What is a Tax Deduction?
A tax deduction is an amount that you can subtract from your taxable income to lower the amount of taxes you owe. You can take the standard deduction, which is a single deduction for a fixed amount, or you can list all of your deductions on Schedule A of your tax return.
If the total of your itemized expenses is more than the standard deduction for your filing status, it makes sense to itemize. Itemized deductions include things like mortgage interest, gifts to charity, unreimbursed medical costs, and state and local taxes.
How to Figure Out Tax Deductions
People can take the standard deduction, which the Tax Cuts and Jobs Act nearly doubled. They can also itemize their deductions. Here is a list of how much the standard deduction will be for the tax years 2022 and 2023.
Taxpayers who are blind or at least 65 years old can get an extra standard deduction. The extra amount for 2022 is $1,400 ($1,750 for single filers and people who are in charge of a household). Those who are over 65 and blind can get twice as much ($2,800 or $3,500, depending on how they file). 4 In 2023, the amount goes up to $1,500 for single people and $1,850 for people who are in charge of a family.
You can either take the standard deduction or itemize your deductions. You can’t do both in the same tax year.
Typical tax breaks
Here are some of the most common tax deductions you can claim on your federal income tax return:
- Interest on student loans of up to $2,500
- Mortgage interest on up to $750,000 of secured home mortgage debt ($1 million if you bought the home before December 16, 2017).
- Contributions to a traditional individual retirement account (IRA), 401(k) plan, or another qualified retirement plan, up to the annual limits
- Local and state taxes of up to $10,000
- Up to annual limits, contributions to a health savings account
- Medical and dental costs that cost more than 7.5% of your gross adjusted income
- Self-employment costs, such as a home office deduction and a health insurance premium deduction
- Charitable contributions
- Investment losses
- Gambling losses
Most of these deductions should go on your 1040’s Schedule A, but there are a few exceptions. For example, to report investment losses, you must use Form 8949 and Schedule D, and to report IRA contributions, you must use Form 5498. Your employer’s contributions to your 401(k) retirement account show up on your paycheck, so you don’t need the extra form.
Tax Breaks that Didn’t Exist in 2018
The Tax Cuts and Jobs Act of 2017 got rid of or limited some tax breaks that were once common (TCJA). You can’t deduct the following things anymore, at least until 2025, when the act is set to end:
- Interest on a home equity loan (unless you spend the money to improve the home)
- Mortgage interest on secured mortgage debts of more than $750,000
- Work costs that aren’t covered
- Local and state taxes that are higher than $5,000 (or $10,000 for a couple)
- Dues for groups of professionals
- Moving expenses (except for military personnel)
- Losses due to accidents and theft (except in federally declared disaster areas)
- The individual tax break
- Costs of getting taxes done
- Alimony payments
- “Other” deductions are called “miscellaneous.”
- Tax breaks for people who work for themselves
There are more freelancers and gig workers now than ever before. A Pew Research study found that more than 16 million Americans now work for themselves.
Wage earners preserved several tax benefits after the 2017 tax code amendment.
Certain deductions are tricky because you have to determine how much of each item is business-related and deductible, and how much is personal and non-deductible.
Some of the most important deductions for people who work for themselves are those for half of their Medicare and Social Security taxes, for their home office, and for their health insurance premiums.
Self-employed people can put off paying taxes on their contributions to retirement plans, which is a very valuable tax break. Tax-deferred retirement plans, like the SEP-IRA, the SIMPLE-IRA, and the solo 401(k), are made for people who work for themselves, run a small business by themselves, or are self-employed.
“Above the line” deductions include contributions to traditional IRAs and qualified plans like 401(k)s. That means the contribution will lower your taxable income even if you choose to take the standard deduction instead of itemizing.
Small businesses can get tax breaks
Profits, which are the difference between how much money a business makes and how much it costs to run, are taxed. That means writing down every expense and telling the IRS about them. Here are some of the best tax breaks for small business owners:
- Promotion and advertising
- Bad debts
- Travel for business
- Charitable contributions
- Continuing education Equipment Insurance
- Costs for lawyers and accountants
- Fees for licenses and rules
- Loan interest tax break for people who don’t pay taxes
- Fixing and taking care of
- Taxes (local, sales, and property taxes) (local, sales, and property taxes)
- Vehicle expenses
- Costs to start up
Many of these deductions have complicated rules, which can be hard for small businesses. For example, vehicle and travel costs must be carefully split between business use, which is tax deductible, and personal or family use, which is not.
Tax credits vs. tax deductions
Tax deductions lower your total taxable income, which is the number used to figure out how much tax you owe. On the other hand, tax credits directly reduce the amount of taxes you have to pay. Some tax credits are even refundable, which means that if you use them and your tax bill goes below zero, you can get the difference back.
Even if you can’t get your money back, a tax credit is better than a tax deduction.
A tax deduction may lower your taxable income by a few notches on the tax tables, but a tax credit reduces the amount of tax you owe dollar for dollar.
One Example of a Tax Break
Here’s what I mean: Think about a single taxpayer who earned $90,000 in 2022 and filed a tax return. This means that the person is in the tax bracket of 24%. So, their tax bill for the year 2022 would be $15,435.50 ($15,213.50 + $222), which is $15,213.50 plus 24% of the amount over $89,075 ($925). This person can choose to itemize deductions or take the standard deduction, just like everyone else.
If the taxpayer lists each item
The taxpayer has put $6,000 into a traditional IRA and paid $10,000 in mortgage interest. Both are deductible expenses.
With total deductions of $16,000 to report, the taxpayer will owe taxes on $74,000 of earned income ($90,000 minus $16,000). So, the person will owe $11,897 in taxes for the year ($4807.50 plus 22% of the amount over $41,775). That is less than the original tax bill, which was $15,435.50.
If the taxpayer uses the standard deduction
For the 2022 tax year, the standard deduction for a single person is $12,950. It’s important to remember that the taxpayer gets the extra $6,000 deduction, which was already mentioned, for the IRA contribution. It’s a “above-the-line” deduction that brings this taxpayer’s gross income down from $90,000 to $84,000. The standard deduction cuts the filer’s taxable income even more, bringing it down to $71,050. So, with the standard deduction, the taxpayer will owe $11,248 ($4807.50 plus 22% of the amount over $41,775). 24
That’s less than what’s owed in taxes after deductions are taken into account. So, even though the taxpayer could write off a lot of mortgage interest, taking the standard deduction would save them $649.
Standard deductions versus itemized deductions
In general, U.S. taxpayers will decide whether to itemize their deductions or take the standard deduction based on which option lowers their taxable income the most.
Contrary to what many taxpayers may think, they may benefit most from the standard deduction because the TCJA nearly doubled the standard deduction amount and got rid of (or capped) many itemized deductions.
If you itemize, you need to keep receipts for all of your eligible expenses and sort them into categories. At tax time, you add up all your expenses and write them down on Schedule A. Keep your receipts in case you are audited.
With the standard deduction, you don’t have to do nearly as much work. Just write the amount of your standard deduction on line 12a of Form 1040 or 1040-SR.
Tax breaks for states
Most of the 41 states that have an income tax try to make their forms look as much like the federal ones as possible.
25 But each state sets its own tax rates and standard deductions. Some states may also allow more deductions or have different rules about how deductions can be used.
Some states don’t let people who take the federal tax deduction also list their state taxes.
In any case, you should look closely at your state’s tax forms to see if there are any extra deductions you might be able to get. For example, in New Mexico, if you are 100 years old, you don’t have to pay state income tax. And Nevadans who file their tax returns can get a free pack of cards.
Tax Breaks Limits
Keep in mind that some deductions can only be used a certain number of times. For example, the mortgage interest deduction is limited by federal tax law to a maximum of $750,000 of secured mortgage debt or $1 million if the home was bought before December 16, 2017. That change in 2017 was a big blow to people with a lot of money and to some people with less money who lived in cities with the most expensive homes.
Then there’s the limit on how much you can deduct for health care. If you itemize your healthcare costs, the costs you paid for yourself, your spouse, and your dependents must be more than a certain percentage of your adjusted gross income (AGI) to be deductible. For your 2022 tax return, the limit for medical costs is 7.5% of your adjusted gross income (AGI).
Carryforward of a capital loss
The tax deduction for capital losses is an extra one that is not part of the standard deduction or the itemized deduction. These are not put on Schedule A, but on Schedule D, along with capital gains.
A tax loss carryforward is a legal way for a taxpayer to rearrange their income in a way that helps them. You can use capital losses from previous years, both for yourself and for your business. As of the 2022 tax year, you can deduct up to $3,000 in capital losses from your taxes ($1,500 if you are married and filing separately) (the tax return you file in 2023). If you lost more than that, you can “carry them forward” to the year or years after that.
What can I put on my tax return?
There are a lot of tax breaks and credits that can help you pay less in taxes. Some of the most common deductions are for mortgage interest, contributions to a retirement plan or HSA, interest on a student loan, donations to charity, medical and dental costs, gambling losses, and state and local taxes.
The Child Tax Credit, the Earned Income Tax Credit, the Child and Dependent Care Credit, the Saver’s Credit, the Foreign Tax Credit, the American Opportunity Credit, the Lifetime Learning Credit, and the Premium Tax Credit are all common credits.
How can I get the most tax breaks?
Whether you itemize your deductions or take the standard deduction, it helps to put as much as you can into a traditional (not Roth) retirement account like an IRA or 401(k) (k). In this way, you can save more for retirement and pay less in taxes for the year.
If you have a lot of mortgage interest, interest on student loans, medical bills, and other expenses that you can deduct, you may find that the total is more than the standard deduction. In that case, you can get the most out of your deductions by itemizing on Form 1040 or 1040-SR, Schedule A.
How much is the most you can get back from your taxes?
There isn’t a cap. But, according to the IRS, the average direct deposit tax refund for individuals in 2022 was $3,121.
A tax deduction is an amount that the IRS lets taxpayers take off of their taxable income, which lowers the amount of tax they have to pay.
Taxpayers can either list each deduction they are eligible for on their tax returns or choose the standard deduction (a single amount). Most likely, the method you choose will be the one that cuts your tax bill the most.
Even though many taxpayers may think that itemizing is better, the Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction. In some cases, it could lower your tax bill more than if you listed all of your income.