Tax season is fast approaching, and some of us are still looking for an answer to a particular question — what is a tax deduction? To shed light on this matter, this article will give you information about the things you need to know about a tax deduction and how we can all benefit from it. There are ways you can use these deductions to lessen Uncle Sam’s inevitable punch because the last thing you want to do is overpay on your taxes!
What is a Tax Deduction? | Ways to Reduce Your Taxes
What is a Tax Deduction?
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Let’s put it this way. A tax deduction is a way to reduce your taxable income. It decreases the amount of taxes you owe to the government. If you have a lot of deductions, you will pay less in taxes. You can determine your deduction using the percentage of your marginal tax bracket. If you fall in the 25% tax bracket, you can save $250 in taxes from a $1,000 tax deduction (0.25 x $1,000 = $250).
It’s important to know what your taxable income is based on your effective tax rate. Remember, your gross income is different from your taxable income, and deductions are different from credits and exemptions. When you’re filing your taxes every year, you have two common options. You can either take the standard deduction or, if you have a lot of time, you can itemize your deductions.
What is a Standard Deduction?
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The fixed amount everyone can deduct from their earnings is called the standard deduction. More often than not, it is adjusted for inflation every year and is based on your filing status. For example, in 2017, the standard tax deduction for single or married taxpayers filing separately is $6,350, while for married couples filing together or for qualified widows, the deduction is $12,700. Almost two out of three taxpayers choose the standard deduction over itemized deductions. You can claim this type of deduction using IRS Tax Form 1040, 1040A, or 1040EZ.
What are Itemized Deductions?
Just like the standard deduction, itemized deductions are deductions from your AGI or adjusted gross income. Here, your deductions have a separate list on your tax return. This can be valuable if and only if your total exceeds the standard deduction. To do this, accurately list your eligible expenses on Schedule A and send it along with your Form 1040. You might want to claim the standard deduction if your combined itemized deduction is smaller.
Following are some of the itemized deductions you can include in your taxes.
- Home mortgage interest – Homeowners can reduce the interest they pay on their mortgages and home equity lines of credit.
- Personal property taxes – This is a deductible that includes real estate taxes along with state and local taxes imposed the previous year.
- Charitable contributions – Any donations or contributions made to a qualified charity are deductible within specific limitations.
- Medical and dental expenses – This type of deduction is one of the most difficult to qualify for. Taxpayers who paid for medical or dental expenses not covered by their insurance can subtract expenses that exceed 10% of their AGI.
- Gambling losses – If you win a huge amount in a casino or while playing Texas Hold ‘Em, you can subtract any amount you lost while playing as long as it does not exceed the amount you won. This also includes lottery tickets.
What are Above-the-Line Deductions?
Above-the-line deductions are deductions from your gross income. This type of deduction is valuable because you can claim it whether you itemize it or use standard deductions, as long as you meet the set requirements. One simple way to identify it is from the first page of Form 1040. Following are some of the usual above-the-line deductions:
- Traditional IRA contributions
- HSA contributions
- Student loan interest
- One-half of self-employment tax
- Moving expenses
What are Schedule C Deductions?
If you own a small business and you want to make it more profitable, if you perform freelance work, or if you have other sources of income, you must take every available deduction. You can use Form 1040 Schedule C to state income or losses from a business you operate or a profession you carry out as a sole owner. You may want to hold onto those receipts and keep documentation or records to back up those necessary deductions. Here’s a list of common Schedule C deductions:
- Advertising – This involves everything you did to earn new business or increase sales. Advertising expenses include manufacturing expenses for promotional items like pens, notepads, and calculators; the cost for printing banners; and online advertising costs.
- Vehicles and machinery – This includes expenses related to operating your car or truck, such as gas and oil, repairs, insurance, etc.
- Wages, commissions, and fees – If you’re running a small business, you may have to hire some people to help you. The good thing is, you can claim the money you pay your employees.
- Property expenses – You can deduct the cost of maintaining the property where your business is located. This includes the rent or lease, repair and maintenance, and utilities.
- Travel, meals, and entertainment – If you handle a business, most likely you’ll go on a business trip. You can deduct hotel fees, plane ticket fees, and meals to which you treat your clients (though not including “lavish meals”).
Looking for more info about tax deductions? Watch this video from How to Adult and learn about the deductions you can use to reduce the taxes you have to pay!
Tax deductions can absolutely save you money, especially if you’re aware of the deductibles for which you are eligible. Keeping records of your expenses is vital to supporting your claims. To learn more about deductions and how you can maximize them, seek the help of a tax professional, such as a tax lawyer. Be knowledgeable, as this will benefit you and your finances in the long run!
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