What is a Tax Deduction

A tax deductible or deduction is a diminution in the amount of tax obligation from the gross income of a taxpayer. These deductions can arise as a result of a number of events that taxpayers experience during a tax year. Tax-deductible amounts are subtracted from a taxpayer’s taxable income, also called adjusted gross income, and thus reduce the overall tax liability of a taxpayer. Different tax codes are assigned to different regions that enable a taxpayer to deduct a range of expenses from his or her taxable income.

Tax codes are different at federal and state levels. Tax authorities at both the federal and state levels are responsible for setting tax code standards on a yearly basis. Government authorities set tax deductions as a means to induce taxpayers to take part in various community service programs for the improvement of society. If a taxpayer is aware of eligible state and federal tax deductions, he or she can avail the benefit of tax deductions annually. In the US, tax is deductible on both federal and state taxes.

Standard Deductions

For most individuals in the US a standard deduction is allowed on federal taxes. The amount of your federal standard deduction will vary on a yearly basis and depends on the filing characteristics of the taxpayer. Different states have their own laws regarding standard deductions, and numerous states also offer standard deductions at the state tax level. As a taxpayer, you can opt for a standard deduction or an itemized deduction. If you opt for itemized deductions, deductions are considered solely for any amount that is in excess of the standard deduction limit.

There are plenty of common tax deductions and numerous tax deductions that are often overlooked by taxpayers, which are available at both federal and state tax levels that you can use to reduce your taxable income. Some examples of common tax deductions are charitable donations and property tax. Homeowners also benefit from a few added advantages in respect of tax deductions.

On the other hand, some uncommon tax deductions are yearly tax on personal property and sales taxes on acquisition of personal property. Numerous expenses that you incur throughout the year because of business and personal reasons may also qualify for itemized deductions. These expenses include travel expenses, some transportation expenses, health expenses and networking expenses.

Tax Loss Carry forward

Another kind of deduction that is not a part of standard or itemized tax deductions is available on capital losses that you incur. This carry forward of capital losses is a legal mechanism that enables you to rearrange earnings to your benefit. Business and personal capital losses of a taxpayer can be carried forward from prior years. A maximum of $3,000 in capital losses is allowed per year.

Schedule A

This is an income tax form used by US taxpayers for reporting their itemized deductions. It can help you lower your federal tax liability. This form is an optional attachment to the standard 1040 form for people paying annual income taxes. Your itemized deductions work as a substitute to claiming a standard deduction on your tax returns, and you can opt for deductions that give you the best returns in terms of tax savings. Similar to standard tax returns, these deductions are excluded from your adjusted gross income (AGI) to arrive at your taxable income.

Itemized Deductions

This is a deduction from your taxable adjusted gross income, which comprises deductions for funds expended on specific goods and services over the course of the year. The particular deductions that you are eligible for are outlined by the IRS and include expenditures, like mortgage interest, local and state taxes, medical costs and gifts. Generally, your itemized deduction is restricted to a specific percentage of your adjusted gross income. In contrast to a standard deduction, for an itemized deduction, you need to keep track of every potential expense that can lower your tax liability.

If you frequently incur hefty amounts on state and local taxes, medical care or donations you may be better off itemizing. However, tax laws usually set thresholds for spending that you have to exceed to be eligible for deductions. As an example, for the medical category, only those expenditures that are in excess of 7.5% of your adjusted gross income are eligible for deduction. Unfortunately, if you don’t end up spending at least that amount on medical bills, none of your medical expenses will qualify for deduction.

Above the Line Deductions

These deductions are specific kinds of deductions that lower your income before the adjusted gross income is computed. It comprises items like alimony payments, loss incurred on sale of a property and educational expenditures. As these deductions are usually deducted from your taxable income, they are beneficial to you as they lower your overall tax burden.

Mortgage Interest Deduction

You are eligible for this deduction if you pay certain kinds of interest. Interest deductions have the effect of lowering your amount of income that is subject to tax. There are 2 main kinds of interest deductions that are available on your home mortgage interest or home equity loan interest and margin account interest. Mortgage deductions are allowed as a means of encouraging home ownership and investment activities. However, there are some restrictions on mortgage interest deductions.

You are required to itemize for claiming either of the above deductions, and investment-related expenses and margin account interest can only be deducted for amounts that exceed 2% of your adjusted gross income. Moreover, interest expense on margin loans is only tax deductible if the loan was used to acquire taxable investments, and your deduction is restricted to net investment income. However, if you meet these conditions, you can lower or even eliminate your taxable income given an adequate amount of interest has been paid.

Deductions on Charitable Contributions

These are itemized deductions that you can claim when you donate to charities. The Charitable Contribution Deduction enables you to deduct all your contributions to eligible charitable contributions of property and cash with some limitations. However, they are required to be listed on Schedule A of the 1040.

Deductions on charitable contributions enable you to donate significant charitable gifts and benefit from a sizeable tax deduction. The deduction will be permitted in the year in which the donations are made. The rules in place for deducting these gifts may be complicated in some scenarios. If you have questions or queries about the deductibility of your charitable gifts, download the instructions for Schedule A off the IRS website.

Student Loan Interest Deductions

This is the deduction that enables you to pay for your education expenses. If you have claimed an education tax credit, you are still eligible for claiming Student Loan Interest Deduction. In case you have started repaying your student loans, you can lower your taxable income by as much as $2,500 of your student loan interest that you have paid on behalf of your dependent or spouse.

Tax deduction on student loan interest is an example of “above-the-line” deduction (discussed above), which means that you don’t have to itemize deductions for claiming it. To be eligible for tax deduction, the student loan on which you are paying interest has to be a commercial loan obtained solely for the purpose of paying for your educational expenses. The loan is applicable only to students who have enrolled at least half-time in a degree program. The student can only be your dependent or spouse.

In 2016, the deductible amount declined, at an adjusted gross income (AGI) of $65,000 or at an amount of $130,000 if you are married and filing jointly. While at an AGI of $80,000 or, $160,000 if you are married and filing jointly, or higher, the deduction was not available.

Expenses that are eligible for Student Loan Interest Deduction are the aggregate expenses of attending an eligible educational establishment, including grad school. These expenses are as follows:

  • Fee and tuition
  • Books, supplies and equipment
  • Room and boarding
  • Other related costs like transportation

Tax-Deductible Car Miles

In case you use your car for eligible business, charitable or medical purposes, you may deduct your vehicle related expenses. For your owned or leased vehicle, you have the option of deducting either the standard rate per mile driven or actual costs. If you have a leased vehicle, and opt to use the standard mileage rates, you must use the standard rates over the life of the lease.

Along with standard mileage rates, you also have the option of deducting parking and tolls costs while using your car for 1 of the approved purposes. These are considered separate tax deductions. However, in case you have already claimed depreciation expense, you are not allowed to deduct parking and tolls charges. Moreover, standard mile rates are not eligible for vehicles that are used as equipment, or for more than 4 vehicles used simultaneously.

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