Do You Understand Tax Lingo?

• Taxpayer & Dependent Exemptions – Prior to changes made by tax reform legislation, you were allowed to claim a personal exemption for yourself, your spouse (if filing jointly), and each individual who qualifies as your dependent. The deductible exemption amount was adjusted for inflation annually; the amount for 2022 was supposed to be $4,400. However, the tax reform didn’t quite repeal the exemption deduction – it just suspended the deduction for exemptions for 2018 through 2025. Although there’s currently no exemption deduction, the $4,400 amount is used other place in the tax law.
  
  
• Dependents – To qualify as a dependent, an individual must be the taxpayer’s qualified child or pass all five dependency qualifications: the (1) member of the household or relationship test, (2) gross income test, (3) joint return test, (4) citizenship or residency test, and (5) support test. The gross income test limits the amount a dependent can make if he or she is over 18 and does not qualify for an exception for certain full-time students. The support test generally requires that you provide (pay for) over half of the dependent’s support, although there are special rules for divorced parents and situations where several individuals together provide over half of the support.
  
  
• Qualified Child – A qualified child is one who meets the following tests:
  
  
  (1) Has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences;
  
  (2) Is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual;
  
  (3) Is younger than the taxpayer;
  
  (4) Did not provide over half of his or her own support for the tax year;
  
  (5) Is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age); and
  
  (6) Was unmarried (or if married, either did not file a joint return or filed jointly only as a claim for refund).
  
  
• Deductions –  A taxpayer generally can choose to itemize deductions or use the standard deduction. The standard deductions, which are adjusted for inflation annually, are illustrated below for 2022.

• To qualify as a dependent, an individual must be the taxpayer’s qualified child or pass all five dependency qualifications: the (1) member of the household or relationship test, (2) gross income test, (3) joint return test, (4) citizenship or residency test, and (5) support test. The gross income test limits the amount a dependent can make if he or she is over 18 and does not qualify for an exception for certain full-time students. The support test generally requires that you provide (pay for) over half of the dependent’s support, although there are special rules for divorced parents and situations where several individuals together provide over half of the support. 
  
  Itemized deductions generally include:
  
  

  (1) Medical expenses, limited to those that exceed 7.5% of your AGI.
  
  (2) Taxes consisting primarily of real property taxes, state income (or sales) tax, and personal property taxes, but limited to a total of $10,000 for the year.
  
  (3) Interest on qualified home acquisition debt and investments; the latter is limited to net investment income (i.e., the deductible interest cannot exceed your investment income after deducting investment expenses). The deduction for interest paid on a home mortgage may be limited, depending on the amount of the loan.
  
  (4) Charitable contributions, generally limited to 60% of your AGI, but in certain circumstances the limit can be as little as 20% or 30% of AGI.
  
  (5) Gambling losses to the extent of gambling income, and certain other rarely encountered deductions.

• Alternative Minimum Tax (AMT) – The Alternative Minimum Tax is another way of being taxed that has often taken taxpayers by surprise, although due to the changes made by the tax reform legislation fewer taxpayers are being hit with AMT. The Alternative Minimum Tax (AMT) is a tax that was originally intended to ensure that wealthier taxpayers with large write-offs and tax-sheltered investments pay at least a minimum tax. However, even taxpayers whose only “tax shelter” is having a large number of dependents or paying high state income or property taxes were being affected by the AMT. Your tax must be computed by the regular method and also by the alternative method. The tax that is higher must be paid. The following are some of the more frequently encountered factors and differences that contribute to making the AMT greater than the regular tax.
  
  

  o    The standard deduction is not allowed for the AMT, and a person subject to the AMT cannot itemize for AMT purposes unless he or she also itemizes for regular tax purposes. Therefore, it is important to make every effort to itemize if subject to the AMT.

  o   Itemized deductions:

  §  Taxes are not allowed at all for the AMT.

  o    Some Home Acquisition Debt Interest. Interest paid on non-conventional homes such as motor homes and boats is not allowed as an AMT deduction.

  o    Nontaxable interest from private activity bonds is tax free for regular tax purposes, but some is taxable for the AMT.

  o    Statutory stock options (incentive stock options) when exercised produce no income for regular tax purposes. However, the bargain element (difference between grant price and exercise price) is income for AMT purposes in the year the option is exercised.

  o    Depletion allowance in excess of a taxpayer’s basis in the property is not allowed for AMT purposes.

  A certain amount of income is exempt from the AMT, but the AMT exemptions are phased out for higher-income taxpayers.

(1) $103,050 for married taxpayers filing separately