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What Is a Tax Deduction: Definition & How Does It Work

Updated: November 25, 2022

Realizing that you neglected to list a tax deduction on your tax return that would have reduced your tax liability or boosted your tax refund is one of the most frustrating realizations.

But what exactly is a tax deduction, and how can I maximize them? Does it work with property taxes or dental expenses? What if I miss the tax filing season?

Read on as we take a closer look into everything to do with tax deductions.

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    KEY TAKEAWAYS

    • Tax deductions are amounts that you apply to your taxable income to reduce the amount of tax you owe. 
    • You have the choice between itemizing your deductions or choosing the standard deduction, but you cannot do both. 
    • If you choose to itemize your deductions, you will fill out Schedule A of Form 1040 or Form 1040-SR.

    What Is a Tax Deduction? 

    A tax deduction is a specific item that you might be eligible for to help reduce the total amount of taxes owed. You subtract the amount of the tax deduction from your taxable income and you have a few choices for how to do this. 

    One of the most common is the standard deduction, which is where you have one single deduction for your taxable income that’s a fixed amount. Or, you can choose to itemize your deductions for an additional deduction. To do this, you fill out Schedule A of your income tax return as a single taxpayer. 

    Whether you choose the standard deduction or itemized deductions can depend. For example, having itemized expenses with a value greater than the standard deduction, your best option might be to itemize. Some of the most common itemized deductions induce state and local taxes, unreimbursed medical expenses, charitable gifts, and mortgage interest deduction to name a few.

    Less Taxin'. More Relaxin'

    The Common Tax Deductions 

    Sometimes it can be a challenge to figure out which tax deductions you might be eligible for. You can find most of them on Schedule A of Form 1040, however, there can be a few exceptions worth highlighting. 

    For example, if you make contributions to an individual retirement account (IRA), you must use Form 5498. Whereas when you need to report losses from investments, you must use Form 8949 and Schedule D. In most cases, you’re unable to deduct charitable contributions if you itemize them. 

    Here are some common tax deductions that you might be able to claim on your federal income tax return:

    • State and local taxes deduction — This amount could go up to $10,000 depending on your filing status
    • Child tax credit deduction — This common credit means that you can claim tax back on the number of children you have. 
    • The earned income tax credit — Enables families and workers with low to moderate incomes receive a tax dollar reduction on their income taxes.
    • Student loan interest deduction — Many students are eligible for up to $2,500
    • Health savings account deduction — Some contributions are tax deductible up to certain annual limits
    • Mortgage interest deduction — If you purchased a home before Dec. 16, 2017, you could be eligible for up to $1 million, but homes purchased after this date can be tax deductible up to $750,000
    • Individual retirement account deduction (IRA) or a 401(k) — Certain contributions up to an annual limit can be tax deductible 
    • Self-employment expenses deduction — Eligible expenses might include the health insurance premiums deductions and the home office deduction 
    • Various investment losses deduction
    • Gambling losses deduction
    • Charitable contributions deduction

    How Can I Maximize My Tax Deductions? 

    Depending on if you take the standard deduction or you itemize, there can be a few options to help maximize your tax deductions. One of the best ways to do this is to regularly contribute the maximum allowable amount to a traditional IRA account or even a 401(k). 

    When you do this, you not only make regular contributions to your retirement savings, but you also reduce the amount of tax you owe for the year. The standard deduction can be a safe way to know exactly what you’re getting. 

    But, what if you have medical expenses, student debt interest, mortgage interest, or other types of deductible expenses that exceed the standard deduction? In this case, the best way to maximize your deductions is to itemize them on Schedule A of Form 1040 or Form 1040-SR. 

    Ahead Of Tax Time Every Time

    Tax Deductions vs Tax Credits 

    While they might seem fairly similar, there are some differences between tax deductions and tax credits worth highlighting. Simply put, tax deductions help reduce your total taxable income. 

    On the flip side, tax credits get subtracted directly from any of the taxes you already owe. As well, you can often find some tax credits that are refundable. This means that when you reduce your total tax bill to less than zero, you will receive a refund for the different amount on your tax forms. 

    Depending on your personal tax return, tax credits are often more valuable compared to a tax deduction. Tax deductions reduce your taxable income, whereas tax credits reduce the tax you owe on a dollar-for-dollar basis.

    Summary

    A tax deduction is a specific amount you can apply to your taxable income to help reduce the total amount of tax owed. You can do this in two ways, either by taking the standard deduction or by itemizing. The range of deductions work similarly for self-employed people.

    The standard tax deduction is a fixed amount, so if your itemized expenses are greater, you can get the most benefit through itemizing. Some of the most common deductions include certain charitable gifts, mortgage interest, and state and local taxes.

    Turn Tax Pains Into Tax Gains

    FAQs About Tax Deduction

    How Many Deductions Can I Claim?

    You can claim the deductions that you’re eligible for. However, certain allowable deductions have annual limits or maximum amounts you can claim. This may also be different for a joint tax return or married filing.

    Which Is Better: A Tax Credit or Tax Deduction?

    A tax deduction can help reduce the amount of taxable income you owe. Tax credits reduce the total amount of tax you owe, dollar for dollar. In this case, tax credits are often more advantageous compared to tax deductions.

    Does Everyone Get a Standard Deduction?

    No, not everyone is eligible for the standard deduction even though it’s a valuable deduction. For example, individuals who were dual status aliens or nonresident aliens during the year are not eligible for the standard deduction.

    How to Claim Tax Deductions

    How to claim your tax deductions depends on which tax deductions. For example, this is commonly done through Schedule A of Form 1040. But, if you make contributions to an IRA, you must use form 5498

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