Tax Deduction Definition

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Tax Deduction Definition
Standard Deduction for the 2021 and 2022 Tax Years
Filing Status2021 Standard Deduction2022 Standard Deduction
Married Filing Separately$12,550$12,950
Heads of Household$18,800$19,400
Married Filing Jointly$25,100$25,900
Surviving Spouses$25,100$25,900

Taxpayers over the age of 65 or who are blind may claim an extra standard deduction. The additional amount for 2021 is $1,350 ($1,700 for single filers and heads of households). Those over the age of 65 and blind are eligible to twice the extra amount ($2,700 or $3,400, depending on filing status).

You may either take the standard deduction or itemize your deductions for the same tax year.

Common Tax Deductions

Some of the most typical tax deductions you may claim on your federal income tax return are as follows:

The majority of these deductions are reported on Schedule A of your 1040, with a few exceptions. For example, to report investment losses, you must use Form 8949 and Schedule D, and to record IRA contributions, you must use Form 5498. Contributions to an employer-sponsored 401(k) retirement plan are automatically deducted from your paycheck, so you don’t need to fill out an additional form.

In general, charitable donations may only be deducted if you itemize. Even if you don’t itemize, you may deduct up to $300 ($600 if married filing jointly) in gifts to qualified organizations in 2021.

Deductions That Went Away in 2018

The Tax Cuts and Jobs Act of 2017 abolished or limited certain formerly prevalent tax deductions (TCJA).You may no longer deduct the following items—at least until 2025, when the statute expires:

  • Interest on a home equity loan (unless you spent the money to improve the home)
  • Mortgage interest on secured mortgage debt in excess of $750,000
  • Unreimbursed work expenses
  • State and municipal taxes in excess of $5,000 (or $10,000 for a married couple)
  • Professional society dues
  • Expenses associated with relocation (except for military personnel)
  • Losses due to casualties and theft (except in federally declared disaster areas)
  • The personal exemption
  • Tax preparation fees
  • Alimony payments
  • Itemized deductions for “Miscellaneous”

Tax Deductions for the Self-Employed

The number of freelancers and gig workers is increasing. More than 16 million Americans now identify as self-employed, according to a Pew Research survey.

Fortunately for them, they have kept some of the tax breaks that wage workers lost as part of the 2017 tax reform package. Some deductions are complicated because you must establish how much of each item is company and hence deductible vs personal and nondeductible.

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The deduction for half of your Medicare and Social Security taxes, the home office deduction, and the health insurance premiums deduction are among the most crucial for self-employed people.

One especially useful deduction for self-employed workers is the deferral of taxes on retirement plan payments. Tax-deferred retirement plans, such as the SEP-IRA, SIMPLE IRA, and solo 401(k), are particularly created for self-employed, solo operators, and small company owners.

Contributions to regular IRAs and qualifying plans such as 401(k)s are deductible “above the line.” That is, even if you use the standard deduction instead of itemizing, the donation will lower your taxable income.

Small Business Tax Deductions

Businesses of all sizes pay taxes on their earnings, which are calculated as total revenues minus total company expenditures. This entails keeping track of all expenses and reporting them to the IRS. The following are some of the most popular deductions for small company owners:

  • Advertising and promotion
  • Bad debts
  • Books
  • Business travel
  • Charitable contributions
  • Continuing education
  • Equipment
  • Insurance
  • Legal and professional fees
  • License and regulatory fees
  • Loan interest
  • Pass-through tax deduction
  • Repair and maintenance
  • Taxes (local, sales, and property taxes) (local, sales, and property taxes)
  • Vehicle expenses
  • Startup costs

Many of these deductions have complicated regulations, especially for small businesses. Vehicle and travel costs, for example, must be properly split between deductible and nondeductible personal or family usage.

Tax Deductions vs. Tax Credits

Tax deductions lower your total taxable income, which is used to compute your tax obligation. Tax credits, on the other hand, are deducted straight from the taxes you owe. Some tax credits are even refundable, which means that if they lower your tax bill below zero, you will get a refund for the difference.

A tax credit is more beneficial than a tax deduction, even if it is not refundable. A tax deduction may lower your taxable income somewhat, but a tax credit reduces the amount of tax you owe dollar for dollar.

Example of a Tax Deduction

Here’s an illustration. Consider a single taxpayer with an annual earned income of $80,000. This places the individual in the 22% tax rate. So, for 2021, their tax burden would be $4,863 (12% of the first $40,525 in income) plus 22% of the amount beyond $40,525, for a total of $13,548. This person, like other taxpayers, has the option of itemizing deductions or taking the standard deduction.

If the Taxpayer Itemizes

The taxpayer has paid $10,000 in mortgage interest and made a $6,000 contribution to a typical IRA. Both are tax deductible.

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With a total of $16,000 in deductions to record, the taxpayer would owe income taxes on $64,000 of earned income ($80,000 – $16,000). After deducting the deductions, the individual will owe $10,028 in taxes for the year (rather than the initial $13,548).

If the Taxpayer Takes the Standard Deduction

For the 2021 tax year, the standard deduction for a single filer is $12,550. It is crucial to remember that the taxpayer will get the IRA contribution deduction in any situation. This is a “above-the-line” deduction, lowering this taxpayer’s taxable income from $80,000 to $74,000. The standard deduction further decreases the filer’s taxable income to $61,450. The individual will owe $9,467 after using the standard deduction.

Even with a hefty mortgage interest write-off, the taxpayer would save $561 by taking the standard deduction rather than itemizing deductions.

Standard Deductions vs. Itemized Deductions

U.S. taxpayers choose to itemize their deductions or take the standard deduction, depending on which most reduces their taxable income. Still, most taxpayers benefit from the standard deduction because the TCJA nearly doubled the standard deduction and eliminated (or capped) many itemized deductions.

If you itemize, you need to keep receipts for eligible expenses throughout the year and organize them into categories. At tax time, you tally and record the expenses on a Schedule A—and hold onto the receipts in case you’re audited.

The standard deduction is substantially less work: You simply fill in the amount of your standard deduction on line 12a of Form 1040 or 1040-SR.

State Tax Deductions

The structure of the federal forms is followed as closely as feasible by the majority of the 41 states that levy an income tax. However, each state has its own tax rates and basic deductions, and it may have extra permissible deductions or various deduction limitations.

Some jurisdictions prohibit taxpayers from itemizing state taxes if they claim the federal tax deduction.

In any event, it’s important carefully examining your state’s tax forms to determine whether you qualify for any extra deductions. In New Mexico, for example, if you reach the age of 100, you are free from state income tax. In addition, Nevada taxpayers may get a free deck of cards in exchange for submitting their tax forms.

Special Considerations

Keep in mind that certain deductions have restrictions. For example, under current federal tax rules, the mortgage interest deduction is limited to a maximum of $750,000 of secured mortgage debt (or $1 million if purchased before to December 16, 2017). That 2017 shift dealt a heavy blow to the extremely rich as well as some not-so-wealthy inhabitants of the most costly cities.

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Then there’s the healthcare deduction cap. If you itemize your healthcare expenditures, the expenses you spent (for yourself, your spouse, and your dependents) must exceed a specific percentage of your adjusted gross income (AGI) in order to be deducted. The medical spending threshold for 2021 tax returns is 7.5% of AGI for all taxpayers.

Capital Loss Carryforward

The capital loss deduction is an extra deduction that is not included in the basic or itemized tax deductions. These, together with capital gains, are reported on Schedule D rather than Schedule A.

A tax loss carryforward is a legal method of rearranging profits for the advantage of the taxpayer. Individual and corporate capital losses from prior years may be carried forward. As with the 2021 tax year, you may deduct up to $3,000 in capital losses ($1,500 if married filing separately) (the tax return you file in 2022).If your losses were higher, you may “carry them forward” to the next year or years.

What Can I Write Off on My Taxes for 2021?

There are several tax deductions and credits available to assist you reduce your tax liability. Mortgage interest, retirement plan contributions, HSA payments, student loan interest, charity donations, medical and dental expenditures, gaming losses, and state and local taxes are some of the more prevalent deductions.

The child tax credit, earned income tax credit, child and dependent care credit, saver’s credit, foreign tax credit, American opportunity credit, lifelong learning credit, and premium tax credit are all examples of common credits.

How Can I Maximize My Tax Deductions?

Whether you itemize or use the standard deduction, it is beneficial to make the maximum permissible contribution to a conventional (non-Roth) retirement plan such as an IRA or 401(k) (k).You’ll be increasing your retirement savings while also lowering your taxes for the year.

If you have a significant amount of mortgage interest, student loan interest, medical expenditures, and other deductible expenses, the sum may surpass the standard deduction. In such instance, itemizing on Schedule A of Form 1040 or 1040-SR will allow you to maximize your deductions.

What Is the Maximum Tax Refund You Can Get?

There is no upper limit. According to the National Taxpayer Advocate, the average refund for people in the 2020 tax filing season was $2,827. (an independent organization within the IRS).

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