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Taxes

What Is a Tax Deduction?

What Is a Tax Deduction?

12 Minute Read

There are two words every taxpayer needs to get familiar with as tax day draws near. These two words will help you shave hundreds, maybe even thousands, of dollars off your tax bill.

Are you ready? Here they are: Tax deductions.

You’ve probably heard phrases like “You can write that off your taxes” or “Those are deductible expenses” and wondered what else you could claim. You’re not the only one!

A lot of folks don’t know what tax deductions are available or how to claim them on their tax returns. But you don’t want to be that guy because it could mean you’re leaving a good chunk of money in the hands of the IRS without even knowing it!

What is a tax deduction?

Simply put, tax deductions reduce how much you pay in taxes by lowering your taxable income. When you hear the word “deduction,” just think subtraction. You’re simply subtracting how much of your income is taxed and reducing how much you owe to Uncle Sam in the process. Cha-ching!

When you hear the word “deduction,” just think subtraction. You’re simply subtracting how much of your income is taxed and reducing how much you owe to Uncle Sam in the process.

For example, charitable donations are one of the most common tax deductions available. That means you could “write off” the money you gave to charity last year and reduce your taxable income by the amount you gave. 

So, if your income is $50,000 and you gave a $1,000 gift to your favorite charity last year, you could claim that gift as a tax deduction and you’ll only be taxed on $49,000 instead of $50,000. 

But that’s only scratching the surface! From retirement plan contributions to home mortgage interest, there are dozens of tax deductions out there you might be able to take advantage of. 

What’s the difference between a tax deduction and a tax credit?

While tax deductions lower your taxable income, tax credits cut your taxes dollar for dollar. So a $1,000 tax credit cuts your final tax bill by exactly $1,000. But, for example, if you get a $1,000 tax deduction and you’re in the 22% tax bracket, that deduction will reduce your taxable income and save you $220 when it’s all said and done.  

Tax credits fall into two main categories: refundable and nonrefundable. If you have a refundable tax credit of $500 but only owe $200 in taxes, the IRS will send you a check for $300. On the other hand, if you have a nonrefundable tax credit worth $750 but you only owe $250 in taxes, you unfortunately won’t get a check for $500 (the balance of the credit you didn’t use).

How do tax deductions work?

When you’re filling out your tax return, there are two ways to claim tax deductions: Take the standard deduction or itemize your deductions. You have to pick one! 

The standard deduction is the easy option—it’s like an automatic tax freebie. If you choose to take the standard deduction, your taxable income is automatically reduced by a set amount based on how you file (like single, married or married filing jointly). That lowers the amount of taxes you have to pay. No need to dig through receipts or bank statements! 

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Since you’ll need to list all the deductions you want to claim one by one, itemizing your deductions takes more work. And you’ll have to fill out a Schedule A form with your tax return and go through your records to back up your claims.(1) 

Yes, itemizing is a bit of a hassle, but it’s worth the effort if you can claim enough deductions to lower your taxable income more than the standard deduction!

Itemizing is a bit of a hassle, but it’s worth the effort if you can claim enough deductions to lower your taxable income more than the standard deduction!

How do you know which option is best for you? There are a few things you need to know before you make your decision this year.  

What is the standard deduction for the 2018 tax year?    

Thanks to the 2018 tax reform bill, the standard deduction has almost doubled from last year. That’s great news for many taxpayers! If you’re single, your standard deduction is now $12,000. Married and filing together? Your standard deduction is $24,000. 

Changes to the Standard Deduction
Filing Status 2017 Standard Deduction 2018 Standard Deduction
Single $6,350 $12,000
Married Filing Jointly $12,700 $24,000
Married Filing Separately $6,350 $12,000
Head of Household $9,350 $18,000

Chart: Changes to the Standard Deduction(2)

Important to note: If you or your spouse are over 65 or legally blind or you’ve been affected by a major disaster, you might be able to get a larger standard deduction. But if you’re married but filing separately, you’re a nonresident alien or a dual-status alien, or someone else claims you as a dependent on their return, your standard deduction may be lower.(3)

What are some tax deductions I can claim for my 2018 tax return?

First, let’s take a look at what you can write off from your taxes when you do your taxes this year. Here are some of the most common deductions that many taxpayers can take advantage of: 

Charitable donations

The more you give, the more you can deduct from your taxes! Any amount you gave to your church, your alma mater or your favorite charities can all be written off your taxes. You can deduct any amount of charitable giving up to 60% of your taxable income.(4)

Medical expenses

Do you have health insurance but still find yourself paying out-of-pocket for medical or dental expenses? The IRS lets you deduct medical expenses that are more than 7.5% of your taxable income for things like surgery costs, dentist appointments and drug prescriptions.(5)

To break it down: If your adjusted gross income is $50,000 and you have $5,000 of medical expenses that weren’t covered by your health insurance, you can write off $1,250 as a tax deduction (the part that’s more than 7.5% of your income, $3,750).

State and local taxes

A lot of folks forget this one! The IRS lets you choose to deduct either your state and local sales tax or income tax, along with some foreign taxes. If you live in a state with no income tax or you made some big purchases like a new car or a furniture set for the living room, the sales tax deduction is the way to go. And if you’re a homeowner, you can also deduct property taxes from your tax bill. 

The new tax law caps the total amount you can deduct in income, sales and property taxes to $10,000.(6,7)

Student loan interest

If you’ve been paying so much in student loans that Sallie Mae seems like that smelly college roommate who just wouldn’t go away, take some comfort in the fact that you can claim a student loan interest deduction of up to $2,500.(8)

Mortgage interest

Ah, the joys of homeownership! There’s the big backyard, the white picket fence, your mortgage payments . . . okay, maybe not that last part. But at least you can deduct that interest you paid on up to $750,000 of mortgage debt.(9)

Retirement and investing

If you happen to have a traditional IRA, those contributions are most likely tax-deductible. But your deduction might be limited based on your income and whether or not you (or your spouse if you’re married) have a retirement plan through your workplace.(10)

But here’s the catch: You’ll have to pay taxes on the money you take out of your traditional IRA in retirement. Yuck. That’s why we always recommend investing with a Roth IRA. Of course, you won’t be able to deduct Roth contributions off your taxes now. But who cares? You’ll be too busy enjoying tax-free growth and withdrawals in retirement later. The future you will thank you!

Contributions to your traditional pre-tax 401(k) also lower the amount of your taxable income, potentially moving you into a lower tax bracket and saving you money on taxes this year. But you’ll also have to pay taxes when you take that money out during retirement. So keep that in mind!

Home office deduction

If you’ve turned part of your home into your own workspace used only for business, you can write off work-related expenses like rent, utilities and maintenance costs.(11)

So stay organized! Whether it’s on your computer or in a filing cabinet in your home office, have a place where you can easily find receipts, bank statements and other important documents that can back up whatever deductions you might claim on your tax return.    

What tax deductions have been eliminated by the new tax law?

Okay, because of the more generous standard deduction and an effort to simplify the tax filing process, the new tax bill also axed or limited several tax deductions. 

Here are some of the main changes made to tax deductions starting this year: 

  • Personal exemptions: This is the amount a taxpayer used to be able to deduct from their taxable income for themselves and any dependents claimed on their tax return. Those exemptions are going, going, gone.

  • Moving expenses: Moved for a new job last year? Unless you’re an active military member, you won’t be able to write off the cost of renting a U-Haul or hiring movers to carry your couch into your new place.

  • Job expenses: You can’t deduct business travel, supplies or other job-related purchases on your tax return anymore. So think twice before going overboard when you wine and dine potential clients!

  • Tax preparation fees: Hired a pro to help you with your taxes? You won’t be able to deduct those costs, either.

  • Casualty and theft losses: In the past, if your home was damaged after a flood or fire and your home wasn’t insured, you might have been able to deduct those losses. But that’s no longer an option unless your losses were caused by a federally declared disaster. Now it’s more important than ever to get the right insurance in place.

  • Home equity loan interest: As if getting a HELOC or home equity loan wasn’t enough of a bad idea, now you won’t be able to claim deductions on home equity debt unless the loan was used to “buy, build, or substantially improve” the home. Stay away!(12,13) 

Whether you’re one of those brave souls who itemizes their taxes every year or you normally just take the standard deduction, there are a lot of changes this tax season. If you still have questions about the changes, reach out to a tax professional who can walk you through all the ins and outs of the new tax bill. 

Itemizing vs. the standard deduction: Which should I choose?

Here’s the deal: With the increase in the standard deduction, taking that automatic deduction will make sense for more taxpayers than before. But it’s still important to add up your itemized deductions before you make that decision.

Take Linda and Eric, for example. They’re married and filing jointly, so they automatically qualify for that $24,000 standard deduction—and they’re excited about that huge deduction! 

But, just to be sure, they go through their records to find all the tax deductions they can claim if they choose to itemize. Would they save money that way? 

After adding up their itemized deductions, they see they can knock more than $28,000 off their taxable income, potentially saving them hundreds of dollars on their taxes. 

Do you think Linda and Eric regret going back through all their receipts, files and bank statements? Not a chance!  

Still, for many other taxpayers, the new standard deduction is far and away the better option. 

Meet Shawn. He’s a single guy just starting out in his career. He’s putting in crazy hours at his accounting job and renting a small apartment while he tries to work through his debt snowball. For him, the standard deduction offers the biggest tax break—almost $7,000 more than if he chooses to itemize. That’s a no-brainer!

What is a Tax Deduction? Itemizing versus the Standard Deduction

When it comes to taxes, everyone’s situation is different. There is no one-size-fits-all solution! If you’re a homeowner or you run your own business, you made a lot of charitable contributions, or you paid out-of-pocket for hefty medical expenses, then itemizing might be the best move for you.

Missed out on tax deductions last year? No problem!

Do you see a deduction you forgot to claim on last year’s income taxes? You don’t need a time machine to fix that mistake! You can amend tax returns for up to three years after the original filing date, so it might be worth going back to check for any deductions you missed. After all, this is money that should be in your pocket!

Whether you need to amend past returns or simply want to be thorough when you file this year’s taxes, a tax pro can give you the guidance you need to claim every deduction and credit you qualify for.

Maximize Your Refund With an Expert Tax Consultant

The bottom line? You want to be sure you’re getting the most out of all these tax deductions. Just one missed deduction could cost you far more than the fee of a professional.

That’s why when you’re in doubt, you should turn to a tax advisor. With years of experience behind them, their wealth of knowledge can take the guesswork out of taxes and prepare your withholdings for next year—protecting you and your wallet.

The sooner you connect with a pro, the sooner you can check taxes off your to-do list. Find a tax expert today!

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