When something is tax deductible — meaning that it’s able to be legally subtracted from taxable income — it serves as a taxpayer advantage. When you apply tax deductions, you’ll lower the amount of your taxable income, which, in turn, lessens the amount of tax you’ll have to pay the Internal Revenue Service that year. But it’s not up to taxpayers to decide what qualifies; the IRS determines what can be used as a deduction on your tax return.
Here’s a quick overview of how tax deductions work.
What Is Tax Deduction?
You can choose either a standard deduction or itemized deductions when filing your taxes — whichever option gives you the largest deduction. Common itemized tax deductions include state and local income taxes, mortgage interest, charitable contributions and medical expenses in excess of 10 percent of adjusted gross income. For many people, choosing the standard deduction — $6,350 for married filing separately and $12,700 if married and filing jointly for 2017 or $6,500 and $13,000, respectively in 2018 — is more beneficial than trying to itemize deductions.
Related: Every Tax-Filing Status Explained
How Do Tax Deductions Work?
When you file your income taxes on Form 1040, you’ll see in black and white how deductions work. After you calculate your adjusted gross income on Page 1 of your return, you’ll subtract your deductions, located on Page 2, Line 40 before you calculate your taxable income. The larger the amount of your deductions, the smaller your taxable income will be.
Although the IRS specifies a wide range of deductions, from work-related expenses to student loan interest and various investment and health care expenses, not all taxpayers can avail of these deductions. You must qualify for each deduction to claim it.
Tax Deductions vs. Tax Credits
Tax credits are related to tax deductions because they can lower the amount of tax you owe. But tax credits are different from tax deductions in that tax credits are applied to your return after your tax is calculated. Unlike tax deductions, which reduce the amount of your taxable income, tax credits reduce the amount of your actual tax, which works out better financially.
When you’re in the 25 percent tax bracket, for example, a $1,000 deduction will reduce your tax by $250. A $1,000 tax credit, on the other hand, will reduce your tax by $1,000, regardless of your tax bracket. Common tax credits include the earned income credit, the child tax credit and the premium tax credit associated with the Affordable Care Act.
Know Before You File: Tax Breaks for 2018
Maximizing Tax Deductions
Tax filing can be complicated, and you might want to consult a tax advisor to be sure you don’t overlook any tax deductions. Although common deductions like the mortgage interest deduction are well-known, some deductions, like those for investment interest expenses and casualty and theft losses, can be overlooked. High-earning taxpayers should also be aware that some deductions might be reduced; for 2018, the phaseout level for the personal exemption begins at an AGI of $266,700 for single filers and $320,000 for joint filers.
Learn More: 13 Commonly Missed Tax Deductions