Glossary of TAX TERMS N - Z
03 Jan 15 - By William Truax
AT LAST!! A glossary of tax terms, in plain English with great (and simple) explanations!
This article contains the glossary N through Z. For A - M, please use the link below.
The following glossary is excerpted from the Tax Savings Strategy Handbook, courtesy of The Office of William D. Truax, E.A., Inc.
For A - M of the glossary, CLICK HERE
GLOSSARY OF TAX TERMS ~ N through Z
Welcome to the wild, woolly, wacky world of taxation. As you read through the definitions of terms in this glossary, you may get the feeling you've entered into a strange, alternate universe where nothing makes any sense except in its own terms. This is the universe of taxation...
Please understand also that the tax universe is not the same as the accounting universe, although some sort of accounting must be included within that of taxes. Since accounting and taxation are different things, some words as used for tax purposes will have different definitions from their accounting usage.
Net income (or net profit) — The gross income from a business or rental activity minus the deductions allowable for that activity.
Ordinary income — Income that's taxed at the usual graduated rates, which currently run from 10% up to 35%. Probably the easiest way to define ordinary income is to say it's any sort of income except investment income, passive income, capital gain income, or other specially treated income.
Outflow — Refers to any kind of funds expended for any purpose whatsoever. It may or may not be an expense as defined above. This could include items as diverse as paying rent, buying an asset, making a loan, paying off a loan or other similar things.
Partnership — There are two main types of partnerships, a general partnership and a limited partnership. A general partnership is, in many ways, treated like a collection of sole proprietorships. All the partners are involved in the business, all can make decisions, and all are liable for the acts of that business.
A limited partnership is a structure where one partner is actively involved and calls the shots (the general partner), while the others are usually silent and passive investors (the limited partners). In a limited partnership, the limited partners' liability is generally limited to whatever they've invested, while the general partner is on the hook for the all the legal liabilities of the business. Partners are taxed on their share of the profits of the business annually, even if these profits are not paid out to the partners. Partners actively involved in their business are also subject to self-employment tax in addition to income tax on their share(s) of the profits of the business.
Pass through entity — These business entities pass their income through to their owners on an annual basis, so that the owners pay the tax, but not the business. This “pass-through” is done in such a way that the character of the income in the hands of the owner is the same as it had been in the business. For example, capital gains which occurred at a business level are treated as capital gains by the owners.
Passive income and loss as well as tax-exempt interest also keep their characterization for the owners, while credits, investment income, and similar items are all passed through as well. Partnerships and “S” corporations are pass-through entities.
Passive income — A concept that came into being in tax law as a result of the 1986 Tax Reform Act. Prior to that time, there was a prevalence of "tax shelters." These usually worked by having a passive investor (one not actively involved in the ongoing management of the business) invest in some sort of activity which produced a loss. The passive investor would then be able to take his share of that loss as a loss on his personal tax return and use it to reduce or offset income on that tax return.
Congress considered this an unacceptable arrangement and created this animal called a passive activity and declared the following items connected with it passive, as well: passive income, passive loss, passive credits, and more. The most common form of passive activity is passive investment in partnerships. These could be real estate partnerships or oil and gas partnerships or partnerships that do just about anything.
As just mentioned, if the investor himself is not actively involved in the ongoing management of the business, he's considered a passive investor. This is significant because Congress’s intention was that passive losses could only be taken to the degree that the taxpayer had passive income in that particular year to offset them. The purpose of establishing this legal construct was to prevent people from investing in tax shelters, since they would no longer be able to write off passive losses against other sorts of income.
Pension plan — An IRS or government-approved structure under which money is set aside to be invested for the future income (usually considered to be retirement income) of an individual. Usually, money contributed to a pension plan is deductible in the current year or is not taxed. Additionally, once money is in the pension plan, any earnings on that money are generally not taxed until they're removed. There are a great number of different pension plan types which operate in a great number of different ways, and not all of them work as described. However, these characteristics mentioned above are typical of most pension plans.
Personal holding company tax — A tax levied when certain types of income, such as dividends, interest, royalties, annuities, rents, film rents, income from personal service contracts, and similar income exceed 60% of the corporation's total income, and more than half of the corporation's stock is owned by a small group of people.
The original purpose of this tax was to prevent “incorporated pocketbooks”, meaning that a person or small group of people use the corporate tax structure to achieve a lower overall rate of tax on “personal-type” income than they could by just receiving that income personally. The rate of the tax is 15%, and it is assessed on all the income from most activities (other than an operating business) which remain undistributed at the end of the tax year, and it is assessed in addition to any other income tax.
Personal service corporation — A “C” corporation where the bulk of the activity and income comes from the performance of services in areas such as accounting, actuarial science, architecture, consulting, engineering, health, law, and the performing arts.
Qualified plan — A pension plan of some sort which qualifies for special tax treatment. A qualified plan does not involve the use of any sort of IRA, and thus IRAs, Roth IRAs, SEPs, and SIMPLEs are not technically considered to be qualified plans. A 401(k) plan is commonly a qualified plan, as are some other corporate or business pension plans. A qualified plan always involves some sort of reporting requirement, made by the employer to the IRS, regarding the contributions, participants, earnings, and other matters on an annual basis.
Rental income and expense — One can make money by renting out property, such as a house or an apartment. Generally, the term “rental” in tax law applies only to rentals of real estate or similar property, as opposed to rental of non-real-estate items, such as autos or computers. If you're renting out those kinds of property, tax law usually considers that to be operation of a business activity.
However, with real property (land, and generally whatever is erected or growing upon or affixed to land), one can experience rental income and rental expenses. These expenses are those necessary to provide, operate, and sustain the rented property. They could include such things as interest on the mortgage loan, insurance, commissions, legal fees, utilities, real estate taxes, and depreciation. Rental expenses are deductible against rental income in order to determine net rental profit or net rental income.
Residence — Refers to either to the building in which you live or the place to which you intend to return after any absence. You might, for example, be considered resident in California even though you spent most of a year in Florida on temporary assignment.
"S" corporation — A corporation organized under state law and makes an election under tax law such that it files a tax return but does not pay its own tax. Rather, the income, losses, credits, and other items of tax significance are passed through to the owners of the corporation based on their percentage of ownership, and then included on their personal tax returns.
So, if I were a 100% owner of an "S" corporation which had a profit of $100,000 last year, that $100,000 would show up as income on my personal tax return, and I would pay tax on it there. The "S" corporation would file a return showing the profit, but would pay no tax on it, itself. When such a corporation has a profit and pays those profits out to an owner or owners, those payments are called profit distributions.
Self-employment — The state of doing business for oneself as oneself. You can be doing business either as a sole proprietorship (you doing business under your own or an assumed name) or as a partner in an actively-managed partnership. This is a special concept because all income from selfemployment is subjected to self-employment tax (see below).
Self-employment tax — The tax levied on all self-employment income and is functionally the same as social security tax. (The current rate for social security tax is 15.3%, with the employer paying half — 7.65% — and the employee paying the other half via payroll withholding.) When one is self-employed, there is no employer to pay half the tax, so the self-employed person is responsible for the entire 15.3% himself. Both social security and self-employment tax are composed of two portions, the old-age pension portion and the Medicare portion. The percentage for the old-age pension portion is currently 12.4% and applies to the first $106,800 of income for 2010, although that income number will change each year. The tax on the Medicare portion is 2.9% and applies to all earned income with no cap.
SEP — A special type of IRA account, SEP is an acronym for Simplified Employee Pension. In this arrangement, an employer sets up a series of IRAs, one for each qualified employee, calculates a fixed percentage of each one's income from that job, then contributes that amount to his or her IRA on an annual basis. It’s called a Simplified Employee Pension because the IRS doesn't require annual reporting by the employer.
SIMPLE— This acronym stands for Savings Incentive Match Plan for Employers. This is a different type of pension plan using IRAs. Here an employer offers to each employee the option to open an IRA account and contribute to that IRA a certain portion of his or her wages or salary.
This is a salary deferral plan for the employee, in that the amount of money each defers into his SIMPLE IRA (as opposed to taking it as part of a current paycheck) is not subject to current income tax. Part of the arrangement with a SIMPLE IRA is that the employer is required to match the employee’s contributions up to a certain amount of money. In the case of both a SEP and a SIMPLE IRA, the account belongs to the employee at all times, and he can take it with him upon separation from employment.
Sole proprietorship — A sole proprietorship is just a person doing business, sometimes operating under a different name (frequently called a “dba,” which is an abbreviation for “doing business as”). So, one could be Clare Smith, doing business as “Mr. Fix-it Repairs.” In any case, the individual is that business, and that business is the individual as far as the law is concerned.
A sole proprietor is fully responsible as an individual for the liabilities of his business. Sole proprietorships are taxed on their share of the profits of the business annually, even if these profits are not paid out to the owner. Sole proprietors are also subject to self-employment tax in addition to income tax on the profits of the business.
Split-dollar Insurance — In common split-dollar coverage, the employer and employee split the premiums and the benefits of a life insurance policy. Typically, the company pays for and gets the cash value of the policy, while the employee (or the employee's heirs) get the death benefits.
Standard deduction — A dollar amount of personal tax deductions determined by your filing status (married, single, and so forth.) which reduces the amount of income on which you're taxed. You cannot take the standard deduction if you claim itemized deductions.
Taxable estate — The figure upon which estate tax is computed. It consists of the current market value of all your property or property rights, plus lifetime taxable gifts, less deductions for debts, charitable donations of the estate, and final expenses.
Taxable income — A computed figure arrived at for people by taking gross income as described above, subtracting adjustments, subtracting personal deductions, and subtracting exemption amounts. What’s left is that taxpayer’s taxable income. For business or rental activities, taxable income is usually gross income less allowable deductions.
Tenants in common — Property owned by two or more people where each owner holds a percentage of ownership interest in the overall property. It's abbreviated as "TIC." The percentages don't have to be equal and are usually determined by how much each owner contributes to the purchase of the property. The ownership interests are divisible, meaning that, with two owners, say, one owner can sell or transfer his or her portion of the asset independent of the other owner. It's almost like taking a chain saw down the middle of a house and saying, “That's your half, this is my half" ((assuming each has contributed an equal amount to the purchase).
Trust — A relationship or legal device in which one person, known as a "trustee," holds control and title to property or assets for the benefit of another person, the beneficiary. Since the trustee is being given control and title to assets and is being trusted to do the right thing for the beneficiary, the entity or device by which this is done is known as a “trust.”
Unearned Income — Any income which comes from investments or other sources unrelated to employment or the provision of services.
Usury — The act of lending money at an interest rate higher than that permitted by law.
Wages — Money paid to an employee for services or work performed, as by the hour, day, or week.
XYZ - No terms defined
Glossary is continued (A through M) CLICK HERE
© 2010. William D. Truax, E. A., Inc. All Rights Reserved
To find out more about William D. Truax, E.A., Inc., visit their web site at www.truax.net
Comments, and opinions in this booklet convey the views of William D. Truax, E. A. Inc. on topics they believe are of interest to their clients and the general public.They are not intended as legal, tax, or investment advice.
If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.