Paying taxes could be a difficult task for many. Though we all have to pay taxes every year to the Internal Revenue Service (IRS), there are ways to lower this amount by making the most of tax deductions and tax exemptions. When you claim tax exemption and tax deduction, each one of them gets subtracted from your adjustable gross income (AGI).
This way the dollar amount that you have to pay taxes on, which is your actual taxable income, goes down. For e.g., if you come in the 12% tax bracket and qualify for $12,000 in tax deductions, your taxable income will get decreased by 12% of $12,000, or $1,440.
- 1 What is a Tax Deduction?
- 1.1 1. Standard Deduction
- 1.2 2. Itemized Deductions
- 1.3 Tax Exemptions
- 1.4 The Changed or Eliminated deductions from 2018
What is a Tax Deduction?
The Tax Cuts and Jobs Act (TCJA) passed in December 2017 made many important changes for the 2018 tax year. These changes are applicable till 2025. Under this new law, many common deductions, to which the public was used to, have been removed.
Due to the confusing nature of these tax deductions, many people end up with Higher-paying tax bills. With the help of these common deductions, you can save some money on your taxes. Here is a simple guide to help you understand these better.
A tax deduction decreases your taxable income and hence lowers your tax liability. Your taxable income lowers when you subtract the amount of tax deduction from your income. When your taxable income goes down, your tax bill also decreases.
Types of Tax Deduction
There are two main types of tax deductions. You are allowed to use only one of them hence it is crucial to consider your options well.
- Standard Deduction
- Itemized Deductions
1. Standard Deduction
When you decide to file taxes with the standard deduction, the deducted amount is based on your filing status. This amount gets deducted from your AGI to determine your taxable income.
The standard deduction by filing status for the 2019 tax year and 2020 tax year is mentioned below:
|Filing status||2019 tax year||2020 tax year|
|Married, filing jointly||$24,400||$24,800|
|Married, filing separately||$12,200||$12,400|
|Head of household||$18,350||$18,650|
People who are more than 65 years old or are blind get a bigger standard deduction.
Read More: Tax Brackets And Federal Income Tax Rates
2. Itemized Deductions
Taking the standard deduction option for filing status is simple but by itemizing your deductions you might succeed in saving more money. There could be instances when you would not qualify for filing the standard deduction, for e.g. if you and your spouse are filing individually, and your spouse is itemizing their deductions, you would also be required to itemize your deductions.
In order to itemize, you would have to keep the following pointers in mind:
- If your standard deduction is less than the sum of your itemized deductions, you can save more money on taxes by itemizing your deductions. In order to itemize your deductions, you would have to spend more time, would be required to fill out more forms, and need to have proof that you are qualified for your deductions.
- If your standard deduction is less than the sum of your itemized deductions then you can take the option of the standard deduction. This process is faster than itemizing.
If you are going ahead with itemizing your taxes, you would have to attach an IRS Schedule A to your Form 1040. Schedule A is an IRS form that is used when you itemize your deductions on your tax return. You need to fill out and file a Schedule A at tax time, then you attach it to or file it electronically with your Form 1040. ‘Itemized Deductions’ is the title of IRS Schedule.
If you have itemized in the past and are a bit hesitant about the standard deduction, you have nothing to worry about. The standard deduction was highly used in 2018 so you might want to use it now.
If you have never itemized your deductions in the past and are not really comfortable with the math or finance, then you can take the help of a tax accountant. They would make sure that you are filing correctly.
Common Itemized Deductions
Here is a list of few of the most commonly itemized deductions.
You might be able to decrease the value of your tax bill if you count your charitable contributions to qualifying organizations for the year and itemize. There is also an option of deducting the average market value of the items which you have donated to the charity. With the new tax act in place, you can now reduce up to 60% of your AGI, up from the previous 50%.
You should document each and every contribution that you make in the form of a receipt from the charity or a written record or a bank record. This documentation should consist of the amount, date of the contribution, and the name of the organization to which the contribution was made.
Medical and Dental Expenses
By using the Medical and Dental Expenses deduction, you might succeed in deducting the costs of medical and dental care for you and your family. This deduction will allow you to subtract the value of your total dental and medical expenses that are more than 7.5% of your adjusted gross income, previously it was marked at 10%.
Home Mortgage Points
Prepaid interest on home mortgages is known as mortgage points. When you itemize deductions on your taxes, these points may be deductible as home mortgage interest. Other itemized deductions for homeowners consist of property taxes and mortgage insurance.
If you are planning to buy a home, you should take maximum advantage of these deductions. This one is confined to interest paid on up to $750,000 for a qualified home loan taken out after December 15, 2017. For loans taken out before that date, it is capped on deductible interest paid up to $1,000,000. If you use the Married Filing Separately status, you have to divide both amounts in halves.
If you itemize, you might be able to deduct the expense of work-related education. Books, supplies, tuition, transportation and travel costs and even the cost of research, all these could be deductibles. In order to claim this deduction, your costs have to be:
- Those that your employer or law needs so that you can keep your entire job or your salary status.
- Used to improve or maintain the necessary job skills.
State and local income, Sales, and Property taxes
For the state and local income, sales and property taxes you paid in 2018, you can take a deduction. However, this deduction limit is different. The deduction is now capped at a merged total education of $10,000 or $5,000 if Married Filing Separately.
Personal Casualty losses
If you are a victim of a disaster declaration as such by the president, you might be eligible for a deduction. The loss of your home, household items and vehicles that your insurance did not cover from your tax bill, are present in this deduction. Please note that this is a change to last year’s casualty, disaster and theft losses deduction.
As time is progressing, in this gig economy, we are seeing more people who are freelancing, working temporarily or engaged in short-term jobs instead of permanent full-time jobs. Based on a study by Intuit, 40% of the American workforce would be of independent contractors by 2020.
If you work in this fashion or are self-employed, you might be able to deduct the cost of your home office if you use itemized deductions. Home office expenses which you can deduct are rent or mortgage interest, utilities, maintenance and more, based on the square footage of that area. Many terms and conditions apply in this category, hence be careful with this itemized deduction.
If you are a self-employed taxpayer using your vehicle to conduct business, you can deduct 58 cents per mile. Instead of the distance, you also have the option to claim a percentage of vehicle expenses like insurance, gas, repairs and depreciation.
The above mentioned list is not a comprehensive one. Deductible taxes, interest expense and using your car for business are other deductions than the ones mentioned in the IRS lists. There is a suggestion to take the help of a tax accountant or a professional which can help with this instead of going through the various rules and regulations of itemizable deductions.
Quite similar to a deduction, a tax exemption reduces your taxable income. However, there’s a difference between a tax deduction and tax exemption. Depending on your filing status and the number of dependents you claim, exemptions would exempt a part of your income from your taxable income. Deductions are an outcome of the expenses you have made during the tax year.
No More Personal Exemption
Before the Tax Cuts and Jobs Act (TCJA) came into the picture, you could claim the personal exemption amount, which was $4,050 in 2017. The personal exemption removes for the 2018 tax season. With this, we have one less method of lowering our taxable income.
This is also applicable to the exemption for dependents, which was also $4,050 and is no longer available.
If you are filing with the Married Filing Separately status, it is the only exception. You can only report your own income, exemptions, credits and deductions if you and your spouse file separate tax returns. If your spouse doesn’t file a tax return, doesn’t have gross income for the tax year and isn’t claim as a dependent by another taxpayer, you might be able to claim a tax exemption for them.
The Changed or Eliminated deductions from 2018
Many deductions removes for the 2018 tax year and they remain unavailable until 2025. Mentioned below is a list of few of them:
Home equity lines of credit and loans
You still have the option to deduct interest on a home equity line of credit (HELOC) or home equity loan. You could do this only if you use it to upgrade an existing home or build a new home. If you use this money for other expenses, you would not be able to take this deduction.
For any divorce that takes place after December 31, 2018, this deduction would not be applicable.
Casualty, Disaster and theft losses
This loss has to be of greater value than 10% of your AGI. If you have been a victim of a natural disaster, like fire, hurricane, tornado, flood or earthquake, or theft, you can only deduct the loss of your home, household items and vehicles that insurance did not cover from your tax bill if, the disaster was declared a federal disaster by the president.
If you are a member of the military on active duty, then you are the only group eligible for the moving expenses deduction. You would not qualify for this deduction if you are not a member of the military or are reallocating because of your job.
Miscellaneous Itemized Deductions
The unreimbursed work expense deduction and the unreimbursed qualified employee education expenses deduction have been removed. You would also notice that the deduction for tax preparation services and investment fees have been eliminated.
These changes are not all of the changes which took place for the tax year 2018. Please go through Tax Reform Basics for Individual and Families or publication 5307 for the tax year 2018.
The changes from the TCJA for 2018 could also add to the confusion of this process. You could use a tax pro or a trusted tax software or online filing tool to help you with tax deductions and exemptions. It would help you maximize your returns and save you from errors which could lead to penalties.