From 'withholding tax' to 'adjusted gross income': Tax season terms for beginners
"Withholding." "Adjusted income." "Standard deduction." With Tax Day approaching, many new to the workforce are searching for explanations to help them make sense of all the lingo.
Shannon McLay knows a thing or two about putting financial language in layman's terms. She left a job as a financial advisor at Merrill Lynch after she realized she really wanted to be helping people who couldn't afford her services. So she started the Financial Gym, where clients pay a monthly fee to work with "trainers" who teach them to manage their finances.
At the Financial Gym, classes are held at least once a week walking clients through the basics. Topics include everything from investing to career planning to yes, taxes. McLay said taxes can sometimes prove more daunting than they need to be.
"Tax time is a confusing, stressful time for a lot of people," she said. "For most people, tax time shouldn't be that complicated."
So what terms do you really need to know to file? McLay breaks down some of the terms her trainers get asked about.
WITHHOLDING
"A withholding is the amount of money that's taken out of your paycheck every time you get paid that gets set aside for your taxes," McLay explains.
If you work for a company, you can request that they make adjustments to how much is withheld. Freelancers, though, should make quarterly payments themselves, something McLay said not everyone does.
"Don't get in trouble for not paying the government all year," she said, "because not only will you get penalized for not paying your taxes, you will have a large IRS debt bill when you file."
And in case you want to get a head start on figuring out your withholding for 2018 taxes, the IRS has a withholding calculator.
EXEMPTIONS
Exemptions are factors, such as having children, that affect how much money you owe from each paycheck. You report how many exemptions apply to you, and this number affects how much is withheld throughout the year.
"The higher your exemption number, the lower your withholding will be, which means that less will be taken out and paid to the government," McLay explained.
McLay recommends filing the correct amount, but putting fewer exemptions than the number that applies to you can't hurt.
"We'll have clients opt to have the least amount of exemptions, even though they might qualify for more, because they want more money withheld every month so that they have to pay less taxes when they go to file in April," she said.
Putting more than apply to you, however, could result in you owing the government.
DEDUCTIONS: STANDARD VS. ITEMIZED
Deductions lower the amount of your income that can be taxed.
"With the recent tax bill regulation, 'deduction' has been a popular word," McLay said.
You can choose to take either the standard deduction or to itemize it. So what's the difference between the two types?
"The standard deduction is what everybody has," McLay explained."It's the amount that you can subtract from your income before you figure out what your tax rate is."
In other words, no math required. An itemized deduction, on the other hand, only applies if you think that adding up your deductible expenses (such as donations to charity) will result in a higher deduction than the standard.
"If you don't have enough expenses that are going to add up to that standard deduction, then you don't have to worry about itemizing anything," McLay explains.
The standard deduction is going up in 2018, and McLay said she advises clients who don't have significant deductible expenses to skip the math and take the standard deduction.
ADJUSTED GROSS INCOME
Your "adjusted gross income" is different from your gross income.
"Gross income is what you know you make," McLay said. "It's $70,000 or $40,000 a year. It's what is on your pay stub. The adjusted gross income, though, is what you're actually taxed on."
The income that you're taxed on can be lower than your actual income if you take deductions, and this can affect your tax bracket.
TAX BRACKETS
Speaking of tax brackets, McLay said that though many worry over which one they're in, they don't need to.
"We have a lot of clients who ask us about tax brackets, and how do they know which one they fit into, and honestly it's very confusing," she said. "We tell people, don't stress out about the tax brackets when you go to file, just make sure you're having taxes withheld or you're paying regularly and it'll all work itself out when you go to file in April."
ACCOUNTANT
Many clients assume they need accountants, but McLay said it depends on your situation. If you have a special case when filing, such as owning a business, McLay said you should consider an accountant.
"If your tax situation's complicated, like you have a business or you own rental properties," McLay said, "definitely invest in an accountant. It'll make sense. You want to make sure that you're checking all the boxes, and an accountant will make sure you do that."
For those with less complex situations, though, McLay said it's best to just power through it.
"My advice to clients who have very basic tax needs is don't waste money on an accountant," she said. "Just get TurbTax and a bottle of wine."
