Last-in, first-out (LIFO)
A rule that applies to the sale of part of a group of similar items in an inventory that assumes the last ones acquired were the first ones sold. This is important if the items in the group were acquired or manufactured at different times or for different costs. (See “First-in, first-out (FIFO).”) Like-kind exchanges. Tax-free swaps of investment property. Commonly used for real estate.
Limited liability company (LLC)
A legal structure that allows a business to be taxed like a partnership but function generally like a corporation. An LLC offers members (among other things) protection against liability for claims against the business that is not available in a partnership.
Listed property
Property listed in the tax code or by the IRS that must comply with special rules before depreciation may be claimed. Cars and personal computers are examples of listed property. The special rules are designed to prevent deductions where the property is used for personal rather than business purposes.
Medical Spending Accounts (MSAs)
An investment fund similar to an IRA that can be used to pay more routine medical expenses, when used in conjunction with “high-deductible” health insurance, which pays the big bills. Only 750,000 of these MSAs are available nationwide under a pilot program that runs through the year 2000. To qualify, you have to be self-employed or employed by a small employer that offers the program.
Modified Accelerated Cost Recovery System (MACRS)
The system for computing depreciation for most business assets.
Net operating loss
The excess of business expenses over income. A business may apply a net operating loss to get a refund of past taxes (or a reduction of future taxes) by carrying it back to profitable years as an additional deduction (or by carrying it forward as a deduction to future years).
Original issue discount (OID)
The purchase discount offered on some bonds (and similar obligations) in lieu of interest. For example: zero-coupon bonds. OID is generally treated as interest income to the holder rather than as a capital gain.
Passive activity loss (PAL)
Loss on an investment that is deductible only up to the limit of gains from similar investments. The limit mainly affects tax shelters and does not apply to stocks, bonds or investments in businesses in which the investor materially participates. Special rules apply to investments in real estate.
Qualified plan
A retirement or profit-sharing plan that meets requirements about who must be covered, the amount of benefits that are paid, information that must be given to plan participants, etc. Qualified plans are entitled to tax benefits unavailable to nonqualified plans.
Real estate investment trust (REIT)
A kind of “mutual fund” that invests in real estate rather than stocks and bonds.
Real estate mortgage investment conduit (REMIC)
A kind of “mutual fund” that invests in real estate mortgages rather than stocks and bonds.
Recapture
The undoing of a tax benefit if certain requirements are not met in future years. For example: (1) The low-income housing credit may be recaptured or added back to tax if the credit property ceases to be used as low-income housing for a minimum number of years. (2) The alimony deduction may be retroactively lost or recaptured if payments do not continue at the requisite level for a minimum number of years.
Regulated investment company (RIC)
A mutual fund.
Rollover
The tax-free termination of one investment and reinvestment of the proceeds. For example: An individual may roll over a lump-sum distribution from an employer’s retirement plan into an IRA.
S corporation
A corporation with no more than 35 shareholders that is not taxed, but treated similarly to a partnership, if other requirements are met.
Savings Incentive Match Plan for Employees (SIMPLE plans)
A simplified retirement arrangement for small businesses that comes in two varieties: one similar to a 401(k) plan and one that funds IRAs for employees.
Standard deduction
A deduction allowed individuals instead of listing or itemizing deductible personal expenses. (See “Itemized deductions.”) The amount depends on the individual’s filing status. Additional amounts are available for taxpayers who are blind or are age 65 or over. Individuals may deduct either their standard deduction or the total of their itemized deductions, whichever is greater.
Straight-line depreciation
A depreciation method that allows equal deductions in each year of an asset’s “life” or recovery period. (See “Accelerated depreciation.”)
Swaps, tax-free
(1) Exchanges of like-kind property that result in no capital gains tax (commonly used for real estate). (2) Sales and repurchases of stock (or other securities) designed to realize a tax loss without discontinuing the investment. Transactions must comply with the wash sale rules to be effective. (See “Wash sales.”)
Taxable income
What is left after all deductions are taken. This is the amount upon which tax is computed.
Taxpayer identification number (TIN)
In the case of an individual, the Social Security number. In the case of a business (even an individual in business), the employer identification number.
Top-heavy plan
An employee retirement or profit-sharing plan that disproportionately benefits top executives.
Uniform capitalization rules (Unicap)
A set of uniform rules for computing the cost of goods produced by a business that prevents current deductions for costs that must be capitalized (See “Capital expenditures.”) or added to inventory.
Wash sales
Simultaneous or near-simultaneous purchases and sales of the same property, usually stocks or bonds, made to generate deductible tax losses without discontinuing the investment. Losses on the transactions are ignored for tax purposes, however, unless a 30-day waiting period is observed between them.
Withholding allowances
Adjustments made to assure correct withholding on wages for individuals who may have unusually large deductions or who may be subject to other special circumstances.