6 Commonly Confused Tax Termstax tips | February 09, 2017 | By Susannah McQuitty
Unless we have some real finance nerds tuned in today – and if we do, hi and welcome! – my guess is that no one is really thrilled about filing their taxes. One of the reasons? It’s just too dang confusing. Even the terms, which you only really hear between January and April every year, can make you feel like a kindergartner reading a calculus textbook.
We’re going to clear up some of the confusion today by looking at three pairs of easily confused tax terms. Knowing the difference will not only help you when you file, but it will also make you really fun at parties. Trust me on this one.
Return versus refund
While “return” and “refund” both mean kind of the same thing (giving or paying something back), they’re completely different terms when it comes to taxes.
Your return is the combination of all the forms you fill out (or all the questions you answer in 1040.com’s interview-style process) to report your finances for the previous year to the IRS. Your taxes are “filed” when your return is completed and sent to the IRS.
Your refund, on the other hand, is the money the IRS sends you if you paid more in taxes during the year than you actually owed. It’s basically like getting change at the store: You hand over too much money, you get a couple bucks and some coins back.
Remember: Your return is basically your financial report that goes to the IRS. Your refund is the change you get back for paying too much in taxes. You file a return. You receive a refund (hopefully!).
Federal return vs state return
Now that we’ve gone over what a tax return is, let’s cover some other commonly confused terms. What’s the difference between a federal return and a state return?
Simple: Your federal return will have all the information related to federal-level income tax reporting, which is governed by the Internal Revenue Service (IRS). Your state return, on the other hand, is filed according to the income tax laws of the state where you lived during the tax year. If you lived in one state and worked in another, you’ll file a return for each state.
The same goes for living in multiple states over the course of the year: You must file a return for each. For example, I live in North Carolina, but I moved from Alabama last year. Because I spent time living in two states, I had two different state returns to file (in addition to my federal return – so three, all together).
Every state has different laws governing the collection of income taxes, and the following seven states don’t collect income taxes at all:
- South Dakota
When you file with 1040.com, we’ll check all the laws in place for filing in your state and automatically pull relevant data from your federal return so you don’t have to insert the same information two or more times!
Credit versus deduction
Alright, time to move on to the good news – tax breaks, here we come! Credits and deductions both work toward getting you a smaller tax bill, but they do it in different ways.
A credit directly reduces the amount that you owe in taxes. Let’s say you owe $1,000 in taxes for the year. If you have a $200 credit, you now only owe $800 in taxes. Even better is a refundable credit, such as the Earned Income Credit or the Child Tax Credit: If you owe nothing in taxes, you can still claim a refundable credit, which means a bigger refund.
A deduction goes straight to what you earned, not to what you owe. So if you made $15,000 over the year, a $200 deduction means you’ll only be taxed on $14,800 of the money you made. Deductions for charitable giving, mortgage interest, IRA contributions, state taxes and medical expenses are a few examples of the many ways you can reduce your “taxable” income.
Dollar-for-dollar, credits offer more tax savings than deductions: A $200 credit will reduce your tax bill more than a $200 deduction would, but both can significantly reduce your tax bill. That’s why we run extensive checks when you file with 1040.com to make sure you cash in on as many credits and deductions as possible.
So there you have it – now you know six tax terms that are easy to confuse and what they actually mean. Anybody think of some others? Let us know below!