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Tax FAQ:

General Tax Terms & Concepts

Learn about General Tax Terms & Concepts and build a stronger understanding of common federal tax terminology.

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General Tax Terms & Concepts

Ability to pay generally refers to a taxpayer’s financial capacity to pay an outstanding tax liability. The IRS may consider income, expenses, assets, and other financial information when evaluating a taxpayer’s ability to pay.

The IRS may review information about your income, living expenses, assets, liabilities, and available equity. The specific financial information required depends on the type of collection alternative or tax resolution being considered.

Ability to pay can influence which collection options may be available. For example, it can be relevant when evaluating installment agreements, currently not collectible status, or an Offer in Compromise.

The IRS generally evaluates a taxpayer’s financial circumstances when determining appropriate collection arrangements. However, the agency may use its own financial standards and documentation requirements when determining allowable expenses and payment capacity.

The IRS may consider income, bank accounts, investments, real estate, vehicles, business assets, debts, necessary living expenses, and other financial information.

Yes. Ability to pay is an important factor in determining whether a taxpayer may qualify for an Offer in Compromise based on doubt as to collectibility.

Yes. Changes in income, employment, expenses, assets, debt, or other financial circumstances can change a taxpayer’s ability to pay.

Depending on your circumstances, you may qualify for options such as an installment agreement, temporary collection delay, or Offer in Compromise.

They can. If you own a business, the IRS may consider relevant business income, expenses, assets, and equity when evaluating your overall financial situation.

You may be able to provide updated financial information and supporting documentation if you believe the IRS’s assessment does not accurately reflect your circumstances.

Tax abatement generally means reducing or eliminating a tax, penalty, interest amount, or other tax-related liability under an applicable legal provision.

Penalty abatement is the reduction or removal of certain penalties assessed by the IRS when the taxpayer qualifies under applicable rules.

In limited circumstances, the IRS may reduce or remove certain interest charges when specific statutory or administrative requirements are satisfied.

The procedure depends on what you are requesting to have abated. Some requests can be made through a tax return, written correspondence, or a specific IRS form or procedure.

Reasonable cause generally refers to circumstances showing that a taxpayer exercised ordinary business care and prudence but was unable to comply with a tax obligation because of circumstances beyond the taxpayer’s reasonable control.

Potentially. Eligible taxpayers may qualify for administrative first-time penalty abatement if they meet the IRS’s requirements.

Generally, penalty or interest abatement does not eliminate the underlying tax itself. Other tax resolution options may be available for taxpayers who cannot pay their underlying liability.

In some circumstances, a taxpayer may be able to request a refund or adjustment of penalties that were previously paid, depending on the applicable rules and deadlines.

Processing times vary depending on the type of request, the complexity of the case, and whether additional documentation is required.

Yes. A qualified tax professional can evaluate whether you may qualify for relief, prepare supporting documentation, and communicate with the IRS on your behalf when authorized.

A tax assessment is the formal determination by the IRS or another taxing authority of the amount of tax a taxpayer owes.

An assessment can result from a taxpayer’s filed return, an IRS examination, an adjustment to a return, a substitute return, or other authorized procedures.

An IRS notice may inform a taxpayer about an assessed tax liability, adjustments, penalties, interest, or collection activity associated with the liability.

Yes. Depending on how and when the assessment was made, taxpayers may have rights to challenge it through administrative procedures, amended returns, appeals, or court proceedings.

If the tax remains unpaid, the IRS may begin collection activity after required notices and waiting periods. Available collection actions can include liens, levies, and other enforcement measures.

An IRS account may include the underlying tax as well as applicable penalties and accrued interest. These amounts are generally tracked separately within the taxpayer’s account.

Federal tax collection is generally subject to a statutory collection period, commonly referred to as the Collection Statute Expiration Date. Certain events can suspend or extend the applicable period.

A deficiency generally represents additional tax determined to be owed after the IRS adjusts a taxpayer’s reported liability.

Taxpayers can review IRS account information and transcripts or contact the IRS to obtain information about assessments and outstanding balances.

Potentially. An assessment may be changed through an amended return, administrative review, audit reconsideration, appeal, court proceeding, or another applicable procedure.

Tax compliance generally means meeting applicable tax obligations, including filing required returns, reporting income accurately, paying taxes on time, and maintaining appropriate records.

Maintaining tax compliance can help taxpayers avoid penalties, interest, collection actions, and other consequences associated with failing to meet tax obligations.

Depending on the circumstances, noncompliance can result in penalties, interest, additional assessments, collection activity, or other enforcement measures.

A taxpayer may need to file delinquent returns, correct inaccurate filings, pay outstanding balances, establish a payment arrangement, or address other unresolved tax obligations.

Not necessarily. A taxpayer may be considered compliant while using an approved IRS payment arrangement or other authorized resolution option, depending on the circumstances.

Taxpayers should generally retain income records, expense documentation, tax returns, receipts, financial statements, and other records supporting items reported on their tax returns.

The appropriate retention period depends on the type of document and the circumstances. Taxpayers should generally retain records for as long as they may be relevant to a tax return, assessment, or collection matter.

Yes. Businesses may have additional obligations involving income taxes, payroll taxes, information returns, accounting records, sales or use taxes, and other federal, state, and local requirements.

Voluntary compliance generally refers to the tax system in which taxpayers are responsible for determining, reporting, and paying their tax obligations rather than having the government calculate every liability in advance.

Yes. A qualified tax professional can help identify filing requirements, prepare returns, maintain records, address outstanding issues, and develop procedures to reduce future compliance problems.

Due diligence generally means taking reasonable steps to verify information and comply with applicable tax rules before preparing or submitting a tax return or making a tax-related decision.

Tax professionals may have specific due diligence obligations when preparing certain returns or claiming certain tax benefits. Taxpayers also have a responsibility to provide accurate and complete information.

Proper due diligence can help tax professionals identify inaccurate information, unsupported claims, eligibility problems, and potential compliance issues.

A tax preparer may face penalties or other consequences if they fail to meet applicable federal due diligence requirements.

Not necessarily. A tax preparer’s due diligence does not automatically eliminate a taxpayer’s responsibility for providing accurate information or meeting tax obligations.

The documents needed depend on the tax issue. They may include income records, receipts, expense documentation, education records, dependent information, business records, and other supporting documents.

Yes. Federal tax law imposes specific due diligence requirements on paid preparers for certain tax credits and filing statuses.

A due diligence checklist is a set of procedures used to verify information, identify inconsistencies, document questions and answers, and support positions taken on a tax return.

Generally, taxpayers are responsible for the accuracy of the information they provide and the returns they sign. They should review their returns carefully before filing.

Taxpayers can improve due diligence by maintaining accurate records, providing complete information to their tax professional, reviewing prepared returns, and promptly addressing questions or inconsistencies.

Tax avoidance generally refers to legally reducing tax liability by using deductions, credits, exclusions, elections, and other provisions permitted by tax law.

Generally, legitimate tax planning and the use of provisions specifically allowed by law are legal. However, transactions designed primarily to improperly evade taxes or conceal income can create serious legal consequences.

Tax avoidance generally involves legally reducing taxes through permitted strategies. Tax evasion involves intentionally using illegal methods, such as concealing income or falsifying information, to avoid paying taxes.

Tax planning can involve tax avoidance when it uses legal provisions to reduce or defer taxes. Legitimate tax planning is generally recognized as part of managing tax obligations.

Yes. Businesses can generally use legitimate deductions, credits, depreciation, retirement plans, entity structures, and other tax provisions to reduce their tax liability.

Claiming legitimate deductions to which you are entitled is generally a normal part of tax compliance and planning.

An abusive tax avoidance transaction is generally a transaction or arrangement designed to produce improper tax benefits rather than legitimate economic or business results.

Yes. The IRS can challenge transactions or positions that it believes do not comply with tax law or applicable anti-abuse doctrines.

No. Some tax shelters are legitimate, while others may be abusive or illegal. The tax treatment depends on the structure and applicable law.

Yes. Complex tax planning can have significant legal and financial consequences, so taxpayers should understand the applicable rules before implementing an aggressive or complicated strategy.

Tax benefits are provisions of tax law that can reduce, defer, exclude, or otherwise modify the amount of tax a taxpayer owes.

Examples include deductions, tax credits, exclusions, exemptions, tax-deferred accounts, favorable capital gains treatment, and certain employer-provided benefits.

A deduction generally reduces taxable income, while a tax credit generally reduces the amount of tax owed. Some tax credits may also be refundable.

No. Eligibility depends on the specific tax provision and can depend on income, filing status, employment, expenses, investments, family circumstances, or other requirements.

Yes. Businesses may qualify for deductions, credits, depreciation, exclusions, and other tax benefits depending on their activities and circumstances.

Some tax benefits, such as deductions and certain exclusions, can reduce taxable income. Other benefits, such as tax credits, generally reduce tax after taxable income has been calculated.

Some tax credits are refundable, meaning an eligible taxpayer may receive a refund even if the credit exceeds the taxpayer’s federal income tax liability.

Some tax benefits may be carried forward to future tax years, depending on the specific provision and applicable limitations.

Yes. Tax laws, income thresholds, credit amounts, deduction limits, and eligibility requirements can change.

You can review the applicable tax rules and your individual circumstances or consult a qualified tax professional to identify potentially available tax benefits.

Tax evasion is the intentional and illegal act of avoiding taxes by concealing income, falsifying information, claiming fraudulent deductions, or using other unlawful methods.

Yes. Federal tax evasion can be a criminal offense and may result in significant penalties, including fines and potential imprisonment.

Examples can include deliberately hiding income, maintaining false records, claiming fictitious deductions, using false documents, or concealing assets to avoid taxes.

Tax avoidance generally involves legally reducing taxes through permitted provisions. Tax evasion involves intentionally violating tax laws to avoid paying taxes that are legally owed.

It can be if the failure is intentional and meets the legal requirements for tax evasion. An honest mistake or misunderstanding is not automatically criminal tax evasion.

Yes. Businesses and individuals can potentially face civil or criminal consequences for intentional violations of federal tax laws.

Potential consequences can include repayment of taxes, civil penalties, interest, criminal fines, and imprisonment, depending on the nature and severity of the conduct.

Yes. The IRS receives information from employers, financial institutions, businesses, and other third parties and may compare that information with taxpayer returns.

You should address the issue promptly. Depending on the circumstances, you may need to amend a return, file a delinquent return, pay additional taxes, or seek professional tax advice.

A qualified tax professional or tax attorney can help evaluate the situation, determine appropriate corrective steps, and communicate with tax authorities when authorized.

Tax liability is the amount of tax a taxpayer is legally responsible for paying for a particular tax period.

Tax liability depends on factors such as taxable income, applicable tax rates, deductions, credits, filing status, and other provisions of tax law.

Tax liability is the amount of tax owed under the applicable tax rules. Tax debt generally refers to an unpaid tax liability that remains due to the taxing authority.

Yes. Nonrefundable tax credits can generally reduce tax liability to zero, while refundable credits may potentially result in a refund if the credit exceeds the applicable tax liability.

Deductions generally reduce taxable income rather than directly reducing the tax owed. The resulting reduction in tax depends on the taxpayer’s applicable tax rate.

Depending on your financial circumstances, you may qualify for an installment agreement, temporary collection delay, Offer in Compromise, or another tax resolution option.

Yes. The IRS can adjust a taxpayer’s liability through an examination, mathematical correction, information matching, substitute return, or other authorized process.

The underlying tax liability is generally separate from penalties and interest, although all three may appear together as amounts due on a taxpayer’s IRS account.

Federal tax collection is generally subject to a statutory collection period, although certain circumstances can suspend or extend that period.

You can review your IRS account or tax transcripts, examine your tax returns and notices, or contact the IRS or an authorized tax professional for account information.

A tax shelter is an arrangement or investment intended to reduce, defer, or eliminate taxes through tax benefits associated with the structure or transaction.

Some tax shelters are legitimate and specifically permitted by law. Others may be abusive arrangements that the IRS challenges or that may violate tax laws.

Certain retirement accounts, tax-advantaged investments, qualified education programs, and other arrangements established under federal tax law can provide legitimate tax benefits.

An abusive tax shelter generally involves transactions structured primarily to obtain improper tax benefits without legitimate economic substance or a valid business purpose.

Yes. The IRS can challenge transactions that it believes improperly reduce taxes or violate applicable tax rules.

Potential consequences can include additional taxes, interest, substantial penalties, and in serious cases, criminal prosecution.

You should examine the legal structure, economic substance, tax authority supporting the treatment, and the qualifications of the professionals promoting the arrangement.

Retirement accounts are generally better described as tax-advantaged accounts rather than abusive tax shelters. Many receive favorable tax treatment specifically authorized by Congress.

Businesses may use legitimate tax planning strategies and tax-advantaged structures. However, transactions designed primarily to generate artificial tax benefits can create significant risks.

Yes. Complex tax-advantaged investments can involve significant legal, financial, and tax consequences, so professional review is advisable before entering into such an arrangement.

A tax year is the annual accounting period used to determine a taxpayer’s income, deductions, credits, and tax liability.

A calendar tax year runs from January 1 through December 31. A fiscal tax year generally consists of a 12-month period ending on the last day of a month other than December, subject to applicable rules.

Most individual taxpayers use the calendar year, although certain taxpayers may qualify to use another accounting period.

A business may use a calendar year or, when permitted, a fiscal year depending on its entity type, accounting method, elections, and other requirements.

The tax year determines when income, deductions, credits, and other tax items generally must be reported.

Some taxpayers may be able to change their tax year, but approval or specific procedures may be required depending on the taxpayer and circumstances.

A business that begins operations during the year generally has a short tax year for its initial return if its chosen tax year does not begin on January 1.

A short tax year is a tax year that covers a period of less than 12 months, such as when a taxpayer starts or ends a business during the year or changes accounting periods.

Generally, yes. Filing and payment deadlines are tied to the applicable tax year and the taxpayer’s filing requirements.

Yes. Tax rates, deductions, credits, thresholds, filing requirements, and other provisions can change between tax years.

A taxpayer is an individual, business, estate, trust, or other entity that is subject to a tax obligation under federal, state, or local law.

Individuals, corporations, partnerships, trusts, estates, and other entities may be taxpayers depending on their circumstances and applicable tax rules.

Taxpayers generally must file required returns, accurately report income and other information, pay taxes when due, and maintain appropriate supporting records.

Taxpayers have rights under federal law, including rights to information, privacy, representation, challenge and appeal certain IRS decisions, and fair treatment during the tax process.

Yes. A taxpayer can generally authorize a qualified representative, such as an attorney, CPA, or enrolled agent, through an appropriate power of attorney.

A taxpayer identification number is an identifying number used for federal tax administration. Examples include Social Security numbers, Employer Identification Numbers, and Individual Taxpayer Identification Numbers.

Yes. Depending on the matter, a taxpayer may have administrative appeal rights or the ability to seek judicial review.

Failure to file can result in penalties, interest, an IRS-prepared substitute return, and potentially collection action.

Potentially. Depending on the circumstances, taxpayers may qualify for payment plans, Offers in Compromise, penalty relief, or other collection alternatives.

Yes. Attorneys, CPAs, enrolled agents, and certain other authorized professionals may represent taxpayers before the IRS when properly authorized.

A tax write-off is a common term for an expense or other amount that can potentially be deducted or otherwise used to reduce taxable income or tax liability under applicable tax rules.

Generally, the terms are often used interchangeably in everyday language. A tax deduction is the formal tax concept involving amounts that reduce taxable income.

Yes. Individuals may be able to claim certain deductions for qualifying expenses, depending on their circumstances and the applicable tax rules.

Yes. Businesses may generally deduct ordinary and necessary expenses incurred in carrying on their trade or business, subject to applicable limitations.

Potential business deductions can include qualifying employee wages, rent, supplies, insurance, professional services, advertising, depreciation, and other ordinary and necessary business expenses.

Generally, personal expenses are not deductible unless a specific tax provision allows the deduction or a portion of the expense qualifies for a particular tax benefit.

Potentially. Eligible self-employed taxpayers may be able to deduct qualifying home office expenses if they meet the applicable requirements.

Potentially. Eligible taxpayers may be able to deduct qualifying charitable contributions if they meet the requirements for claiming the deduction.

No. A deduction generally reduces taxable income rather than providing a dollar-for-dollar tax refund. The actual tax savings depend on the taxpayer’s applicable tax rate and other circumstances.

You should determine whether the expense meets the specific requirements of the applicable deduction or tax provision and maintain documentation supporting the amount and business or tax purpose of the expense.

 
 
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