What Is a Tax Deduction: Definition & How Does It Work
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 you maximize them? Does it work with property taxes or dental expenses? What if you miss the tax filing season? Read on as we take a closer look into everything to do with tax deductions.
Table of Contents
- Tax deductions are amounts that you deduct from 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 or expense that you might be eligible to deduct 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 specific deduction amount that reduces your taxable income and is adjusted each year for inflation. For the 2022 tax year, the standard deduction amount is $12,950 ($25,900 for married filing jointly). Alternatively, you can choose to itemize your deductions for a greater deduction. To do this, you fill out Schedule A of your income tax return Form 1040.
Whether you choose the standard deduction or itemized deductions can depend. For example, if you have itemized expenses with a value greater than the standard deduction, your best option might be to itemize. Some of the most common itemized deductions include state and local taxes, unreimbursed medical expenses, charitable gifts, and mortgage interest deduction.
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 in 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 use Form 8880 to claim the saver’s credit and report it on Schedule 3 (Form 1040). Whereas when you need to report losses from investments, you must use Form 8949 and Schedule D. Charitable contributions to qualified organizations may be deductible if you itemize deductions on Schedule A.
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 is limited 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. This credit reduces your income tax by $1,000 for each qualifying child under the age of 17.
- The earned income tax credit — This 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 deduction for the interest paid on student loans.
- 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 the interest on 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 of $6,000 ($7,000 if you are age 50 or older) 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 also be a safe way to know exactly what deduction you’re getting.
What if you have medical expenses, student debt interest, mortgage interest, or other types of deductible expenses that exceed the standard deduction? In these cases, the best way to maximize your deductions is to itemize them on Schedule A of Form 1040 or Form 1040-SR.
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.
You can often find some tax credits that are refundable. This means that if the amount of your credit is larger than your total tax bill, you will receive a refund for the difference.
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.
A tax deduction is a specific amount you can deduct from 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.
FAQs About Tax Deduction
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.
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. Since certain credits are refundable, you will receive a refund for any remaining credit even if your income tax due is zero.
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 you claim your tax deductions depends on whether you choose to itemize or use the standard deduction. For example, itemized deductions are commonly reported on Schedule A of Form 1040. You may also be required to attach additional forms to your return.
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