Tax Law Legal Terms Glossary
Explore definitions, related concepts, and supporting case briefs.
Definitions
Gross Income
Under IRC Section 61, gross income encompasses all income from whatever source derived, including but not limited to compensation for services, business income, gains from property dealings, interest, rents, royalties, dividends, and alimony. The Supreme Court in Commissioner v. Glenshaw Glass Co. (1955) established the foundational definition: gross income includes all accessions to wealth, clearly realized, over which the taxpayer has complete dominion and control. This broad definition means that unless Congress has specifically excluded a receipt from income, it is presumptively taxable. The concept is the starting point for all individual and corporate tax computations.
Adjusted Gross Income
Adjusted Gross Income (AGI) is an intermediate tax computation defined under IRC Section 62, calculated by subtracting certain 'above-the-line' deductions from gross income. These above-the-line deductions include trade or business expenses, certain losses from property sales, contributions to qualified retirement accounts, student loan interest, and alimony payments (for pre-2019 agreements). AGI serves as a critical threshold figure because numerous tax benefits, including medical expense deductions, charitable contribution limits, and eligibility for credits, are phased in or out based on AGI levels. Understanding the distinction between above-the-line and below-the-line deductions is essential because above-the-line deductions reduce AGI and thereby expand access to other tax benefits.
Taxable Income
Taxable income, defined under IRC Section 63, is the final figure upon which a taxpayer's federal income tax liability is computed. It is calculated by subtracting from AGI either the standard deduction or itemized deductions (below-the-line deductions), plus any qualified business income deduction under Section 199A. For corporations, taxable income is gross income minus all allowable deductions under IRC Section 63(a). The distinction between gross income, AGI, and taxable income reflects the progressive narrowing of the tax base as Congress provides various forms of relief at each computational stage.
Deduction
A deduction is an amount that Congress permits taxpayers to subtract from gross income or AGI, thereby reducing the tax base against which rates are applied. Deductions are a matter of legislative grace, meaning the taxpayer bears the burden of proving entitlement, and any ambiguity is resolved against the taxpayer. Key categories include business deductions under IRC Section 162 (ordinary and necessary business expenses), investment-related deductions under Section 212, and personal deductions such as mortgage interest (Section 163), charitable contributions (Section 170), and state and local taxes (Section 164). Unlike exclusions, which keep amounts out of gross income entirely, deductions reduce income that has already been included.
Exclusion
An exclusion is a statutory provision that removes a specific category of income from the definition of gross income, so the amount is never included in the tax base at all. Common exclusions include employer-provided health insurance (IRC Section 106), gifts and inheritances (Section 102), life insurance proceeds (Section 101), municipal bond interest (Section 103), and certain gain from the sale of a principal residence (Section 121). Exclusions are more valuable than deductions of equal dollar amounts because they prevent the income from being reported in the first place, avoiding any impact on AGI-dependent calculations. Like deductions, exclusions are a matter of legislative grace and must be specifically authorized by the Code.
Capital Gain
A capital gain is the gain realized from the sale or exchange of a capital asset, as defined under IRC Section 1221. Capital assets include most property held by the taxpayer, with specific statutory exceptions for inventory, depreciable business property, accounts receivable, and certain creative works. The distinction between long-term capital gains (assets held for more than one year) and short-term gains (one year or less) is critical because long-term gains receive preferential tax rates. In Arkansas Best Corp. v. Commissioner (1988), the Supreme Court clarified that the definition of capital asset turns on whether the asset falls within the statutory exclusions of Section 1221, rejecting the judicially created 'business motive' test.
Capital Loss
A capital loss arises when a taxpayer sells or exchanges a capital asset for less than the taxpayer's adjusted basis. Under IRC Section 1211, individual taxpayers may deduct capital losses against capital gains without limitation, but may only deduct up to $3,000 of net capital losses against ordinary income per year, with excess losses carried forward indefinitely under Section 1212. In Arrowsmith v. Commissioner (1952), the Supreme Court held that the character of a loss must be determined by reference to the original transaction, establishing that gains and losses from the same underlying transaction must be treated consistently. Capital losses are subject to the wash sale rule under Section 1091, which disallows the loss if substantially identical securities are purchased within 30 days.
Basis
Basis is the taxpayer's investment in property for tax purposes, used to compute gain or loss upon disposition and to calculate depreciation deductions. Under IRC Section 1012, the initial basis of purchased property is generally its cost. Basis is adjusted upward for capital improvements and certain other expenditures, and downward for depreciation, casualty losses, and other recoveries of capital under Section 1016. Special basis rules apply in particular contexts: inherited property receives a stepped-up basis to fair market value at death (Section 1014), gifted property generally takes a carryover basis from the donor (Section 1015), and property received in like-kind exchanges takes a substituted basis (Section 1031).
Depreciation
Depreciation is the tax mechanism allowing a taxpayer to recover the cost of a tangible asset used in a trade or business or held for the production of income over the asset's useful life, as authorized by IRC Section 167 and the accelerated cost recovery system (MACRS) under Section 168. Depreciation is not optional when available; it reduces basis whether or not the taxpayer actually claims it (a concept known as 'allowed or allowable' depreciation under Section 1016). The Modified Accelerated Cost Recovery System assigns assets to recovery period classes and prescribes either declining balance or straight-line methods. Section 179 expensing and bonus depreciation under Section 168(k) allow immediate or accelerated write-offs, significantly altering the timing of deductions.
Tax Credit
A tax credit is a dollar-for-dollar reduction in the taxpayer's actual tax liability, making credits substantially more valuable than deductions of equal amounts. Credits are categorized as either refundable (payable to the taxpayer even if the credit exceeds total tax liability, such as the Earned Income Tax Credit under Section 32) or nonrefundable (limited to reducing tax liability to zero, such as the child and dependent care credit under Section 21). Congress uses credits as targeted incentive mechanisms for policy objectives including education (American Opportunity Credit, Section 25A), energy efficiency (Section 25C), and low-income assistance. The distinction between credits and deductions is one of the most heavily tested concepts in tax law courses.
Progressive Taxation
Progressive taxation is a rate structure in which the marginal tax rate increases as the taxable income base rises, so that higher-income taxpayers pay a larger percentage of their income in tax. The U.S. federal income tax employs a progressive system with graduated brackets under IRC Section 1, currently ranging from 10% to 37% for individuals. A critical distinction exists between the marginal tax rate (the rate on the last dollar of income) and the effective tax rate (total tax divided by total income), and students must understand that moving into a higher bracket does not retroactively increase the rate on income in lower brackets. Progressive taxation is the structural counterpart to regressive taxes (like sales taxes) and proportional taxes (flat rates), and its policy justifications include the ability-to-pay principle and diminishing marginal utility of income.
Estate Tax
The federal estate tax, imposed under IRC Sections 2001-2210, is an excise tax on the transfer of a decedent's taxable estate at death. The taxable estate is calculated by determining the gross estate (all property in which the decedent had an interest at death, including life insurance proceeds, jointly held property, and certain transferred property under Sections 2031-2046), subtracting allowable deductions (debts, administrative expenses, charitable bequests under Section 2055, and the unlimited marital deduction under Section 2056). A unified credit effectively exempts estates below a threshold amount (currently $13.61 million per person, indexed for inflation). The estate tax interacts with the gift tax through the unified transfer tax system, and the stepped-up basis rule under Section 1014 eliminates unrealized capital gains at death.
Gift Tax
The federal gift tax, codified under IRC Sections 2501-2524, is imposed on the donor upon the transfer of property by gift during the donor's lifetime. The gift tax operates as a backstop to the estate tax, preventing taxpayers from avoiding transfer taxes by giving away property before death. Each donor may exclude a specified annual amount per donee (currently $18,000, indexed for inflation) under Section 2503(b), and transfers exceeding the annual exclusion consume the donor's unified credit, which is shared with the estate tax exemption. Certain transfers are wholly exempt, including payments of tuition or medical expenses made directly to educational or medical institutions under Section 2503(e), and unlimited transfers to a U.S. citizen spouse under the marital deduction of Section 2523.
Tax-Exempt Organization
A tax-exempt organization is an entity that qualifies for exemption from federal income tax under IRC Section 501, most commonly Section 501(c)(3), which covers organizations operated exclusively for religious, charitable, scientific, literary, or educational purposes. To maintain exemption, the organization must not allow its net earnings to inure to the benefit of any private individual, must not engage in substantial lobbying activity, and must not participate in political campaigns. Even exempt organizations are subject to the Unrelated Business Income Tax (UBIT) under Sections 511-514 on income from regularly carried-on trade or business activities not substantially related to their exempt purpose. The distinction between public charities and private foundations under Section 509 carries significant regulatory and operational consequences.
Transfer Pricing
Transfer pricing refers to the rules governing the prices charged in transactions between related entities, particularly in the international context where affiliated companies operating in different tax jurisdictions may set intercompany prices to shift income to low-tax jurisdictions. IRC Section 482 grants the IRS broad authority to distribute, apportion, or allocate gross income, deductions, credits, or allowances among commonly controlled entities to prevent tax evasion or clearly reflect income. The arm's length standard, which requires related-party transactions to be priced as if conducted between unrelated parties, is the foundational principle under both U.S. and OECD guidelines. Acceptable methods for establishing arm's length prices include the comparable uncontrolled price method, the resale price method, the cost-plus method, and the comparable profits method, with significant penalties under Section 6662(e) for substantial valuation misstatements.