stock or securities is not allowed. The disallowed loss is added to the cost of the new stock or securities. TAs a result, the taxpayer takes a new basis in the new stock or securities; the necessary adjustment operates to postpone the loss deduction until the disposition of the new stock or securities.
