When filing your taxes there are many ways to reduce your tax bill or ways to get yourself a bigger refund. This can happen using different credits and deductions that are available.
This article will discuss different tax deductions that can be used on your tax return to reduce your taxable income. I will start off by discussing the choice of either using the standard deduction or itemizing your deductions. I will also discuss above the line deductions which can be used in addition to the standard deduction.
What is a Tax Deduction?
A tax deduction is a deduction that lowers a person’s or organization’s liability by lowering their taxable income. Deductions are typically expenses that the taxpayer incurs during the year that can be applied against or subtracted from their gross income to figure out how much they owed. There is always confusion about the difference between the deduction and a tax credit. Remember a deduction reduces your taxable income while a credit directly reduces your tax bill.
On a tax return, you can either take the standard deduction or you can itemize your deductions. You cannot do both. When making the decision to itemize your deductions or to take the standard deduction it is especially important that you evaluate your situation thoroughly to see which will better benefit you.
It is much easier to take the standard deduction but if you qualify for many deductions the choice to itemize can equate to many tax dollars saved so take your time to review the different deductions that are available and which ones that you qualify for. If these deductions that you qualify for are greater than the standard for your filing status, then you have the answer to your question.
Having a true tax professional to assist you in reviewing your situation to make this decision is recommended. I will start off with the standard deduction so you have the information on that choice to compare to the breakdown of the possible itemized deductions that you could qualify for.
What is the Standard Deduction?
The standard deduction is the portion of income not subject to tax that can be used to reduce your tax bill. Even if you have no other qualifying deductions the IRS allows you to take the standard deduction no questions ask. In the past, the decision to take the standard deduction or to itemize was much more difficult. In 2017, with the Tax Cuts and Jobs Act, the standard deduction was almost doubled making this decision much easier. This will remain in effect for 2018 through 2025.
The amount of your standard deduction now is based on your filing status, age, and whether you are disabled or claimed as a dependent on someone else’s tax return. The standard deduction adjusts every year based on inflation. The allowable standard deduction for 2020 and 2021 is laid out below as seen on Nerd Wallet.
|Filing status||2020 tax year||2021 tax year|
|Married, filing jointly||$24,800||$25,100|
|Married, filing separately||$12,400||$12,550|
|Head of household||$18,650||$18,800|
The standard deduction is higher for taxpayers who are 65 and older at the end of the year and/or blind. This extra deduction applies to taxpayers and spouses if married. Increase the standard deduction by the following for each occurrence of the conditions above.
For married filing jointly, married filing separately or qualified widow there would be an increase in the deduction by $1300 for 2020 and $1350 for 2021.
For single or head of household filers, the increase would be $1650 for 2020 and $1700 for 2021.
If a taxpayer is claimed as a dependent on someone else’s tax return is limited to the greater of $1,100 in 2020 or the individual’s earned income for the year plus $350.
Tax Deductions You Should Itemize
Itemized deductions are expenses that can be subtracted from adjusted gross income to reduce your taxable income and therefore reduce the amount of taxes owed. Such deductions would permit those who qualify the ability to pay less in taxes than if they had taken the standard deduction. Itemized deductions are listed on Schedule A of Form 1040. If you decide to itemize you must save all receipts in case the IRS decides to audit you because they can request proof.
There are many different deductions that one may qualify for. If the amount of these deductions that you qualify for are more than the standard deduction and you have proof of all these deductions, then you should itemize.
State and Local Taxes
Taxpayers can deduct state and local real estate, personal property, and either income or sales taxes. For taxes 2018 through 2025 this deduction is limited to $10,000.
Taxpayers can deduct home mortgage interest on the first $750,000 of mortgage debt. Homeowners can only deduct mortgage interest on home equity loans if the debt was used to buy, build, or substantially improve the taxpayer’s home that secures the loan. Homeowners may deduct mortgage interest on the primary and secondary properties.
Taxpayers are allowed to deduct charitable contributions up to 60% of the adjusted gross income.
A taxpayer can deduct unreimbursed medical expenses that are more than 7.5% of their adjusted gross income for the tax year.
Long-Term Care Premiums
Long-term care insurance premiums are tax-deductible to the extent that the premiums exceed 20% of an individual’s adjusted gross income. There is a deduction limit based on your age and the insurance must be qualified.
A taxpayer can deduct gambling losses only to the extent of their winnings. You can not deduct more than you win.
Student Loan Interest
A taxpayer can deduct up to $2500 of the interest paid on a student loan from their taxable income.
Casualty and Theft Losses
Any casualty or theft loss incurred because of a federally declared disaster can be reported on a Schedule A. Unfortunately, only losses of more than 10% of the taxpayer’s adjusted gross income are deductible.
If a taxpayer is in the military and the move is permanent and was ordered by the military then they can claim a deduction on unreimbursed moving expenses. They can claim travel and lodging expenses, the cost of moving household goods, and the cost of shipping cars and pets.
Educator Expense Deduction
If a taxpayer is a schoolteacher or other eligible educator, they can deduct up to $250 spent on classroom supplies.
Tax Deductions That Have Been Limited or Eliminated
Many commonly used and well know deductions have been recently eliminated or limited. In the past, an employer could reimburse a taxpayer up to $20 a month tax-free for bicycle commuting expenses. There were also employer-related deductions for parking, transit, and carpooling. The 2017 Tax Cuts and Jobs Act suspended these benefits.
Another common deduction was the expenses from a move. In the past when a taxpayer relocated for a new job, they could use the expenses not only from the cost of moving their possessions but the cost of travel as well. Beginning in 2018 this deduction is only allowable for specific situations and only allowable for taxpayers in the military.
Also, in the past, a taxpayer that made alimony payments was able to receive a deduction for alimony paid and the person receiving the alimony would include the money as taxable income. With any divorce decree beginning in 2019 the payer will no longer receive a deduction and the spouse receiving no longer must claim alimony as income.
The medical expense deduction has not gone away but the threshold has changed so that the expenses must exceed 7.5% of your adjusted gross income. In years past the threshold was 10%.
The Tax Cuts and Jobs Act also set limitations on SALT Tax deductions. SALT Tax is state and local taxes. In the past the amount that a taxpayer could deduct was unlimited. Now the SALT deduction is limited to $10,000.
Understand Which Tax Deductions You Are Eligible For
In conclusion with the rise in the standard deduction and the limitation in many of the itemized expenses the decision of which method to utilize has gotten easier but it is still difficult. Also, with the many recent changes, it is especially important that you understand what you are eligible for and what you are not if you are thinking about itemizing overtaking the standard deduction. Unless a taxpayer has mortgage interest and property taxes, significant charitable gifts, or a major medical event it would probably make more sense to take the standard deduction.
As I always recommend when filing taxes and tax planning, it will always benefit a taxpayer to consult with somebody that has the knowledge and licensing to correctly advise them. An Enrolled Agent and a CPA (Certified Public Accountant) are the tax professionals that have the educational background to best advise a taxpayer.