A tax deduction is an invaluable tool that allows a taxpayer to subtract eligible expenses from their gross income, parsing down the portion of income subject to taxation. In other words, deductions have the potential to significantly lower your taxable income for the fiscal year.
For instance, imagine earning $50,000 in a year and contributing $1,000 to a charitable cause. You are then eligible to claim a deduction for that donation, thereby decreasing your taxable income to $49,000. Such deductions are acknowledged and allowed by the IRS.
Taxpayers have options when it comes to deductions: either itemizing them individually or opting for the standard deduction, which is a predetermined amount based on one’s tax filing status.
Key Highlights
- Reduction of Taxable Income: A deduction is an expense deducted from taxable income to reduce tax liability.
- Simplified Filing: Taxpayers choosing the standard deduction need to file only Form 1040.
- Detailed Itemization: Itemizing deductions requires filling out Schedule A Form 1040 to list all allowable deductions.
- Increasing Standard Deductions: The standard deductions have increased steadily since 2017 due to the Tax Cuts and Jobs Act.
A Deeper Understanding of Deductions
Taxpayers in the U.S. face the choice of taking the standard deduction or opting to itemize their deductions. The standard deduction is easier to claim and involves lesser paperwork. This can be done using Form 1040 of the tax return.
Itemized deductions, on the other hand, are expenses subtracted from adjusted gross income (AGI) and require Schedule A Form 1040 for detailing allowable deductions. For example, taxpayers need to keep receipts as proof in case they are audited.
Common itemized deductions include:
- Interest on a mortgage
- Unreimbursed healthcare costs
- Charitable contributions
- State and local taxes
Consulting a tax professional can help decide which method yields better financial results. Generally, substantial deductions make itemization worthwhile, whereas lesser expenses may be less than the standard deduction.
Standard Tax Deductions for 2023 and 2024
Since the Tax Cuts and Jobs Act of 2017, the standard deduction amounts have seen a consistent increase to keep pace with inflation.
| Filing Status | 2023 | 2024 |
|---|---|---|
| Married Filing Jointly and Surviving Spouse | $27,700 | $29,200 |
| Head of Households | $20,800 | $21,900 |
| Single | $13,850 | $14,600 |
| Married Filing Separately | $13,850 | $14,600 |
These deductions mark significant support compared to pre-2017 Tax Cuts and Jobs Act levels. For instance, the standard deduction was $6,350 for single filers and $12,700 for married joint filers in 2017.
While claiming the standard deduction still allows for some itemized deductions, including eligible student loan interest and tuition fees.
Distinguishing Deductions from Credits
A tax deduction reduces your taxable income, whereas a tax credit directly reduces the amount of taxes you owe. There are refundable and non-refundable credits. Refundable credits can trigger a tax refund if they exceed your tax owed.
To illustrate, if after deductions, you owe $500 in taxes but are eligible for a $600 tax credit, a refundable credit would give you a $100 tax refund, whereas a non-refundable credit would just nullify your tax bill without any refund.
Certain businesses also benefit from tax credits for activities that contribute to economic benefits, such as upgrading infrastructure or investing in research.
Special Considerations for Business Owners
For business owners, the process during tax time is more complex since taxes are calculated on business profits rather than proceeds or revenue. Proper documentation of business expenses and deducting them from gross proceeds helps determine net taxable income.
Even though tedious, tracking expenses can notably reduce taxable income and tax liabilities.
If you are a sole proprietor or own a pass-through business, you may also deduct business expenses and opt for either itemizing or standard deduction.
Examples and Importance of Tax Deductions
Common tax deductions include mortgage interest, contributions towards retirement plans, student loan interest, charitable contributions, certain health expenses, gambling losses, and HSA contributions. These deductions are good as they lower your income, and thus, reduce the amount of tax owed.
Standard Tax Deduction for 2023 and Next Year
In 2023, the standard tax deduction for single filers is $13,850, the same for married individuals filing separately. For joint filers, $27,700, and heads of households, it is $20,800. For 2024, these amounts will increase to $14,600, $29,200, and $21,900 respectively.
Conclusion
Tax deductions allow taxpayers to lower their taxable income, offering a way to reduce overall tax liability. Depending on your financial situation, you may opt for the standard deduction or itemize your deductions, which has become a substantial option since the 2017 Tax Cuts and Jobs Act. Consulting a tax professional can optimize your tax benefits and tailor a strategy to your needs.
Related Terms: tax credit, adjusted gross income, tax refund.
References
- Internal Revenue Service. “Topic No. 551, Standard Deduction”.
- Internal Revenue Service. “Here Are Five Facts About the New Form 1040”.
- Internal Revenue Service. “Topic No. 501, Should I Itemize?”
- Internal Revenue Service. “Instructions for Schedule A, Itemized Deductions”, Page 11.
- Internal Revenue Service. “Schedule A (Form 1040), Itemized Deductions”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2024”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2023”.
- Internal Revenue Service. “Taxpayers Can Choose to Itemize or Take Standard Deduction for Tax Year 2017”.
- Internal Revenue Service. “Tax Benefits for Education: Information Center”.
- Internal Revenue Service. “Credits and Deductions for Individuals”.
- Tax Policy Center. “What is the Difference Between Refundable and Nonrefundable Credits?”
