If completing your taxes each year feels like pulling teeth, it’s probably because they’re so darn confusing. But considering that well over $1 trillion in tax deductions are claimed every year, it really pays to understand how they work.
If tax deductions have you confused, don’t fear. We’ve put together a handy guide that answers your biggest questions about tax deductions and how to claim them.
Should You Claim The Standard Deduction Or Itemize?
When it comes to filing taxes, the decision to itemize or claim the standard deduction is a big one.
To offset some of your general expenses paid throughout the year, you’re allowed to claim the standard deduction. This deduction reduces your taxable income by a certain amount, depending on your tax filing status. It’s set each year and adjusted for inflation.
These are the standard deduction amounts for tax year 2019, which you file in 2020:
- Single: $12,200
- Married filing jointly: $24,400
- Married filing separately: $12,200
- Head of household: $18,350
On the other hand, if you think you qualified for more tax write-offs than the standard deduction is worth, you can choose to itemize your taxes instead. “Essentially, this means forgoing the standard deduction and using your actual expenses in certain pre-defined categories to push your deductions higher,” said Dane Janas, an IRS-licensed enrolled agent and the owner and CEO of Boundless Tax.
Going with the standard deduction is much easier from a filing standpoint, he said, but it’s always worth checking whether itemizing your deductions would save you more money on your return.
So how do you know which option is best? “If all of your deductible expenses combined — including things like mortgage interest, charitable contributions and other expenses — add up to more than the standard deduction, then it make sense to itemize,” said Andrea Coombes, a tax specialist for personal finance education site NerdWallet. On the other hand, if your deductible expenses add up to less than the standard deduction, you have to claim the standard deduction.
“The most difficult part of this decision is figuring out if you have any expenses that qualify as deductible,” Coombes said. The most foolproof way of finding out for sure is hiring a tax professional to complete your return. However, most popular tax software programs are sophisticated enough to run the numbers and choose the best option for the average taxpayer.
Most likely, the standard deduction will be your best bet. “If you’re not self-employed, don’t own your home, have few medical expenses and don’t make large charitable contributions, there’s a good chance you’ll be better off claiming the standard deduction,” Coombes said. In fact, about 90 percent of taxpayers do.
Understanding Tax Deductions Vs. Tax Credits
When it comes to potential tax write-offs you can claim, the terms “deduction” and “credit” are often used interchangeably. But there are important distinctions between the two as far as of how they can be claimed and how your overall tax bill is affected.
“Tax deductions are valuable — they reduce the amount of your income that’s subject to tax. But for most people, tax credits are even more valuable, because they reduce your total tax bill, dollar for dollar,” Coombes said. “A $1,000 tax credit will reduce your tax bill by $1,000. But a deductible expense of $1,000 will reduce your tax bill by only a fraction of that — the precise amount depends on your tax rate.” For example, if your effective tax rate is 20 percent, a $1,000 deduction reduces your tax bill by $200.
What About Tax Exemptions?
The Tax Cuts and Jobs Act, which passed at the close of 2017, involved some of the biggest changes to our tax code in decades. Last year’s tax season was the first time we felt any of the repercussions, with some smaller further changes coming to us this tax season, according to Janas.
One of those changes was the phasing out of personal exemptions. “Prior to 2017, each [dependent] claimed on your return (spouse, children, other dependents) was worth a $4,050 deduction,” Janas said. This was in addition to the standard deduction. Effectively, if you were married with two children, you would have claimed a $29,200 deduction between exemptions (four total) and the standard deduction.
Now, personal exemptions no longer exist. “However, the standard deduction has increased accordingly to make up for the loss of personal exemptions,” Janas noted.
Other Ways Tax Deductions Have Changed Recently
In addition to getting rid of tax exemptions, there were several more major changes to how tax deductions work. For one, the standard deduction was increased significantly, as Janas mentioned above.
However, many deductions were reduced or killed off completely. For example, a cap was placed on property taxes. “Before 2018, taxpayers could claim their total property taxes paid, but now they can claim a maximum of $10,000 per year in property taxes,” Coombes said.
The same goes for mortgage interest. Previously, taxpayers could deduct interest on mortgages of up to $1,000,000. Now, the mortgage amount is capped at $750,000.
Other deductions that have been suspended or eliminated include work-related expenses, tax preparation fees and a host of other miscellaneous expenses.
Common Itemized Tax Deductions
Even though there was a major overhaul to tax deductions recently, there are still plenty of ways to reduce your taxable income in addition to those mentioned above. The following are several common itemized tax deductions to keep in mind as you prepare your return, according to Lisa Greene Lewis, a certified public accountant with TurboTax:
Charitable contributions: If you donated to a charity in 2019, you can write off the value as long as you’re itemizing your taxes. Lewis noted that you can’t deduct the value of your time spent volunteering, but you can deduct your travel expenses, including parking fees, tolls and 14 cents per mile driven.
State income or sales and local tax: Though the state and local tax (SALT) deduction was capped at a combined $10,000 as of 2017, this deduction is still available to those who itemize. In addition to property taxes, you can choose to deduct either state income tax or state sales tax paid during the year, whichever gets you the biggest tax deduction.
Home office: If you’re self-employed and use part of your home to conduct business, you can deduct home office expenses such as rent or mortgage interest, utilities, maintenance and more, based on the square footage of that area. However, keep in mind that the space you claim must be used regularly and exclusively for business purposes.
Mileage expenses: Self-employed taxpayers who use their vehicles to conduct business can deduct 58 cents per mile. You also have the option to claim a percentage of your vehicle expenses instead, such as gas, insurance, repairs and depreciation.
Health insurance: Self-employed individuals can deduct their health insurance premiums, including those for their family. Even if you aren’t self-employed, though, you might still be able to deduct health insurance premiums if you itemize.
Medical expenses: If you’re itemizing, you may be able to deduct additional medical expenses if they exceed 10% of your adjusted gross income for 2019. This includes preventive care, treatment, surgeries and more, as well as travel expenses for medical care such as gas mileage, bus fare and parking.
Don’t Overlook These Valuable Tax Deductions And Credits
Even if you don’t itemize your taxes, there are several tax credits and “above-the-line” adjustments to your income that you may be able to claim in addition to the standard deduction:
Retirement contributions: You may be able to deduct contributions made to an IRA, 401(k) or other tax-advantaged retirement account. The rules surrounding this deduction vary, so familiarize yourself with the guidelines for your particular account type.
Student loan interest: If you borrowed student loans to pay for your college education, you may be able to deduct up to $2,500 in interest. This deduction phases out as your income increases.
Gambling losses: If you risked some cash on gambling over the year, you might be able to write off some of the losses ― but only up to the amount of gambling winnings. “So you can’t deduct $500 spent throughout the year on lottery tickets unless you won at least $500,” Janas said.
Education credits: There are two education credits available. The American Opportunity Tax Credit is worth up to $2,500 for education expenses paid during the first four years of college. If claiming this credit causes your taxable income to come up to zero, you can have 40 percent of any remaining amount of the credit refunded to you, up to $1,000. The Lifetime Learning Credit is worth up to $2,000 for qualified expenses related to undergraduate, graduate or professional courses. There’s no cap on the number of years you can claim this credit.
Child and dependent care credit: Depending on your filing status, you may be able to claim up to $3,000 for day care or similar costs for a child under 13, an incapacitated spouse or parent, or another qualified dependent, if paying for care allowed you to work or actively look for work.
Other dependent credit: If you don’t qualify for the child and dependent care credit, you may still qualify for the other dependent credit. This new credit allows you to claim up to $500 per non-child dependent that you support.
Earned income tax credit: This can score you between $529 and $6,557 in 2019 depending on how many kids you have, your marital status and your income level.
Keep in mind that this is by no means an exhaustive list of the tax deductions available to you. However, you should see that there are many ways to reduce what you owe in April, so take the time to investigate the various deductions you might qualify for. And again, if you aren’t sure, it’s always a good idea to hire a tax professional and ensure you aren’t missing out.