The Internal Revenue Service (IRS) offers many tax benefits for taxpayers to take advantage of during the tax season. Tax deductions are different from tax credits because they allow you to take the amount of the tax deduction from your taxable income. Tax credits, on the other hand, give you a dollar to dollar deduction from your total tax bill.
Many tax deductions are available for taxpayers; for example, the charitable contributions deduction is very beneficial if you give away a lot to charitable causes. If you have donated money to a qualified charitable organization, be sure to check out how you can take advantage of this tax deduction. You are only allowed this tax deduction if you qualify for it.
Keep in mind, however, that ordinarily, you can only take the charitable contribution tax deduction if you itemize your deductions. If you decide to itemize, you must have meticulous, accurate records, and you will not be able to take the standard deduction. The standard deduction changes each year, so check out the latest tax rates to ensure you have the right number.
You can figure out your taxes both ways (with the standard deduction and with taking itemized deductions) to determine which way is most beneficial for your particular tax situation.
It may be best to work with a qualified tax consultant when filing your taxes this year, especially if you plan on taking tax credits or tax deductions.
Tax Deductions Vs. Tax Credits
Tax deductions reduce your taxable income, which can help you save on your tax return, but tax credits reduce your tax bill dollar for dollar. When you file your tax return, it’s better to take tax credits than it is to tax deductions because of this, but you can only take what you are allowed to and what you qualify for, according to the IRS rules and tax laws.
- Read more about Tax Savings Strategies so that you can save big on your taxes this year!
Some examples of tax credits include the following tax credits:
- The Tax Credit for Other Dependents can save you big time if you do not qualify for the Child Tax Credit.
- The Adoption Tax Credit can help you curb some of your adoption costs.
- The Lifetime Learning Tax Credit is perfect for students who have education expenses.
- The American Opportunity Tax Credit (AOTC) is another great tax break for students. If you are a student filing your tax return for the first time, check out our article on How to File Taxes as a Student. If you can take the AOTC, you should try to do that; it’s very beneficial.
- The Tax Credit for the Elderly or Disabled is ideal for those who are elderly or disabled, offering specific advice for that group of taxpayers.
Another article that may help you decide which tax credits are best for you is the following:
- The Best Tax Credits for Parents article may help you find the greatest tax benefits for you and your family, so be sure to check that one out.
How Do Tax Deductions Work?
Tax deductions give you the opportunity to deduct the amount of the tax deduction or a portion of it from your taxable income, depending on what you qualify for. When filing your federal tax return, you will just fill out the appropriate schedule and follow the directions on how to subtract the amount from your taxable income on your IRS 1040 form.
Tax deductions will reduce the tax you owe because they reduce your taxable income. This may mean that you will receive a tax refund if you are due one, but you won’t know that until you have calculated your tax return. Unlike tax credits, which may be refundable, tax deductions will not reduce the total amount of tax you owe dollar for dollar.
Popular Tax Deductions that Could Save You Money
1. Property Tax Deduction
If you own property, you may be able to claim the property tax deduction on some or all of the taxes you had to pay on the property as assessed by your state or local government, provided the property was for personal use, and you itemize your tax deductions on your annual tax return.
For those who paid taxes on commercial or rental properties, unfortunately, you cannot take this tax deduction. Also, if you paid property taxes on property you do not own, you cannot take this deduction. The maximum amount for this tax deduction is $5,000 per taxpayer, or $10,000 if married filing a joint tax return.
Read more on this in IRS Topic 503: Deductible Taxes.
3. Charitable Contributions Tax Deduction
The charitable contributions tax deduction is very beneficial if you have decided to itemize your tax deductions and have made several charitable donations to qualified organizations. It is very important that you understand that you must choose between taking the standard deduction or itemizing your tax deductions on your tax return.
We advise that you seek the counsel of a qualified tax professional when calculating your taxes, so you can get the most tax benefits. Also, you want to make certain that your tax return is completed correctly! When itemizing, it can get complicated. You must itemize to take the charitable contributions deduction.
You should calculate your taxes both ways (once with you taking the standard deduction and once with you itemizing your tax deductions) to see which way is most beneficial. Also, be sure you have the backup materials to support your itemized deductions.
For example, if you take the charitable contributions deduction, you will need to have receipts and/or letters from qualified charitable organizations with the date, the value of items donated, and the name of the charitable organization you are donating to.
Learn more about how to maximize your charitable contributions deduction this year!
3. Retirement Plan Tax Deductions
Contributions made to a traditional 401(k) or contributions made to another qualified retirement plan may be tax-deductible. Since the contributions are made with pre-tax dollars, you are able to deduct the amount of the contribution from your taxable income. For the tax year 2020, you can contribute up to $19,500 of pretax dollars.
You will need to pay taxes on this amount when you withdraw from your retirement plan upon retirement. Unfortunately, this amount is considered taxable at that time. Read more about the IRS Deduction Limits on the IRS’s website.
4. Student Loan Interest Tax Deduction
There are many tax breaks for students. As mentioned, there are several tax credits available for students, so it is nice to file as a student if you qualify for those tax breaks.
The student loan interest tax deduction gives students the chance to deduct the amount of interest on their student loans from their taxable income. You can take up to $4,000 off your taxable income with this tax deduction.
There is also a Tuition and Fees Tax Deduction available for qualified students. If you have qualified educational expenses, you can deduct up to $4,000 with this tax deduction. Qualified students must have a specified modified adjusted gross income, so be sure you understand the requirements before trying to take this tax deduction.
To take the tuition and fees tax deduction, you will need to complete IRS Form 8817: Tuition and Fees Tax Deduction.
5. Dental and Medical Expense Tax Deduction
If you decide to itemize your deductions rather than take the standard deduction, you may be able to deduct certain qualified dental and medical expenses. Qualified medical and dental expenses for the purposes of this deduction include expenses you incurred and paid during the tax year for yourself, your husband or wife, or your dependents.
For your 2020 annual tax return, you are allowed to deduct a total amount of unreimbursed qualified medical and dental expenses for the 2020 tax year that exceeds 7.5% of your adjusted gross income (AGI).
Qualified dental and medical expenses include medications, eye doctor visits, dental treatments, hospital fees, hospital services, and other medical expenses.
Medical expenses must be associated with the cost of diagnosing, curing, preventing, mitigating, or treating any disease recognized by the medical community and the expenses for treatments affecting any function or area of your body.
This would include the cost of equipment, diagnostic devices, and supplies needed for preventing, mitigating, curing, diagnosing, or treating any of these diseases. This also includes dental expenses.
The following list is not all-inclusive but lists some conditions approved for tax purposes.
- Acupuncture
- Addiction
- Annual physical checkup exam
- Blood sugar test kit
- Body scan
- Birth control pills
- Braille books and magazines
- Chiropractor
- Clinic costs
- Contact lenses
- Cosmetic surgery if used to treat a disfigurement
- Crutches
- Dentist
- Dental examinations
- Diagnostic tests and treatments
- Disabled dependent care expenses
- Drug addiction
- Drugs if prescribed by a qualified medical professional
- Eye doctor
- Eyeglasses
- Eye surgery
- Guide dog or other assisted helper animal service
- Hearing aids
- Home care
- Hospital fees and services
- Insulin treatments
- Insurance premiums
- Legal fees
- Medical conferences
- Medical examinations
- Medicare supplemental costs
- Operations
- Organ donations
- Physical exams
- Physical therapy
- Pregnancy tests
- Prescription medications, if prescribed by a qualified medical professional
- Psychiatric care
- Psychologist
- Special education
- Stop smoking programs
- Surgery
- Therapy
- Weight-loss programs, if qualified
- X-ray services
To learn more about the medical and dental expenses and which ones you qualify for, check out IRS Publication 502: Medical and Dental Expenses.
To calculate the correct maximum amount of the deduction you are allowed to take, you would take your adjusted gross income (AGI). You would multiply your AGI by the 7.5% allowance to determine your limit. If your AGI was $80,000, you could deduct up to $6,000 of qualified dental and medical expenses ($80,000 X 7.5%).
If your qualified medical and dental expenses were $8,000 and you decided to itemize your tax deductions, you could take up to $6,000. You would not be able to take $2,000 (the $8,000 less the $6,000 you were allowed to take) as qualified medical and dental expenses.
When taking the dental and medical expense deduction, it is advised that you seek the counsel of a reputable, knowledgable, and experienced tax professional who is qualified to give you tax advice. They can best show you how to itemize correctly.
6. Bad Debt Tax Deduction
To take this tax deduction, you must first determine if your bad debt is business or non-business related. If it is business-related, you may have had loans, credit sales, or other qualified bad debts that were unpaid by clients or employees. Non-business bad debts must be totally worthless to qualify for this tax deduction.
Read more on this tax deduction in IRS Topic No. 453: Bad Debt Deduction.
7. Business Expense Deductions
There are many deductible items as they relate to business available to taxpayers who qualify. These expenses must qualify as business expenses according to the IRS.
To name a few of the business expenses you may be able to deduct, here is a list:
- Business Meals
- Business Travel
- Business Insurance
- Business Auto Expenses
Be sure you keep a detailed mileage log for your records so that your business travel expenses related to your vehicle are reported correctly. Read more about the habits you need to adopt when keeping a mileage log.
8. Home Mortgage Tax Deduction
The home mortgage tax deduction gives homeowners the opportunity to deduct the interest they incurred on their mortgage, up to a limit of $750,000 of the principal of the loan. You do have to itemize to take this deduction, and most taxpayers find it financially more beneficial to take the standard deduction rather than itemizing their tax deductions.
9. Standard Deduction
The standard deduction is a set amount established by the Internal Revenue Service (IRS). It helps lower your taxable income, as do all tax deductions. What’s unique about the standard deduction is the fact that you do not have to file a separate form or schedule for this one. Instead, it is listed on the main tax form, IRS 1040 form.
When you file your taxes, you must choose between taking the standard deduction or itemizing your tax deductions. Many of the tax deductions listed are structured to be itemized tax deductions, so you must list them out on a separate form (Schedule A: Itemized Deductions).
10. Home Office Tax Deduction
Small business owners and freelancers who are making extra money with a side hustle can save money on their annual tax return by taking the home office deduction, provided they qualify for it. The IRS requirements state that you must be using your home office regularly and exclusively for business-related tasks.
Another requirement is that the home office must be the principal place of business. This means that the home office is the place where the work is done, where the clients are met, and where the inventory is stored. You can have more than one place of business, but the home office must be the chief place of business.
If you qualify for the home office deduction, the IRS will let you write off expenses like real estate taxes, repairs, rent, utilities, maintenance, and other business-related expenses. It can be quite complicated to calculate the home office tax deduction because there is more than one way to figure out the amount of the deduction.
Consult a tax expert before taking it. Read more about how to earn some extra cash on the side with our complete guide to a side hustle: The Ultimate Side Hustle Guide: Everything You Need to Know to Get Started.
11. Health Savings Account (HSA) Tax Deduction
A health savings account (HSA) is an account for you to use on certain medical expenses. If you have a high-deductible health plan, you may be eligible. Any contributions made to a health savings account are considered to be tax-deductible. If you earn any money in the HSA, those earnings are also considered to be tax-deductible.
When you withdraw funds from a health savings account, those funds are also tax-deductible. The IRS does have restrictions on this tax deduction, though. You can contribute up to the maximum amount, and it will be tax-deductible.
For the 2020 tax year, the individual coverage limit that you can contribute is $3,600 per taxpayer. The family coverage limit that you can contribute is $7,200. For taxpayers who are 55 years old or older, they are permitted to put an additional $1,000 into the health savings account, and it will be tax-deductible.
Check out IRS Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans for more information on the Health Savings Account (HSA) tax deduction.
Frequently Asked Questions
What is a tax deduction, and how does it work?
A tax deduction reduces the amount of your taxable income, which should lower your tax liability. Because of this, you are able to pay less on your annual tax return. Most people take the standard deduction, but you can itemize your tax deductions; you just have to pick between one or the other.
What is a tax deduction example?
The home office tax deduction allows you to deduct a portion of your business-related expenses in relation to your home office. The charitable contributions tax deduction allows you to deduct a portion of your charitable donations on your annual federal tax return.
Is a tax deduction good or bad?
A tax deduction is a tax break that reduces your taxable income. Your taxable income is the portion of your total gross income that is taxable. There are different types of taxable incomes and nontaxable incomes, which you need to know so that you can pay on the right income.
Do tax deductions increase your tax refund?
Basically, your tax liability is what you are to pay taxes on, so you want this amount to be as low as possible. If your taxable income is reduced, your tax liability will also be reduced, which will affect your tax refund. Tax deductions reduce your taxable income.
What is the standard deduction for 2020?
Your standard deduction depends on your filing status. There are 5 filing statuses available for taxpayers. Married taxpayers can choose between filing jointly or separately. Check out our tax rates for the latest numbers concerning the current tax year.
Conclusion
As you approach the time for tax preparation, you may be wondering if you can take certain tax deductions and whether they will benefit you or not. You may be curious as to which way to go – take the standard deduction or itemize your tax deductions. Remember that you can only choose one way. It’s a good idea to get expert advice when filing your tax return.
When working with tax deductions and/or tax credits, we recommend working with a tax consultant who understands tax law and what is expected of them by the IRS. Taking tax credits or tax deductions can be tricky because there are a lot of limitations. You should really consider hiring someone to do your taxes this tax season to get the best results.
When hiring a tax accountant, you should understand what the different types of tax professionals are. Some tax professionals can only do your taxes for you; others, like enrolled agents, can represent you in the event of an audit. This is especially important if you think you may be audited.
When working with tax professionals, make sure you get a tax consultation and are prepared for it in advance. This is the best way to get the most out of your visit with a tax consultant! Remember that your time is valuable, and you want to use it wisely!
Borshoff Consulting does tax consultations, tax resolution, business consulting, and many other services. Check out what we offer on our services page for individuals and businesses.
We are excited to help you! Please contact us to find out how we can best serve you with your particular tax or business needs. You can trust Indiana’s tax expert!
