"You can deduct that." "You can write that off." "Deductible expenses."
You've probably heard these phrases a hundred times. But what do they mean? What are tax deductions and how do they work? And why are tax deductions so important?
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The purpose of tax deductions is to decrease your taxable income, thus decreasing the amount of tax you owe to the federal government. There are hundreds of ways to use deductions to reduce your taxable income, but many people don't know about them or know how to take advantage of them. The IRS is currently holding more than $1 billion of unclaimed tax refunds. [source: Carter].
To find out how you can maximize your deductions, it's best to talk to a tax professional, such as a tax preparer or lawyer. It's their job to know about tax deductions, and they can guide you to use deductions efficiently and legally. The earlier in the year you learn about possible deductions, the easier it will be to take advantage of them. This article will teach you the basics so that you'll have a good understanding of the deductions that may apply to you.
A lot of people think that deductions are just for the rich and famous. That's not so. A wealth of tax deductions and credits are available to middle- and lower-income taxpayers. The biggest dividing line in the world of deductions is itemizing. Whether or not you can itemize plays an enormous role in the world of deductions.
In this article, we'll find out what itemizing is, exactly. We'll also discuss how to claim deductions on your federal income tax return, even if you don't itemize. Finally, we'll go through a number of examples of deductions to help you save on your taxes every year.
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Contents
- Claiming Tax Deductions
- Examples of Tax Deductions
Claiming Tax Deductions
If you're unfamiliar with deductions, it helps to understand the different deductions available to you.
Above-the-line deductions are deductions from your gross income. On your tax form, subtract the total above-the-line deductions from the gross income to get the adjusted gross income, or AGI. Everyone who fills out a Form 1040, whether they itemize or not, can claim above-the-line deductions.
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A standard deduction is an amount of money the IRS allows you to subtract from your AGI based on your filing status. If you itemize, you don't claim a standard deduction. In tax year 2019, the standard deductions were:
- Single, or married filing separately: $12,200
- Married filing jointly: $24,400
- Head of household: $18,350
Itemized deductions, like the standard deduction, are deductions from your AGI. Think of itemization as a type of receipt. Itemized deductions are simply things you paid for that have an effect on your tax status. There is no limitation on the amount of itemized deductions you can take thanks to the Tax Cuts and Jobs Act of 2017. However, your personal exemption was eliminated by the same act.
If your combined itemized deductions are larger than the standard deduction you would normally claim, you should itemize. But if your combined itemized deductions are smaller than the standard deduction you would normally claim, you should just claim the standard deduction. The less you pay in taxes, the happier you'll be.
Here is a list of itemized deductions that can be included in your taxes:
- Job expenses that are not reimbursed by your employer: These include union dues, uniforms you're required to purchase and wear, and business-related vehicle expenses, such as gas and repairs.
- Student loan interest that your parents pay: If your parents don't claim you as a dependent, you can deduct up to $2,500 of the interest your parents paid on a student loan for you.
- Self-owned business: You can deduct office equipment, sales tax on business purchases, health insurance premiums, anything "necessary and ordinary" to perform your business.
- Charity: To see if an organization is eligible for a tax-deductible donation, check out the IRS's Tax Exempt Organization Search.
- Home mortgage interest: In most cases, you'll be able to deduct the entire amount of interest paid on your mortgage for the year.
- State and local income or sales tax paid: You can deduct up to $10,000 ($5,000 if married filing separately) of state and local income, sales and property taxes.
- Personal property tax: These deductions are based on personal property taxed like boats or cars.
- Real estate taxes and points: A point is 1 percent of the value of a home loan. Banks charge you a fee to get a home loan. This fee is expressed in points, which you can write off.
- Gambling losses: If you play casino games, lotteries or other forms of betting you can write off your losses, but the amount cannot exceed what you are reporting as income from gambling. For example, if during the tax year you lost $12,000 but also won $10,000, you could write off $10,000 in losses. You can't deduct the other $2,000 – and if you had a really bad year and only lost money gambling, you can't just write off your losses without reporting any gambling income. You do need to keep a diary showing how much you won and lost and where and when you gambled.
While this list looks like it contains a lot of deductions, you can't deduct anything you want. Find out what limitations and restrictions exist around tax deductions on the next page. We'll also look at some other deductions that don't have to be itemized for you to get credit for them.
Oops!
If you realize too late that you were eligible for certain deductions, you can file IRS Form 1040X to amend your return. But if you have this epiphany more than three years late, you're out of luck.
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Examples of Tax Deductions
Unfortunately, you can't just deduct whatever you want at any value. All deductions have restrictions. Here are some examples:
Health care expenses: Your out-of-pocket expenses must exceed 7.5 percent of your AGI before you can start writing them off.
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You can also write off any preminums you bought through the Health Insurance Marketplace, under certain conditions.
Charity: You can deduct up to 50 percent of your adjusted gross income as charitable donations to public organizations, such as the American Heart Association, and 30 percent of your adjusted gross income as donations to private foundations, such as the Bill & Melinda Gates Foundation. If, however, you make contributions that can show capital gain, such as shares of stock, you are limited to 30 percent for public organizations and 20 percent for private organizations.
Earned Income Credit: This credit is limited by income level, number of dependent children and whether you're filing as a single person or married filing jointly. If you're married, filing jointly and have three or more dependent children, you can claim this credit if your income is $55,952 or less. The maximum credit for tax year 2019 is $6,557 (for married filing jointly with three or more children.)
Some deductions don't require you to itemize them to claim the deduction or credit. These include:
- Moving expenses, if you're moving more than 50 miles to be closer to your job
- Education: In addition to $2,500 of student loan interest, you may be able to claim education credits like the Lifetime Learning or the American Opportunity Credits. You can no longer deduct $4,000 for college tuition and fees.
- Educators' expenses: For example, a teacher who uses her own money to buy construction paper and markers for her classroom can deduct those expenses (maximum of $250 or $500 if both spouses are eligible educators).
- Traditional IRA contributions, to a maximum of $6,000, plus a catch-up contribution of $1,000 if you're over 50.
- Retirement withdrawal penalties: If you withdraw from your IRA account before the age of 59 ½, your withdrawal may be taxed at 10 percent .
- Credits for self-employed workers: You can deduct half of your self-employment tax, health insurance premiums and contributions to some retirement plans, such as Roth IRAs, SIMPLEs or SEPs. Also, you can claim home-office deductions, such as a percentage of rent, electricity and phone service, if these costs are business-related.
- Child tax credit: You may be able to reduce the tax you owe up to $2,000 for each qualifying child under the age of 17.
- Child and dependent care credit: This applies to each child (under age 13) or a spouse or other person living with you that is physically or mentally handicapped that you paid someone to care for so you could work. You can get up to $3,000 of care costs deducted, or $6,000 if you are claiming care for two or more people.
To learn more about tax deductions and related topics, follow the links on the next page.
What You Can't Deduct
Here are some examples of things you can't deduct:
- interest and penalties (such as late-payment penalties) on taxes
- federal income taxes
- gift taxes
- taxes you pay on estates and inheritance
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Tax Deductions FAQ
What is the standard tax deduction for 2020?
The standard tax deduction is $12,400 (for single folks) for 2020.
What is the average tax rate formula?
The average tax rate formula is your total taxes divided by your total taxable income.
Did the Tax Cuts and Jobs Act work?
The Tax Cuts and Jobs Act was expected to boost the country's economic output by a modest amount in the short term. Economic experts believe that it did boost economic output modestly. Over the long run, however, there is little evidence that there will be a strong effect, notes the Tax Policy Center.
Can you make less money in a higher tax bracket?
If you move into a higher tax bracket, you won't necessarily make less money. The U.S. uses a progressive tax system and marginal tax rates, which means that while you may pay more in taxes, a higher tax bracket won't cause all of your income to be taxed at a higher rate. Your take-home pay should remain pretty much the same.
What is a corporate tax cut?
A corporate tax cut is a reduction in the amount of corporate income tax a corporation must pay. For example, the Tax Cuts and Jobs Act included a corporate tax cut, reducing the top corporate income tax rate from 35 percent to 21 percent.
Lots More Information
Related Articles
- How Income Taxes Work
- How Wages Work
- How Inheritance Tax Works
- How Capital Gains Tax Works
More Great Links
Sources
- "7 Requirements for the Child Tax Credit." Intuit Turbo Tax. 2017 (Jan. 23, 2018) https://turbotax.intuit.com/tax-tips/family/7-requirements-for-the-child-tax-credit/L3wpfbpwQ
- "In 2017, Some Tax Benefits Increase Slightly Due to Inflation Adjustments, Others Are Unchanged." IRS. Sept. 30, 2017 (Jan. 25, 2018) https://www.irs.gov/newsroom/in-2017-some-tax-benefits-increase-slightly-due-to-inflation-adjustments-others-are-unchanged
- Bell, Kay. "The IRS has over $1 billion in unclaimed tax refunds. Is any of it yours?" Bankrate. March 8, 2017 (Jan. 23, 2018) https://www.bankrate.com/finance/taxes/irs-1-billion-unclaimed-refunds.aspx
- "Charitable Contribution Deductions." IRS. Aug. 6, 2017 (Jan. 23, 2018) https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions
- "Deducting Gambling Losses at a Glance." IRS. Sept. 29, 2017 (Jan. 23, 2018) https://www.irs.gov/credits-deductions/individuals/deducting-gambling-losses-at-a-glance
- "Do I Qualify for EITC?" IRS Jan. 16, 2018 (Jan. 23, 2018) https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/do-i-qualify-for-earned-income-tax-credit-eitc
- "Here's what you need to know before withdrawing money from your IRA." USA Today. May 9, 2017 (Jan. 23, 2018) https://www.usatoday.com/story/money/personalfinance/2017/05/09/ira-withdrawls-retirement-planning/101448010/
- "In 2016, Some Tax Benefits Increase Slightly Due to Inflation Adjustments, Others Are Unchanged." IRS. Aug. 6, 2017 (Jan. 23, 2018) https://www.irs.gov/newsroom/in-2016-some-tax-benefits-increase-slightly-due-to-inflation-adjustments-others-are-unchanged
- "Medical and Dental Expenses at a Glance." IRS. Sept. 27, 2017 (Jan. 23, 2018) https://www.irs.gov/credits-deductions/individuals/medical-and-dental-expenses-at-a-glance
- "Retirement Topics - IRA Contribution Limits." IRS. Oct. 20, 2017 (Jan. 23, 2017) https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
- "Retirement Topics - IRA Contribution Limits." IRS. Oct. 20, 2017 (Jan. 23, 2017) https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits"Tax Benefits for Education: Information Center." IRS. Oct. 18, 2018 (Jan. 23, 2018) https://www.irs.gov/newsroom/tax-benefits-for-education-information-center
- "The 10 Most Overlooked Tax Deductions." Intuit Turbotax. 2017 (Jan. 23, 2018) https://turbotax.intuit.com/tax-tips/fun-facts/the-10-most-overlooked-tax-deductions/L2WjmvZAH
- "The Ins and Outs of the Child and Dependent Care Tax Credit Intuit Turbo Tax. 2017 (Jan. 23, 2018) https://turbotax.intuit.com/tax-tips/family/the-ins-and-outs-of-the-child-and-dependent-care-tax-credit/L2H7rzUWc
- "Top Tax Write-offs for the Self-Employed" Intuit Turbotax. 2017 (Jan. 23, 2018) https://turbotax.intuit.com/tax-tips/self-employment-taxes/top-tax-write-offs-for-the-self-employed/L7xdDG7JL
Alright, let's break down the concepts in the article you shared:
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Tax Deductions: These are strategies to decrease your taxable income, thereby reducing the amount of tax you owe. They come in various forms: above-the-line deductions, standard deductions, and itemized deductions.
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Above-the-Line Deductions: These are deductions directly subtracted from your gross income to calculate your adjusted gross income (AGI). They are available to everyone filling out a Form 1040, regardless of whether they itemize deductions.
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Standard Deduction: An amount permitted by the IRS based on your filing status. If you don't itemize deductions, you can claim this deduction. It varies according to your filing status.
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Itemized Deductions: These are specific expenses, like job-related costs, student loan interest, charitable donations, mortgage interest, state and local taxes, etc., that can be deducted from your AGI. You should itemize if your total itemized deductions exceed the standard deduction.
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Tax Credits: These directly reduce the amount of tax you owe and are not related to your income level. Examples include the Child Tax Credit, Earned Income Credit, and education credits.
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Limits and Restrictions: Some deductions have restrictions, such as health care expenses needing to exceed a certain percentage of your AGI, or limits on charitable deductions based on the type of organization.
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Non-Itemized Deductions: Certain deductions, like moving expenses, education-related deductions and credits, retirement contributions, child tax credits, etc., don't need to be itemized to be claimed.
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Non-Deductible Items: There are also items you can't deduct, like federal income taxes, gift taxes, and certain penalties on taxes.
Understanding these concepts helps in managing taxes more efficiently. They involve a careful assessment of expenses and knowing which deductions or credits apply to your situation.
If you need further specifics on any of these aspects or if you're looking to delve deeper into the nuances of tax deductions, just let me know!
