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Financial Planning

Income tax glossary: Basic terms your clients should know

If there's one thing that might get your clients feeling anxious, it's tax season. Taxes can frustrate your clients, especially if they're trying to file on their own.

There are a number of tax terms and definitions your clients might not understand. That confusion can lead to avoidance and costly mistakes — for example, your clients could face penalties if they are late paying their taxes.

So it's critical that you help educate them. Here's one way to start that process.

Provide an income tax glossary

Financial professionals should think outside the box and anticipate their clients needs. Sometimes that means going the extra mile and providing clients with a few extra tools to help them better understand financial topics.

For taxes, consider providing a basic tax glossary for your clients.

It doesn't have to be complex — the last thing you want to do is potentially send your clients further into the weeds. Instead, focus on making a list that features the most basic tax terms with simple and straightforward definitions.

Basic income tax terms

Here is a list of basic tax terms and definitions you can share with clients:

Adjusted gross income

Your adjusted gross income (AGI) is a calculation the Internal Revenue Service (IRS) uses to determine your eligibility for certain deductions and credits. It is your total gross income minus certain adjustments. One common adjustment, for example, is interest on student loan debt.

After-tax retirement account

For an after-tax retirement account, you have already paid taxes on your contributions since they were made with after-tax dollars. So you do not pay taxes on any withdrawals as long as the IRS-declared requirements have been met.

Audit

An audit is a review of your tax return by the IRS. Some audits are random, however, they are usually triggered by a red flag. If you are audited, the IRS will contact you and ask you to provide specific information to resolve any issues.

Capital gain

A capital gain is profit from the sale of specific assets, including shares of mutual funds, real estate and stock. Depending on how long you've held the asset, it can be taxed at different tax rates.

Capital loss

A capital loss is any loss from the sale of real estate, stocks, bonds and other similar assets. These losses can be used to offset any capital gains you might have for the year up to a certain amount. Any excess losses over that amount can be carried over to the next year to offset capital gains or ordinary income up to the allowable limit.

Deductions

Deductions are amounts subtracted from your gross income to determine your taxable income. These are also referred to as write-offs, as well.

There are two common classes of deductions. The standard deduction is a write-off that is a specific amount based on your filing status. You can choose to forgo the standard deduction and claim itemized deductions, which are certain eligible expenses. Determining which method to use is a matter that should be discussed with your tax advisor first.

Estimated tax

Many people who own a business — including freelancers, consultants and self-employed individuals— have income that is not subject to withholding. In this case, they need to make quarterly payments that cover the estimated amount of that year's tax bill.

Exemption

An exemption is a deduction allowed by law to reduce the amount of income that would otherwise be taxed. (Visit IRS.gov to view changes to exemptions due to the 2017 Tax Cuts and Jobs Act. )

Extension

You can request an extension to filing your taxes. Typically, it will move your filing deadline out by three additional months. It's important to note that if you miss a filing deadline and pay your taxes late, you could be subjected to penalties.

Filing status

Your filing status helps the IRS determine your tax rates, as well as your standardized deduction. Some of the options include single, married filing separately and married filing jointly. If you've recently gotten married, for example, determine your best options for how you want to file.

Pre-tax retirement account

Pre-tax retirement accounts are also known as qualified retirement accounts. With these accounts you do not pay any taxes on your contributions until they are withdrawn.

Tax bracket

This is the tax rate you will pay for each portion of your income that falls within a certain set range. It's part of a progressive tax system where the more income you have the higher the taxation rate. Depending on your income, any changes to it — including taking a part-time job — could impact your tax bracket and how much you pay.

Withholding

This is the amount of your wages that are held from each pay check and cover your Social Security and income taxes each year.

Helping your clients better understand tax terms

A basic list like the one above should help your clients get a good handle on the terms they've probably heard before, but weren't quite sure exactly what they meant.

Create an atmosphere where your clients feel comfortable enough to ask questions and get the help they need. An empathetic approach where there are no bad questions can go a long way toward building a great long-term relationship.

It is particularly important to check in with your clients if they have gone through recent life changes, including getting married or divorced, having a baby or buying a new home. Each of these can impact taxes.

Finally, ask if your clients have a tax professional. If they don't have one, and you think there's a need, offer up a few suggestions of resources who can give more tailored advice based on their knowledge and expertise around the tax code.

Taxes don't have to be confusing for your clients. Taking a proactive approach to helping them with the basics can build your relationship and allow them to feel more comfortable come tax season.

Read more to help your retired clients understand how part-time work could impact their taxes.

SM.1578905.03.20

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