Income Categories and Taxation Principles

A set of vocabulary flashcards covering the components of earned, investment, and passive income, as well as capital gains netting and the Alternative Minimum Tax system.

Earned Income

Money received from working at a job or running a self-employed business, including wages, salaries, tips, bonuses, and commissions; it is taxed at the taxpayer’s marginal tax bracket.

Excluded from Earned Income

Types of income the IRS does not classify as earned, which include Social Security, unemployment benefits, alimony, child support, retirement benefits, and proceeds from real estate sales.

Investment Income

Money received from investments, which is generally grouped into three main forms: dividends, interest, and capital gains.

Qualified Dividends

Dividends taxed at lower rates of $0\%$, $15\%$, or $20\%$ instead of the higher rates applied to non-qualified dividends.

Non-qualified Dividends

Dividends that are taxed at higher rates, potentially up to $37\%$, compared to qualified dividends.

Capital Gains (Long-term)

Realized gains from the sale of assets held for more than a year, taxed at rates of $0\%$, $15\%$, or $20\%$.

Capital Gains (Short-term)

Realized gains from the sale of assets held for a year or less, taxed at rates up to $37\%$.

Net Capital Loss Deduction

The ability of an investor to deduct up to $\$3,000$ of net capital losses against earned income in the current year.

Capital Loss Carry Forward

The process of rolling over any net capital loss exceeding $\$3,000$ to future years to offset future capital gains.

Passive Income

Income derived from a business that the recipient does not manage or actively control, commonly including rental real estate properties and limited partnerships.

Passive Loss Limitation

The IRS rule specifying that passive losses can only be used to offset passive gains, preventing taxpayers from using these losses to reduce tax on earned or portfolio income.

Tax Filing Status Suitability

Selecting the most beneficial investment strategy for a client’s tax situation, such as utilizing the lower rates and higher standard deduction of Head of Household status over Single status.

Alternative Minimum Tax (AMT)

A system created by the Tax Reform Act of 1969 where higher-income taxpayers must perform a second tax calculation that removes certain benefits, paying the higher of the standard or AMT results.

Tax Preference Items

Specific benefits removed under the AMT calculation, including certain limited partnership deductions, incentive stock option (ISO) taxation at exercise, and interest on municipal private activity bonds.

Municipal Private Activity Bonds

Bonds issued by municipalities to finance non-government projects, such as airport terminals, whose interest may be taxable for investors subject to the Alternative Minimum Tax (AMT).