Deductions are an excellent way to recoup some of your expenses incurred throughout the year. How you account for those expenses, however, can make a big difference on your tax bill. Taxpayers have two methods of claiming deductions- itemizing or taking the standard deduction – and they must choose one to use when filing their tax returns.
First, you have to understand what a deduction is, and how it affects your tax liability. When you have a deductible expense during the year, you are able to subtract the dollar amount from your taxable income. Since your taxable income determines how much you pay in taxes, the lower your taxed income, the less you pay. So deductions can lower your bill by decreasing the amount you are taxed on.
Examples of deductible expenses include:
Casualty and theft losses.
There is a wide number of deductions available to taxpayers. You are able to calculate and report each deductible expense separately on your tax return, and save every receipt for each expense. This method is known as itemizing. You also have the option to take the standard deduction, a pre-determined dollar amount, and call it a day. The standard deduction is set, and is not adjusted based on your individual expenses, therefore taxpayers must find the method of deduction which saves the most money.
The biggest benefit of the standard deduction is that it makes preparing a tax return easier, since it’s just a flat, non-adjustable, reduction of your adjusted gross income. Because you aren’t required to meticulously document each expense, taking the standard deduction is quick, and proves to be the most popular way to deduct expenses, as almost 70% of taxpayers opt for the standard deduction.
Congress is responsible for determining the amount of the standard deduction, which is generally adjusted for inflation each tax year. Your filing status determines the amount you qualify for.
Filing Status 2015 2016 2017
Single $6,300 $6,300 $6,350
Married, separate $6,300 $6,300 $6,350
Head of Household $9,250 $9,300 $9,350
Married filing jointly $12,600 $12,600 $12,700
Taxpayers who are blind or over 65 years of age have a greater standard deduction available, however it is still dependent on your filing status. If you are claimed as a dependent by another taxpayer, then your standard deduction may be lowered.
Taking the standard deduction may make you able to use the Form 1040EZ, or 1040A, and since they are shorter and simpler than the regular Form 1040, you can save time and energy prepping your return.
If you are married and you file separately from your spouse, you are not eligible to take the standard deduction if your spouse itemizes. Both spouses have to use the same method of deduction.
Taxpayers who opt to itemize generally do so because it results in a higher amount of deduction than the standard deduction, therefore reducing their tax liability.
Itemized deductions are expenses that the IRS allows you to subtract from your taxable expenses. Itemized deductions are specific and tailored, whereas the standard deduction is a general amount. Consider this: If you were ordering a meal, itemized deductions would be like customizing your burger from the bun up, where standard deduction would be closer to saying “Chef’s choice.”
There are some circumstances in which you may find itemizing to be beneficial. If you own your home, you are able to deduct mortgage interest and property taxes if you itemize, and these expenses alone can be greater than the amount allotted in the standard deduction.
The list of possible deductions seems endless, though the most common are medical expenses, property taxes, home-office expenses, charitable contributions, tax-prep fees, job-search expenses, mortgage interest, and casualty and theft losses. Check with your financial advisor to determine which deductions you are able to take, and calculate if the total of itemized deductions is more than the standard. Additionally many tax software will help you get the best benefit.
There are deductions that are limited. If you are under 65 years old with medical expenses, you are only able to deduct the amount that is greater than 10% of your adjusted gross income. Unreimbursed work expenses or other types of miscellaneous itemized deductions are limited by excess of 2% of your AGI.