A tax deduction is a subtraction of an amount of money from your adjusted gross, taxable income. They lower your overall tax liability and have the ability to change your tax bracket to a lower one. Because of this, deductions can result in your paying fewer taxes.
Types of Tax Deductions
There are two main types of deductions: standard and itemized.
The IRS allows most taxpayers to take a standard deduction. This amount changes each year for inflation and varies depending on your filing status. IRS publication 501 states that the standard deductions for the 2013 tax year are:
| Individuals and married couples filing separately || $6,100 |
| Head of household || $8,950 |
| Married Couples filing Jointly || $12,200 |
| Dependents (when a dependent files his own return, but is claimed as a dependent on another person's return) || The greater of $1,000 or the individual's earned income plus $350, as long as that amount does not exceed the amount for individuals ($6,100) |
According to IRS Tax Topic 551, additional amounts are granted to individuals who are 65 or older at the end of the taxable year or who are blind.
However, the standard deduction is not available to some taxpayers, including:
- Married individuals filing separately in which one spouse itemizes deductions
- Individuals who are dual-status aliens or non-resident aliens for a portion of the year
If you are eligible, you may claim the standard deduction, you do so on line 40 of IRS Form 1040.
The option to itemize deductions is available to taxpayers whose deductible expenses exceed the amount of standard deductions. This option requires you to individually list each deduction and its deductible amount. Deductions that you can itemize include, but are not limited to, medical and dental expenses, paid interest, taxes paid during the tax year, and charitable gifts. The deductions in the miscellaneous category are also subject to a two percent adjusted gross income limitation.
The specific type of deductions are listed on Schedule A of Form 1040, which must be completed and submitted along with Form 1040 when filing your taxes. Once calculated, you insert this amount on line 40 of IRS Form 1040.
The IRS recommends itemizing your deductions in circumstances such as:
- When you cannot use the standard deduction
- If you had large uninsured losses
- Because you made large charitable contributions
As of 2013, itemized deduction amounts may be reduced if your income exceeds:
| $250,000 || for single individuals |
| $300,000 || for married individuals filing jointly and widows |
| $150,000 || for married individuals filing separately |
| $275,000 || for heads of households |
If your deductible amount is restricted due to your meeting one of these income thresholds, use the Itemized Deduction Worksheet to determine the amount you may claim as a deduction.
Individual vs. Business Deductions
The basic definition of a tax deduction does not change if it was a business or personal expense. However, differences between the two include:
- For a business, a deduction is taken against the business income, not your personal income.
- There is no standard deduction for business expenses; all business deductions must be itemized.
- Deductible business expenses must be both necessary and ordinary and incurred in the cost of carrying on a business.
Examples of Personal Deductions
Taxpayers claim personal deductions on their tax returns. Examples of personal deductions include:
- Health care expenses: This includes any premiums and out-of-pocket expenses you paid for medical care over the taxable year. Note that premiums are only deductible if they are paid out-of-pocket and not through payroll deduction.
- Charitable contributions: Cash and other types of contributions, such as clothing, to non-profit organizations are deductible.
- Taxes paid to state or local governments: You may be able to deduct property and other taxes paid to other government entities.
Examples of Business Deductions
A business deduction is taken for an amount of money that is expended to carry on a business. Examples of business deductions include:
- Business assets: This includes any furniture, patents, franchise rights, and land purchased to start a new business.
- The cost of raw goods: This includes any materials you must purchase to create a product that your business sells.
- Using part of your home for a business: You can deduct and depreciate the portion of your home that you've dedicated to your home office. You can also deduct the cost of utilities and other items that you need to operate out of your home office.
- Using your car for your business: You can deduct the mileage you drive for business purposes on your personal vehicle. Standard Mileage is allowed, but so are actual expenses (depreciation, insurance, repairs, fuel). Taxpayers can choose between either of these methods in the first year the vehicle is placed in service. If a taxpayer chooses the standard mileage method in the first year, then he can also choose between the two in future years. However, if the taxpayer chooses to use the actual expense method in the first year, he must continue to use that method until that vehicle is no longer used for business.
The amount of these deductions can be limited by how often they were used, such as in the case of your car, and whether it was used partly for business and partly for personal use.
Determining if Something Is Deductible
If you're wondering whether something is deductible, consider reviewing IRS rules for the item. IRS Tax Topic 500 provides information about the numerous types of deductions that can be itemized on a personal return. IRS publication 535 details the types of business expenses that are deductible.
Claiming Your Deductions
Claiming deductions on your tax return can save you money. Because of this, check the IRS rules for deductions to ensure that you claim the most available to you.