Making Sense of IRS Forms and Terms: “Alphabet Soup”

As an accountant here in PA, you probably receive many questions from clients about IRS forms. IRS forms and designations can be confusing to your clients. Give them a quick review so they understand what the different forms or terms mean. 

Common tax forms

  • 1040: The 1040 is the most typical form taxpayers use to file their annual federal income tax.
  • 1040-SR: The SR is an alternative to the regular 1040 for taxpayers who are 65 and older.
  • 1040-ES: This form is used for income that is not subject to withholding (i.e., self-employment, rental, interest, dividend) to estimate taxes and make quarterly payments.
  • W-2: Employers send this form to employees and the IRS at the end of the tax year, listing wages and withholdings.
  • W-4: This form is completed by the employee to help the employer determine how much federal income tax should be withheld from the employee’s paycheck. 

Common retirement accounts

  • 401(k): This is a company-sponsored retirement account to which employees can contribute and employers may choose to match. With the traditional 401(k), contributions are pre-tax, reducing taxable income and pushing tax into the future when it is withdrawn. Roth 401(k) contributions are made with after-tax income, so future withdrawals are tax-free.
  • 403(b): Similar to the 401(k), the 403(b) is for employees of certain governments and tax-exempt organizations. Many 403(b) do not include employer-matching contributions.
  • 457(b): Again, this is similar to the 401(k) but for employees of state and local governments and some non-profits. 457(b) plans rarely include employer-matching contributions.
  • Traditional IRA: These contributions are made only by the employee and are not deducted from the paycheck. Like the traditional 401(k), contributions are in pre-tax dollars, lowering the taxable income for that year, and postponing taxes on the contribution until withdrawal.
  • Roth IRA: Like the traditional IRA, having nothing to do with the employers, contributions to a Roth IRA are not deductible, so taxes are paid in the year they are earned, with future withdrawals tax-free.
  • SEP IRA: Simplified Employee Pension (SEP) IRAs are set up and funded by the employer for the employee. The employer gets tax benefits for SEP IRAs. This is also a good option for the self-employed.
  • SIMPLE IRA: Savings Incentive Match Plan for Employees (SIMPLE) is similar to 401(k) but is more beneficial for small businesses and the self-employed. 

Charitable organizations

  • 501(c)3: This is a category for some nonprofit tax-exempt organizations, such as charitable organizations, churches and religious organizations, and private foundations. Donations made to a 501(c)3 are tax deductible.
  • 501(c)4: This category usually refers to civic leagues and local employee associations whose net earnings fund charity and education work. These organizations are usually tax-exempt, but contributions to them usually are not. 

Business structures

Sole proprietorship: A self-employed individual who has complete managerial control and is personally liable for the financial obligations of the company.

Partnership: Two or more people share profits or losses of the business and all are personally liable for financial obligations, but losses can be listed on personal income tax filings.

Corporation: A legal entity created to conduct business, separate from its founders, which is responsible for the financial liabilities and accrues profits and losses.

S Corporation: Similar to the corporation in structure, the Subchapter (S) Corporation allows income and losses to pass through to individual tax returns, much like a partnership.

LLC: A hybrid of partnership and corporation, the LLC owners are shielded from personal liability but profits and losses are passed through to the owners’ personal finances.

This overview of the most common terms your clients may hear should help them understand you better when you guide them through the best options for their particular financial situation and their taxes.