What is a Tax Deduction? Most Common Tax Deductions
As a taxpayer steering the complexities of tax season, understanding tax deductions is crucial to maximizing your savings. For 2023, there are various tax deductions available that can significantly reduce your taxable income.
Whether you’re familiar with the basics or new to the concept, knowing which deductions you qualify for can make a substantial difference in your tax return.
This page will walk you through the essential tax deductions 2023, helping you to identify and claim the ones that can benefit you the most.
What Is a Tax Deduction?
A tax deduction is a way to reduce your taxable income, which in turn lowers the amount of taxes you owe. Essentially, it's a portion of your income that you can subtract from your total earnings to make your tax bill smaller. You can either take the standard deduction—a fixed amount—or itemize your deductions if your expenses add up to more.
Itemized deductions can include things like mortgage interest, charitable donations, unreimbursed medical costs, and state and local taxes. You must note that choosing the right deduction can significantly impact your tax savings, so it's important to compare itemized deductions with the standard deduction to determine which option benefits you the most.
KEY TAKEAWAYS
What Are the Types of Tax Deductions?
The IRS gives you two options to lower your taxable income: you can either take the standard deduction or itemize your deductions. But before you decide which of these two options to use, you can also reduce your gross income with above-the-line deductions. These adjustments help you calculate your adjusted gross income (AGI), which is the number you use to determine your final tax bill.
What is Above-the-Line Deduction?
Above-the-line deductions are adjustments you can make to your gross income before calculating your adjusted gross income (AGI). Think of these as "income adjustments" rather than traditional deductions. They help reduce your gross income, which in turn lowers your AGI.
Some common examples of above-the-line deductions include:
- Retirement Contributions: Money you put into retirement accounts, like a 401(k) or an IRA, can be deducted from your gross income. This not only helps save for your future but also lowers your taxable income.
- Health Savings Account (HSA) Contributions: If you contribute to an HSA, those contributions are deducted from your gross income. HSAs are great for managing medical expenses and reducing your taxable income at the same time.
- Student Loan Interest: Paying off student loans can be expensive, but the interest payments you make may be deductible. This can provide some relief by lowering your AGI.
These deductions are available regardless of whether you choose to itemize your deductions or take the standard deduction. They are important because they directly impact your AGI, which is the starting point for calculating your overall tax liability.
What is Below-the-Line Deduction?
Below-the-line deductions, on the other hand, come into play after you’ve calculated your AGI. These deductions are subtracted from your AGI to determine your taxable income. This is where you decide between taking the standard deduction or itemizing your deductions.
Examples of below-the-line deductions include:
- Medical Expenses: If your medical expenses exceed a certain percentage of your AGI, you can deduct the amount that goes beyond this threshold. This can be significant if you have high healthcare costs.
- Charitable Contributions: Donations to qualified charities can be deducted. This not only benefits the organizations you support but also reduces your taxable income.
- Mortgage Interest: If you own a home, the interest you pay on your mortgage can be deducted, which can lead to substantial savings on your taxes.
Choosing between itemizing and taking the standard deduction depends on which option will give you the most tax benefit. Itemizing requires keeping track of and documenting various expenses, but it can be worth it if your deductions exceed the standard deduction amount.
Standard vs. Itemized Deductions
Standard Deductions
The standard deduction is a fixed amount that reduces your taxable income. For the tax year, the standard deduction amounts are determined based on your filing status (single, married filing jointly, etc.) and your age.
Itemized Deductions
Itemized deductions allow you to deduct specific expenses instead of taking the standard deduction. Common itemized deductions include:
- Mortgage interest
- State and local taxes (SALT)
- Medical expenses
- Charitable contributions
Itemizing can be beneficial if your total deductions exceed the standard deduction amount. You must use Schedule A to itemize your deductions on your tax return.
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IRS and State Filing Status
Your filing status impacts your deduction amounts. The main filing statuses are:
- Single
- Married Filing Jointly
- Married Filing Separately
- Head of Household
- Qualifying Widow(er)
Each status has different standard deduction amounts and tax rates. For instance, Head of Household filers typically receive a higher standard deduction compared to Single filers. For this reason, ensure that your filing status is accurate to maximize your deductions.
Most Common Tax Deductions
Here are the most common tax deductions you can claim to reduce your taxable income. From mortgage interest to charitable donations, these deductions can help lower your tax bill if you qualify and meet the specific IRS requirements.
1. Dependent Deductions
You can claim dependents on your tax return if they meet specific criteria. While dependents typically include children, other relatives may also qualify. The IRS determines dependents based on their relationship to you, residency, and financial support. If someone doesn’t qualify as a dependent, they may still be considered a qualifying relative, which can affect your tax deductions. To find out, use the free RELucator tool to see if the person qualifies as a relative, or the DEPENDucator tool to check if they qualify as a dependent.
2. Life-Changing Event Deductions
Significant life events such as marriage, divorce, having children, buying or selling a home, or changes in employment can affect your tax deductions. For example:
- Marriage might change your filing status and eligibility for certain deductions.
- Childbirth may qualify you for additional deductions or credits.
Keep track of these events as they can influence your eligibility for various deductions and credits.
3. Home Mortgage Interest
You can deduct interest on your mortgage if it’s reported to you on Form 1098. This deduction applies to interest paid on a loan for your primary residence or a second home. For mortgages taken out after December 15, 2017, the deduction is limited to interest on loans up to $750,000 ($375,000 if married filing separately). Additionally, you can deduct points paid to reduce your mortgage rate, which are considered prepaid interest.
4. State and Local Taxes (SALT)
The SALT deduction allows you to deduct up to $10,000 ($5,000 if married filing separately) for state and local taxes. This cap includes a combination of:
- Property taxes
- State and local income taxes or sales taxes
To claim this deduction, you must itemize on Schedule A. However, if the total of your itemized deductions doesn’t exceed the standard deduction, it might be better to opt for the standard deduction.
5. Retirement Contributions
Retirement contributions, such as those made to 401(k) or IRA accounts, can offer significant tax benefits. These contributions not only help you save for the future but can also lower your taxable income for the current year.
5.1 Traditional IRA Contributions
Contributions to a traditional IRA are often deductible from your taxable income. For 2023, you can contribute up to $6,500 ($7,500 if age 50 or older) to a traditional IRA. If neither you nor your spouse is covered by a retirement plan at work, you can deduct the full amount of your IRA contributions. If you are covered by a retirement plan, your deduction may be limited based on your income.
5.2 Roth IRA Contributions
Contributions to a Roth IRA are not tax-deductible. However, withdrawals during retirement are tax-free. For 2023, you can contribute up to $6,500 ($7,500 if age 50 or older) to a Roth IRA, subject to income limits.
5.3 SEP and SIMPLE IRAs
If you are self-employed, contributions to a SEP (Simplified Employee Pension) or SIMPLE (Savings Incentive Match Plan for Employees) IRA are generally deductible. These plans have higher contribution limits compared to traditional and Roth IRAs.
6. Home Office Expenses
If you work from home as a self-employed person or independent contractor, you might be able to deduct home office expenses. The home office deduction can include:
- A portion of your home’s rent or mortgage
- Utilities
- Insurance
- Repairs and maintenance
To qualify, your home office must be used exclusively and regularly for business purposes. The deduction is calculated using either the simplified method (a standard rate per square foot) or the actual expense method.
7. Energy Efficient Home Improvements
While direct deductions for energy-efficient home improvements are not available, you might qualify for tax credits. These credits can reduce your tax bill directly and are available for various upgrades, such as solar panels or energy-efficient windows. Check current IRS guidelines for eligible improvements and associated credits.
8. Medical Expenses
You can deduct medical expenses that exceed 7.5% of your adjusted gross income (AGI). For example, if your AGI is $40,000 and you have $5,000 in medical expenses, you can only deduct the amount exceeding $3,000 (7.5% of $40,000), so $2,000 would be deductible.
8.1 Medical Savings Accounts
Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) allow you to save money tax-free for medical expenses. Contributions to these accounts are deductible, and withdrawals for qualified medical expenses are tax-free. Health Reimbursement Arrangements (HRAs) are another option for tax-free reimbursement of medical expenses.
9. Charitable Contributions
Donations to qualified charitable organizations can be deducted if you itemize your deductions. You can deduct contributions made in cash or property, such as clothing or vehicles. For 2023, you can generally deduct up to 60% of your AGI for charitable contributions.
10. Education Expenses and Credits
Education expenses and credits can help reduce the cost of schooling. Whether you're paying for tuition or student loan interest, there are valuable tax credits and deductions available to lessen the financial burden of education.
10.1 American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) allows you to claim up to $2,500 per student for qualified education expenses, including tuition and fees, but not living expenses. This credit is partially refundable, meaning you can get some of the credit back even if you don’t owe taxes.
10.2 Lifetime Learning Credit
The Lifetime Learning Credit provides a maximum credit of $2,000 per tax return for qualified education expenses. Unlike the AOTC, this credit is not refundable and covers a broader range of education-related expenses.
10.3 Student Loan Interest Deduction
You can deduct up to $2,500 in student loan interest paid during the year. This deduction is available even if you do not itemize, and it can help reduce your taxable income.
11. Self-Employment and Business Deductions
Self-employed individuals can deduct various business expenses, including:
- Office supplies
- Business travel
- Advertising costs
Additionally, the Qualified Business Income (QBI) deduction allows you to deduct up to 20% of qualified business income. This deduction is available whether you itemize or not.
12. Other Deductions
In addition to the common deductions, there are other deductions you might qualify for. These can include gambling losses, moving expenses, and others.
12. 1 Gambling Losses
Gambling losses can be deducted up to the amount of gambling winnings reported. You must itemize your deductions to claim gambling losses.
12. 2 Casualty and Theft Losses
You can deduct losses from theft or damage due to a federally declared disaster. This deduction applies to losses not covered by insurance and is subject to certain limitations.
12. 3 Moving Expenses
The moving expense deduction was suspended for most taxpayers due to the 2018 Tax Reform Act, except for active military members. Some states, however, may still offer moving expense deductions.
12. 4 Jury Duty Pay
Jury duty pay is taxable income. If you receive payment from both your employer and the court, you might need to report the total amount as income but can deduct any amounts paid to your employer.
12. 5 Child Care and Adoption
While child care expenses are not directly deductible, you may be eligible for the Child and Dependent Care Credit. Adoption expenses can be offset by the Adoption Tax Credit, which helps cover qualifying adoption costs.
What's the Deduction Expense Claim Period?
To claim a deduction, the expense generally needs to occur within the tax year—January 1 to December 31. There are exceptions, such as retirement plan contributions, which can sometimes be made in the following year up to the tax return due date. Always check specific deadlines for your deductions to ensure you claim them correctly.
What Doesn't Count as a Tax Deduction?
Not all expenses can reduce your tax bill, so it's important to know what doesn't count as a tax deduction. Here's a quick list of expenses that won't help you save on taxes:
- Car inspection fees
- Customs duties
- Employee business expenses (not deductible since 2017)
- Federal excise tax
- Federal income tax
- Gas tax
- License fees
- Gift tax
- Personal expenses
- Social Security, Medicare, FUTA, and RRTA taxes
- Real property improvements
- Taxes paid for someone else
What Is the Standard Tax Deduction for 2023?
For the 2023 tax year, the standard tax deduction amounts are straightforward and vary based on your filing status. If you’re single or married but filing separately, you can claim a standard deduction of $13,850. Heads of household can claim $20,800, while married couples filing jointly or surviving spouses can deduct $27,700.
If you're 65 or older or blind, you can get an extra deduction. For 2023, this additional amount is $1,500 for most filers, and $1,850 for single filers and heads of household.
What Is the Difference Between a Tax Credit and a Tax Deduction?
A tax deduction reduces the amount of income that's subject to tax. For example, if you earn $50,000 and claim a $5,000 deduction, you'll only pay taxes on $45,000. Deductions lower your taxable income, which can reduce the total amount you owe.
On the other hand, a tax credit directly reduces your tax bill. If you owe $1,000 in taxes and have a $200 credit, your tax bill drops to $800. Credits are more valuable because they reduce your tax liability dollar-for-dollar.
In summary, tax deductions lower your taxable income, while tax credits directly reduce the amount you owe. Both are important tools for managing your taxes effectively!
Can You Deduct Property Taxes If You Don't Itemize?
When it comes to tax deductions, property taxes can often be a point of confusion. The key question is: Can you deduct property taxes if you don't itemize? The short answer is no. To claim property taxes as a deduction, you need to itemize your deductions on your tax return. This means you forgo the standard deduction and list out all possible deductions individually, including property taxes.
If you opt for the standard deduction, you won't be able to deduct property taxes. However, if you are eligible for itemizing, you can include property taxes along with other deductions like mortgage interest and charitable contributions.
For many taxpayers, the standard deduction is more beneficial, but if your itemized deductions exceed this amount, it might be worth the extra effort.
How Do You Claim Tax Deductions?
Claiming tax deductions can save you money, but it’s important to follow a few simple steps to make sure you do it right.
Step 1: Identify Eligible Deductions: Start by determining which expenses qualify as tax deductions. Common ones include mortgage interest, medical expenses, and charitable donations.
Step 2: Gather Documentation: Collect receipts, bills, and other documents that support your deductions.
Step 3: Use IRS Schedules: Complete the necessary IRS forms, like Schedule A for itemized deductions or Schedule C for business expenses.
Step 4: Double-Check Your Work: Review everything to ensure accuracy.
Step 5: eFile Your Return: Use a tax filing service like eFile.com to enter your information and ensure all deductions are accurately claimed.
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What Are Tax Write-Offs?
Tax write-offs, often called tax deductions, are expenses you can subtract from your income to reduce how much you owe in taxes. Though the IRS doesn’t use the term "tax write-off," it’s commonly used to describe deductions. These are specific expenses you’ve incurred, like medical costs or business expenses, that can lower your taxable income. Unlike a tax credit, which directly cuts down your tax bill, tax write-offs just reduce the amount of income that’s taxed. So, keeping track of your eligible expenses can help you save money come tax season!
Related Resources:
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Are health insurance premiums deductible?
Can I deduct home mortgage points?
What kind of retirement contributions are deductible?
Does my standard deduction increase when I get married?
Can I deduct legal or attorney fees?
How do I report and deduct business expenses?
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