Accounting Terms & Definitions - Vyde

What is a Tax Credit?

A tax credit reduces the amount of tax a business or individual has to pay. The government uses tax credits to encourage or reward behavior that they find beneficial. For example, the government can give a tax credit to people for replacing old appliances with new, energy efficient ones. Most tax credits are given to benefit the economy or environment; however, the government can create tax credits for any reason.

Tax Credits cover expenses that you have paid during a tax year. In most cases, you have to meet certain requirements in order to qualify for a tax credit. Because there is such a wide range of tax credits, it is good practice to check with your accountant before you make purchases that could be tax credit. Once you are aware of the qualifications for each credit, you can follow the regulations so you can claim the tax credit.

Both tax credits and tax deductions reduce the amount of tax liability, but there is a difference between the two. Tax credits directly reduce your taxes. Tax credits are “dollar-for-dollar,” meaning that if you owe $1,000 in taxes, but have $1,000 of tax credits, then you would owe zero dollars in taxes. A tax deduction, on the other hand, decreases your taxable income. If you made $100,000 but had $20,000 in tax deductions, you would only be taxed on the $80,000 for that tax year.

Tax Credit Scenario

Derek is a doctor of chiropractic and owns his own business. As a small business owner, Derek tries to take advantage of as many tax credits and deductions as he can. After reviewing the business tax credits, he’s decided to make some changes in his business so that he can take advantage of these credits.

First, Derek is going to start a retirement plan so that he can take advantage of the Credit for Small Employer Pension Plan Startup Costs. Most employers with fewer than 100 employees don’t have retirement plan options. The government encourages business owners to start pension plans by offering a tax credit. The Pension Plan Startup Costs tax credit offers a credit of 50% or $500 a year for three years. This should help offset the costs of setting up a plan and educating employees about it,

Another tax credit Derek can take advantage of as a small business owner is the Credit for Employer-Provided Childcare Facilities and Services. Derek has a few working mothers on his staff. To help ease the burden on them he has decided to pay for some of their child care services. The employer-provided childcare services tax credit offers small business owners a 25% credit or up to $150,000 a year.

Finally, Derek is going to take advantage of the Credit for Small Employer Health Insurance Premiums. The small employer health insurance tax credit rewards small business owners who pay for insurance coverage for their employees. However, it is a little harder to take advantage of. You must have at least 10 full-time (or full-time equivalent) employees. Those employee must have wages under a certain amount, which changes each year. Small business owners must purchase plans through the Small Business Health Options Program (SHOP.) Finally, you can only claim the credit for two consecutive years.

When Derek does his taxes for the next year these tax credits will be deducted from the taxes he owes and will lower what he pays in taxes.

Frequently Asked Questions:

1. What is a tax credit?

A tax credit is a financial incentive provided by the government that directly reduces the amount of tax a business or individual has to pay. Unlike deductions, which reduce taxable income, tax credits lower the actual tax liability dollar-for-dollar.

2. How does a tax credit differ from a tax deduction?

A tax credit directly reduces your tax bill, meaning if you owe $1,000 in taxes and have $1,000 in tax credits, you owe nothing. A tax deduction, on the other hand, lowers your taxable income, which reduces your tax liability indirectly by lowering the amount of income subject to tax.

3. What types of expenses can qualify for a tax credit?

Tax credits can cover a wide range of expenses, such as energy-efficient home improvements, retirement plan startup costs for small businesses, and employer-provided childcare services. The specific expenses that qualify depend on the type of tax credit and the criteria set by the government.

4. Are there specific requirements to qualify for a tax credit?

Yes, most tax credits have specific eligibility requirements that must be met to qualify. These requirements vary depending on the type of credit. It’s advisable to consult with an accountant to understand the qualifications and ensure you meet them before claiming a tax credit.

5. Can a small business owner claim multiple tax credits?

Yes, a small business owner can claim multiple tax credits, provided they meet the eligibility requirements for each. For example, a business owner might claim credits for starting a retirement plan, providing childcare services, and offering health insurance to employees, all within the same tax year.

What is Sales Tax?

Sales tax is a consumption tax on goods and services. State governments, along with county and local governments, set the sales tax; however, not every state has sales tax.

The purpose of sales tax is to fund government projects. The revenues from sales tax are used to fix roads, improve communities, or build infrastructure.

Consumers pay sales tax at the point of sale on goods or services. Businesses charge the consumers and then pass the taxes onto governments. Businesses are liable to pay sales tax if they have any presence in the state. This can mean a brick-and-mortar business, an affiliate, an employee or any other type of presence. States have passed laws requiring online retailers, like Amazon, to charge and pay sales tax.

Because products can pass between many businesses between production and the final sale, only businesses who sell directly to customers have to pay sales tax. The other businesses who handle the products get a resale certification from the government. The resale certification says that the business is not liable for the sale tax because they are not selling directly to consumers.

Sales Tax Scenario

Sales tax at brick-and-mortar businesses are fairly straight forward. We’ll present a scenario for affiliate sales taxes.

Jordan is a tech blogger. He uses affiliate links from several companies to make money from his blog. Jordan lives in Georgia, where there are affiliate nexus laws. Affiliate nexus laws state that companies who use affiliate links and make over a certain amount from those sales must pay sales tax.

The Georgia nexus affiliates state that if a company makes over $50,000 from the nexus in Georgia, then the company must pay sales tax. The companies who work with Jordan have a two options on how they want to proceed. First, they can wait and see if the hit the threshold of sales before paying the taxes. The downside to this is that they may be liable for any penalties or interest due on the unpaid taxes. The second option is that the company collects sales tax up front and then if they have to pay sales tax, they already have the funds set aside to do so.

Jordan, as an affiliate, doesn’t have anything extra to do. However, some companies avoid working with bloggers who live in states with affiliate nexus laws. As more states enact affiliate nexus laws this may change.

What is the Rehabilitation Tax Credit?

The rehabilitation tax credit is a federal tax credit that encourages real estate developers to renovate or restore older buildings. Buildings built before 1936 are the target of the rehabilitation tax credit.

Any renovations made on buildings from 1936 or earlier are eligible for a 10% tax credit. Any buildings that have historical status are eligible for a 20% rehabilitation credit. The tax credit only applies to buildings being restored for business purposes. Buildings with historical status must work with the National Parks Service and meet their requirements.

Contractors cannot claim the tax credit. In order to claim the rehabilitation tax credit you must be the title holder of the property.

The purchase of a building is not eligible for the rehabilitation tax credit. It also cannot be used for landscaping, or repairs to sidewalks or parking lots. You must make improvements to the structure in order to qualify for the credit.

If you want to qualify for the rehabilitation tax credit you must meet certain requirements. You must also meet project deadlines and hit the completion date on time in order to qualify.

Rehabilitation Tax Credit Scenario

Jonathan recently purchased a building in the historic downtown portion of his town. The building is registered as a historical site through the National Parks Service. Because of it’s age, the building needs a lot of updates and repairs.

Jonathan is planning to make those repairs and wants to take advantage of the rehabilitation tax credit. However, since his building is already a historical site, the National Parks Service has to review all of his plans.

The first step Jonathan takes is to contact his local State Historic Preservation Office. He’ll start the process with them. They’ll provide all the forms he needs. Next, the National Parks Service will review his application and see if the repairs Jonathan intends to make conform to the standards set by the Secretary of the Interior.

Once the National Parks Service approves the project, Jonathan can begin construction. Throughout the project the State Historic Preservation Office will make site visits.

Jonathan will claim the rehabilitation tax credit on his taxes for the year in which the project is completed. On the return, Jonathan must put the project number the National Parks Service issued to him. The Rehabilitation tax credit will cover 20% of the qualifying expenses.

Frequently Asked Questions

What is the Rehabilitation Tax Credit?

The Rehabilitation Tax Credit is a federal tax credit that incentivizes real estate developers to renovate or restore older buildings. Buildings constructed before 1936 can receive a 10% tax credit, while those with historical status are eligible for a 20% credit. The credit applies to structures restored for business purposes.

Who is eligible to claim the Rehabilitation Tax Credit?

Only the title holder of the property can claim the Rehabilitation Tax Credit. Contractors are not eligible to claim this credit. The credit applies to renovations or restorations of buildings, not to the purchase of the buildings themselves.

What types of buildings qualify for the Rehabilitation Tax Credit?

Buildings built before 1936 are eligible for a 10% tax credit. Buildings with historical status, as recognized by the National Parks Service, are eligible for a 20% rehabilitation credit. The credit is applicable only to buildings restored for business purposes.

What kinds of improvements qualify for the Rehabilitation Tax Credit?

To qualify for the Rehabilitation Tax Credit, improvements must be made to the structure of the building. The credit does not apply to landscaping, sidewalk repairs, or parking lot repairs. The renovations must meet certain requirements and project deadlines to be eligible.

How does the process work for claiming the Rehabilitation Tax Credit?

To claim the Rehabilitation Tax Credit, you must first contact your local State Historic Preservation Office. They will provide the necessary forms and guide you through the application process. The National Parks Service will review your application to ensure compliance with the Secretary of the Interior’s standards. Once approved, you can begin renovations. After completion, you will claim the credit on your tax return, including the project number issued by the National Parks Service.

What are Pretax Earnings?

Pretax earnings can be applied to individuals or businesses. In each case, pretax earnings refer to the amount of money an individual or business earns before income tax is taken out. Pretax earnings are also referred to as pretax income or earnings before tax.

In order to determine the pretax earnings for businesses you have to do a little bit of math. To calculate the pretax earnings for a business, you should subtract all of the operating expenses, including interest and depreciation, from the total sales or total revenue.

It’s helpful for businesses to understand what their pretax earnings are so that they can compare revenues across areas where corporate taxes may differ.

Pretax Earnings Scenario

Individual Pretax Earnings

Mollie is an employee who receives a regular paycheck. When she looks over her paycheck she can see that her employer has paid her income tax for her. Employers will typically pay the state and federal income taxes, social security and Medicare for their employees. This means that the check Mollie receives and deposits in the bank is her after tax income. In order to determine what she made pretax, she can check her pay stub for her gross earnings.

Business Pretax Earnings

Frederick is the Chief Financial Officer at his company. The company has locations in three different states. The corporate taxes differ in each state. In order to determine how much revenue each location is bringing in Frederick needs to compare the pretax earnings of each store.

Frederick asks the store managers to submit reports with all of the operating costs and total revenues for their store. Once Frederick receives the data he can determine which stores are making the most profits. The numbers would be skewed if he looked at the after tax income, since the tax laws in each state are different.

Glossary: Accounting and Tax Terms

This glossary of accounting & tax terms will hep you understand basic accounting vocabulary. Click on any of the terms for a expanded definition and examples.

Accounting & Tax Terms

After-tax income: The amount of disposable income that a person or company has left over after all federal, state and withholding taxes have been deducted from the taxable income. You can spend your after-tax income on future investments or on present consumption.

Business Tax Credits: Business Tax Credits are a group of credits available to business owners. These tax credits are grouped together and submitted through IRS Form 3800. There is a limit on how many credits you can claim. It is based on your tax liability. Use IRS form 6251 to find out how many credits you can claim.

Charitable Donations: Charitable donations are gifts given to nonprofit organizations. Common gifts include: money, real estate, vehicles, clothing, securities, jewelry or other assets or services. Most charitable donations are tax deductible. It’s important to get a receipt from the organization that you donate to in order to claim it on your taxes.

Tax Credit: A tax credit reduces the amount of tax a business or individual has to pay. The government uses tax credits to encourage or reward behavior that they find beneficial. For example, the government can give a tax credit to people for replacing old appliances with new, energy efficient ones. Most tax credits are given to benefit the economy or environment; however, the government can create tax credits for any reason.

Tax Deductions: A tax deduction is a credit that is subtracted from your income, which lowers your taxable income. The Internal Revenue Service (IRS) allows taxpayers to take a standard deduction or an itemized deduction.

Earned Income Credit: The Earned Income Credit (EIC) is a tax credit for low to moderate income earners. In order to qualify for the Earned Income Credit, you must file a tax return, even if you are not required to file taxes. Those who file for an Earned Income Tax Credit may receive a tax refund if their taxable income is less than the credit.

Federal Tax Lien: A federal tax lien is used to put a lien on property, or any other assets, as collateral for unpaid back taxes. The Internal Revenue Service (IRS) can issue federal tax liens to secure payment of those unpaid back taxes.

Gifts of Equity: A gift of equity is when family members sell property to other family members for less than market value. The gift of equity is specifically the difference between the market value and what the buyer pays. A gift of equity can be for any amount, up to the total value of the home.

Hobby Loss Rule: If your business goes too many years without making a profit it can be classified as a hobby. When it becomes a hobby you can no longer claim losses as business deductions.

Itemized Tax Deduction: An itemized tax deduction is the alternative to taking the standard tax deduction. An itemized deduction counts all of your tax deductions in order to lower your taxable income. It requires more work than claiming the standard deduction, but it can also pay off if your itemized tax deduction is greater than the standard deduction

Kiddie Tax: The Kiddie Tax is a tax applied to a child’s unearned income. When children under the age of 18 make $2,100 or more in unearned income, that income is taxed at the guardian’s tax rate. Unearned income is considered any gifts of stock or other investments. The Kiddie Tax does not apply to earned income (income made through employment.)

Mileage Allowance: The Internal Revenue Service (IRS) allows people who use their vehicles for business, charity, moving or medical expenses to take deductions on those expenses; this is called mileage allowance. The IRS deducts a certain cent-per-mile; the IRS determines the deduction each year. This is also referred to as the “standard mileage rate.”

Nanny Tax: The Nanny Tax is a federal (and sometimes state) tax paid by people who have household help and pay them over a certain threshold. The nanny tax applies to nannies, housekeepers, gardeners or any other household help.

Pretax Earnings: Pretax earnings can be applied to individuals or businesses. In each case, pretax earnings refer to the amount of money an individual or business earns before income tax is taken out. Pretax earnings are also referred to as pretax income or earnings before tax.

Rehabilitation Tax Credit: The rehabilitation tax credit is a federal tax credit that encourages real estate developers to renovate or restore older buildings. Buildings built before 1936 are the target of the rehabilitation tax credit.

Sales Tax: Sales tax is a consumption tax on goods and services. State governments, along with county and local governments, set the sales tax; however, not every state has sales tax.

Underwithholding: Underwithholding is when you haven’t had enough income taxes withheld during a year. If a tax payer’s incomes taxes are underwithheld, it does not mean that tax payers doesn’t have to pay the taxes. Tax payers pay the underwithheld taxes when he or she files a tax return.

Withholding Tax: Withholding taxes are a form of income taxes. These taxes are taken out, or withheld, from an employee’s paycheck, which the employer pays directly to the government.

What is Withholding Tax?

Withholding taxes are a form of income taxes. These taxes are taken out, or withheld, from an employee’s paycheck, which the employer pays directly to the government.

The IRS determines how much to withhold from your paycheck using the W-4 form you fill out when you’re hired. The number of deductions you take determines how much the IRS withholds. The W-4 form will ask the following questions to see how much should be withheld.

Whether to withhold at the single rate or at the lower married rate.
How many withholding allowances you claim. (Each allowance reduces the amount withheld.)
Whether you want an additional amount withheld.

The amount of taxes withheld determines if you get a tax refund each year. If you withhold more than you need to, you’ll get a refund. If you don’t withhold enough, you’ll owe more income taxes.

After you do your taxes, if you realize that you haven’t had enough taxes withheld, or have a life changing event that changes your deductions, then you can fill out another W-4 claiming fewer deductions. This will help so that you don’t have to pay more taxes during tax season.

It doesn’t really matter if you have the correct amount withheld from your paycheck. If you prefer to get a refund then you’ll want to take fewer deductions. However, if you don’t mind paying taxes later, then you can take fewer deductions and have more take-home pay.

The IRS also withholds taxes on other income such as pensions, bonuses, commissions, and gambling winnings.

Withholding Tax Scenario

Jack Taylor is employed and filled out a W-4 when he first started at his job. However, his wife recently had a baby and quit her job. So he needs to readdress his withheld tax deductions.

In order to do this, Jack asked his employer for a new W-4 form (it can also be found online and then submitted to your employer). Jack will follow the personal allowances worksheet on the W-4 to find out his new deductions.

According to the Personal Allowances Worksheet on the W-4 Form Jack is eligible for 6 deductions. However, if Jack takes all of those deductions he may not have enough taxes withheld. Instead of taking all those deductions Jack chose to only take 2 deductions in the hope that he would get a tax refund. After he does his taxes for the year he can reassess if he needs to take more deductions.

What is the Nanny Tax?

The Nanny Tax is a federal (and sometimes state) tax paid by people who have household help and pay them over a certain threshold. The nanny tax applies to nannies, housekeepers, gardeners or any other household help.

The Internal Revenue Service (IRS) instituted the nanny tax because a taxpayer becomes an employer when they are consistently paying another person’s salary. The nanny tax requires taxpayers to pay social security, Medicare and federal unemployment taxes for their employees. Employers traditionally pay these taxes for their employees.

The nanny tax does not apply under a few circumstances. The first, is if the babysitter or help is the taxpayer’s parent or spouse, or if the employee is under 18 and is not in the household profession.

The taxpayer can also avoid the nanny tax by hiring household help through an agency. In this case, the agency is the employer so they would be responsible for any taxes.

Finally, if the employees are officially self-employed, then they are responsible for their own taxes.

Nanny Tax Scenario

Emily Kent is a work-at-home-mom. She hired a nanny to watch her two children for a couple of hours every day, so that she can work. Because she is incredibly busy, she also employs a house keeper, who comes once every two weeks for a few hours to help.

Emily pays her nanny over $2,000 a year, which is the 2017 threshold for the nanny tax. Therefore, Emily is required to pay nanny taxes. This means that Emily will pay the social security, Medicare and unemployment taxes for her nanny.

On the other hand, Emily’s housekeeper won’t meet the $2,000 threshold. While she would fall under the umbrella of employees for the nanny tax, Emily won’t have to pay any taxes for her because she doesn’t meet the threshold. Emily’s housekeeper will be liable to pay taxes on her own.

What is Mileage Allowance?

The Internal Revenue Service (IRS) allows people who use their vehicles for business, charity, moving or medical expenses to take deductions on those expenses; this is called mileage allowance. The IRS deducts a certain cent-per-mile; the IRS determines the deduction each year. This is also referred to as the “standard mileage rate.”

The business mileage rates are based on an annual study of fixed and variable costs of operating a vehicle, while the moving and medical cost are based on just the fixed costs. The charitable rate is set by a statute, so it does not change from year-to-year.

In order to claim the mileage allowance you have to keep records of your miles. In the event that you are audited the IRS will require proof of your mileage. Keeping a mileage log will help you prove that you claimed a necessary deduction. You should include the miles you drove, the date and the reason for the trip on your mileage log.

Taxpayers can choose not to use the mileage allowance and instead calculate the actual cost of using his or her vehicle for business, charity, moving or medical purposes. If you choose to do this, make sure that you keep records of each of the costs of using your vehicle.

Mileage Allowance Scenario

Janice Price is a real estate agent. She frequently uses her car for business purposes. She’ll drive clients around to look at homes. She has to drive to homes she’s selling to put signs out front. Janice also drives to meetings at title companies. She puts a lot of miles on her personal car in order to conduct business. When she files her taxes, she takes the mileage allowance to help recoup some of those costs.

Rather than calculate the actual cost of using her car, Janice opts to use the standard mileage deduction. In order to do this she keeps a mileage log in her car and notes her odometer reading when she leaves and when she finishes a trip. She also notes the date of the trip and the reason for the trip.

When it comes time to pay her taxes Janice uses her mileage log to let her accountant know how much driving she did. Her accountant then puts her miles in and takes a deduction based on her numbers.

What is the Kiddie Tax?

The Kiddie Tax is a tax applied to a child’s unearned income. When children under the age of 18 make $2,100 or more in unearned income, that income is taxed at the guardian’s tax rate. Unearned income is considered any gifts of stock or other investments. The Kiddie Tax does not apply to earned income (income made through employment.)

The Internal Revenue Service (IRS) uses the Kiddie Tax to discourage parents to put investments in their children’s names to try and reduce their taxes. The original law only applied to children under 14; however, the law was changed to include a wider age group. The law now applies to:

Any children under 18
Children who are 24 or under and are full-time students.

If your child owes Kiddie Tax it should be reported on their tax return. You can report Kiddie Tax on the parent’s tax return but it can affect deductions and credits, so it’s best to file a return for the child.

When you are filing a return for a child you will need the parent’s information. Here’s how to determine which parent’s information to use:

If parents are married filing jointly use the primary taxpayer’s information. (They will appear first on the tax return.)
If the parents have never been married use the parent with the highest taxable income.
If the parents are divorced use the custodial parent’s information.

Kiddie Tax Scenario

Dennis and Janet Feinstein gifted their daughter DeeDee a stock that pays out approximately $3,000 a year. Joanna was gifted this stock when she was 12 years old; she is now 17.

The first two years she had this stock her profits were under the Kiddie Tax requirements so she did not have to pay any tax on it. However, for the last three years she has made $3,000 a year. Because it exceeds the $2,100 for the Kiddie Tax DeeDee has to pay taxes on her stocks.

Dennis and Janet make $85,000 a year, which puts them in the 25% tax bracket. DeedDee’s stock are taxed at her parent’s tax rate, so she will pay $750 in taxes on her stocks.

Dennis will prepare DeeDee’s tax return using his information, because he is the primary taxpayer in their family. DeeDee will have a separate tax return filed in her name to pay the taxes on her unearned stock income.

DeeDee’s stock can be taxed under the Kiddie Tax until she is either no longer a full-time student or until she’s 24, whichever comes first.

FAQs

1. What is the Kiddie Tax?
The Kiddie Tax is a tax applied to a child’s unearned income, such as dividends or investment income, over $2,100. It is taxed at the parent’s rate.

2. Who is affected by the Kiddie Tax?
The Kiddie Tax applies to children under 18 and full-time students under 24, as long as their unearned income exceeds $2,100.

3. Does the Kiddie Tax apply to earned income?
No, the Kiddie Tax only applies to unearned income, such as gifts of stock or other investments. It does not apply to income earned through employment.

4. How is the Kiddie Tax reported on a child’s tax return?
The Kiddie Tax should be reported on the child’s tax return, although the parent’s information is needed. It is typically filed separately to avoid affecting the parent’s deductions or credits.

5. How long does the Kiddie Tax apply to my child’s income?
The Kiddie Tax applies until your child turns 18 or until they turn 24 if they are a full-time student. After that, their unearned income is taxed at their own rate.

What is an Itemized Tax Deduction?

An itemized tax deduction is the alternative to taking the standard tax deduction. An itemized deduction counts all of your tax deductions in order to lower your taxable income. It requires more work than claiming the standard deduction, but it can also pay off if your itemized tax deduction is greater than the standard deduction.

Taxpayers are allowed to take personal tax deductions in the following categories:

Medical Expenses
Mortgage Interest on up to two homes
State and Local Taxes
Sale Tax
Property Taxes
Charitable Donations

If you want to claim an itemized tax deduction then you need to keep records of all the items you want to deduct. If the IRS audits you, you need to be able to prove that the deductions you took were legitimate. You should hold onto receipts or other paperwork on tax deductible items for at least seven years.

Itemized Tax Deduction Scenario

Juliet is preparing her taxes and is debating if she should claim the standard deduction or if she should itemize. In the past she has claimed the standard deduction, but over the last year she has had more tax deductible expenses.

She purchased a home in the last year and has been paying a mortgage and property taxes. Juliet also had some unexpected medical expenses when she had her appendix removed.

Because she had the bigger expenses, she is going to do an itemized deduction, which will lower the amount she has to pay in taxes.

When Juliet files her taxes she will fill out the Schedule A form. The Schedule A form lists all of her itemized deductions. The total deductions from the Schedule A form are then entered on a 1040. The deductions are subtracted from Juliet’s income to determine her taxable income.

Juliet will submit her completed taxes to the IRS through the eFile system, just like she has in previous years. Now all she has to do is wait for that tax return!

Resources

Category: Accounting Terms & Definitions