Key Tax Terms Every Investor Should Understand

Adjusted Gross Income (AGI)

AGI is your total gross income minus specific above-the-line deductions such as student loan interest, IRA contributions, and self-employment tax. It is the figure used to determine eligibility for many tax deductions, credits, and phase-outs — making it a central number in tax planning.

Cost Basis

Cost basis is the original value paid for an asset, including commissions and fees, used to calculate capital gain or loss upon sale. Accurately tracking basis — especially across dividend reinvestments, stock splits, and inherited assets — is essential to avoid overpaying taxes.

Capital Gain

A capital gain is the profit realized when you sell a capital asset for more than its cost basis. Short-term gains (assets held one year or less) are taxed as ordinary income, while long-term gains (held more than one year) qualify for preferential rates of 0%, 15%, or 20% depending on taxable income.

Marginal Tax Rate

The marginal tax rate is the rate applied to the last dollar of taxable income within a given bracket under the US progressive tax system. It is distinct from your effective (average) tax rate, which reflects the blended rate across all income brackets.

Wash-Sale Rule

Under IRS rules, a wash sale occurs when you sell a security at a loss and repurchase the same or a substantially identical security within 30 days before or after the sale. The disallowed loss is added to the cost basis of the repurchased security rather than permanently forfeited.

Tax-Loss Harvesting

Tax-loss harvesting is the practice of intentionally selling investments at a loss to offset realized capital gains, potentially reducing your tax liability for the year. Losses exceeding gains can offset up to $3,000 of ordinary income annually, with remaining losses carried forward.

Required Minimum Distribution (RMD)

RMDs are the minimum amounts the IRS requires holders of traditional IRAs and most employer-sponsored retirement accounts to withdraw each year once they reach the applicable age threshold. Failing to take the full RMD triggers a significant excise tax on the shortfall.

Step-Up in Basis

When an asset is inherited, its cost basis is generally reset to the fair market value at the date of the original owner's death, potentially eliminating embedded capital gains. This provision significantly affects estate and inheritance planning strategies.

Qualified Dividends

Qualified dividends are dividends that meet IRS holding period and payer requirements, entitling them to be taxed at the lower long-term capital gains rates rather than ordinary income rates. Not all dividends qualify — distributions from money market funds or certain foreign corporations typically do not.

Alternative Minimum Tax (AMT)

The AMT is a parallel tax system with its own set of rules and rates designed to ensure high-income taxpayers pay a minimum level of federal tax regardless of deductions. Investors with large amounts of certain preference items — such as incentive stock option exercises — may be subject to AMT calculations.

Net Investment Income Tax (NIIT)

The NIIT is a 3.8% surtax applied to the lesser of net investment income or the amount by which modified AGI exceeds statutory thresholds ($200,000 for single filers, $250,000 for married filing jointly, as of current law). It applies to interest, dividends, capital gains, and passive rental income.

Tax-Deferred vs. Tax-Exempt

Tax-deferred accounts (e.g., traditional IRA, 401(k)) allow contributions to grow without current-year taxation, with withdrawals taxed as ordinary income. Tax-exempt accounts (e.g., Roth IRA) are funded with after-tax dollars, but qualified withdrawals — including growth — are generally free from federal income tax.