Year-end tax guide: Terms and definitions

2015 Year-end tax guideTalking tax 
Get the most out of our year-end tax guidance by understanding the terms.

Alternative minimum tax (AMT) — This is essentially a separate tax system with its own set of rates, rules and deductions. Each year you must calculate your tax liability under the regular income tax system and the AMT, and then pay the higher amount.

Asset sale — It allows buyers to have depreciation write-offs. For a C corporation, an asset means the seller would be taxed twice — first at the corporate level when the assets are sold to the buyer, and then at the individual level when the proceeds are distributed.

C corporation income — It is taxed first at the corporate level and again at the shareholder level when it is distributed to shareholders as dividends.  

Charitable lead annuity trust (CLAT) — Basically the opposite of a charitable remainder trust (CRT), a CLAT provides a similar benefit. For a given term, the trust pays income to one or more charities, and the trust’s remaining assets pass to your designated beneficiary at the term’s end. It is not a taxable gift if the annuity payment to charity is structured so that based on the IRS’s prescribed interest rates, the expected value at the end of the term is zero.

Charitable remainder trust (CRT) — You contribute property to a CRT, and the trust pays you income over a number of years, with the remainder going to a charity after the trust term ends. As long as certain requirements are met, the property is deductible from your estate for estate tax purposes and you receive a current income tax deduction for the present value of the remainder interest transferred to the charity. Because a CRT is a tax-exempt entity, it can sell the property without having to pay tax on the gain. You don’t recognize income until actually receiving the distributions from the CRT.

Extenders — More than 50 popular temporary tax provisions expired at the end of 2014. They have typically been retroactively extended by Congress every year or two, and both Democrats and Republicans have proposed extending them this year.

Incentive stock options (ISOs) — ISOs give you the option of buying company stock in the future. The price (known as the exercise price) must be set when the options are granted and must be at least the fair market value (FMV) of the stock at that time. The exercise price is customarily set at exactly the FMV. Therefore, the stock must rise before the ISOs have any value. If it does, you have the option to buy the shares for less than they’re worth.

Like-kind exchange — A like-kind exchange under Section 1031 allows you to exchange similar property without incurring capital gains tax. Under a like-kind exchange, you defer paying tax on the gain until you sell your replacement property.

Marginal tax rate — Your income is subject to different rates as you climb the tax brackets. Your marginal tax rate is typically the top rate that applies to you. It’s what you would pay on your next dollar of income.

Material participation — Your business income is generally considered passive unless you “materially participate” in the activity. IRS rules allow you to establish material participation in a business by meeting any one of seven tests. The most common test is to work in the business for at least 500 hours during the year. Participation includes almost any work performed in a business as an owner, manager or employee as long as it isn’t an investor activity. Investor hours spent on activities such as studying financial statements, preparing financial analyses or summaries, or monitoring the finances and operations, don’t count as participation.

Medicare tax on earned income — It requires employee and employer contributions on earned income and is uncapped. The employee and employer shares are 1.45% until earned income reaches $200,000 (single) or $250,000 (joint), when the employee rate share increases to 2.35%.

Net investment income tax (NII) — The new NII tax applies a 3.8% tax on all NII once your adjusted gross income exceeds certain thresholds.

Nonqualified deferred compensation (NQDC) — These plans are designed to make payments to employees in the future for services performed now. But they don’t have the restrictions of qualified retirement plans like 401(k)s. Specifically, NQDC plans can favor highly compensated employees and offer executives an excellent way to defer income and tax.

Pass-through entities — They effectively pass taxation through to individual owners, so the business income is generally taxed only at the individual level.

Restricted stock
— It is granted and vests once certain conditions are met.

Restricted stock units (RSUs) — They differ from restricted stock awards. An RSU is a promise made to an employee to transfer stock in the future and is generally subject to the nonqualified deferred compensation rules under Section 409A.

Reverse audit — Professionals review your purchase records over the past three to four years to identify potential missed exemptions, misapplied rates and overpayments. The reviews can often generate significant refunds and identify areas of exposure.

Roth accounts — Four of the defined contribution plans — 401(k)s, 403(b)s, governmental 457(b)s and IRAs — offer Roth versions. The tax benefits of Roth accounts differ slightly from those of traditional accounts. Roth accounts allow for tax-free growth and tax-free distributions, but contributions are neither pretax nor deductible. The difference is in when you pay the tax. With a traditional retirement account, you get a tax break on the contributions — you pay taxes only on the back end when you withdraw your money. For a Roth account, you get no tax break on the contributions up front, but you never pay tax again if distributions are made properly.

Social Security tax — It requires matching employee and employer contributions equal to 6.2% on earned income up to a yearly cap that is adjusted for inflation each year and is $118,500 in 2015.

Stock options — They allow you to buy stock at a set price and become valuable when the value of the stock exceeds the price.

Stock sale — It allows a C corporation owner to be taxed only on one layer of gain.

Tax-deferred transfer — The transfer of ownership of a corporation can be tax-deferred if made solely in exchange for stock or securities of the recipient corporation in a qualifying reorganization, but the transaction must comply with strict rules.

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