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A Guide to Advanced Tax Terminology

Taxes are something that every American must face for the majority of his or her life. With the start of a first job, income taxes become one of the great inevitabilities of living in our modern society. Many people learn tax basics but there are numerous complex tax questions that everyday people will never encounter. The list below explores a few of the complicated terms and calculations that an individual may need to know.

Adjusted Basis

In tax, investments, and accounting, basis represents the value of an asset to a taxpayer. For example, the price of a house a taxpayer buys is the original basis. If the taxpayer puts in a new kitchen, the basis increases by the amount of the renovations. If the house burns down, the basis is decreased by the amount of the damage. The basis amended for changes and improvements is called an adjusted basis. Basis is critical for calculating gain or loss on personal property as well as business property for tax reporting purposes.

Alternative Minimum Tax

An alternative rate of taxation in the form of a virtually flat-rate tax imposed above a certain exemption amount after adjustments to gross income. The calculations for AMT are complicated and the rates have not recently been adjusted for inflation, making its use controversial. Any taxpayer can be subject to AMT if their income falls within a certain window and are subject to certain tax situations like accelerated depreciation and tax-exempt private activity bond interest.

Capital Loss Carryover

Capital losses from the sale or disposition of capital assets are limited to $3,000 per year. If you have more income than the full amount of the $3,000, any amount of your unused capital loss will carry over to the next year. To determine the amount of the capital loss subject to carryover, you must first net short-term and long-term capital losses to come up with one total amount and subtract the $3,000 used in the current year.

Foreign Tax Credit

Taxpayers who pay foreign taxes, either on earned or unearned income, can sometimes be permitted to take a credit for the taxes paid. While most people don’t have a general source of income from working in other countries, many individuals have passive foreign source income from investments in international securities. When a taxpayer pays foreign taxes, they must report the income and taxes paid on Form 1116. This form calculates a tax credit, which can be used to offset income.

Passive Income

Many people believe that all income is the same no matter where it comes from. However, this is not true. Some income, like income earned at a job and reported on a W-2, is active or general income. Income from things like partnership interests where a taxpayer is not materially involved or from sources like rental properties are considered passive and thus subject to different rules. While passive gains must be recognized as income, passive losses can only be used to the extent of passive gains and cannot be used to offset any other kind of income.

Section 265 Disallowance

For taxpayers who pay an investment advisor to oversee their portfolios, investment management fees are deductible on Schedule A. This provides a tax relief to these taxpayers, as many asset management firms have steep rates. However, taxpayers cannot deduct management fees imposed on tax-exempt income. Taxpayers in this category must calculate the tax-exempt percentage of their investment portfolios, find the percentage of investment management fees related to this portion, and subtract it from the gross total of fees they wish to deduct.

Byline

Vince Truman is a freelance writer based on Cleveland, Ohio who specializes in taxation. Vince covers a wide variety of taxation issues, including lesser known issues such as Casualty Loss Form for Taxes.

© 2013, Jen Carrigan. All rights reserved.

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