The Tax Cuts and Jobs Act (TCJA) prompted renewed interest in tax deductions. Some deductions were increased, and others reduced, while certain tax deductions were eliminated while others were created. Whether the tax plan benefits you depends greatly on whether you itemize deductions, are self-employed or own a business. For example, some homeowners lost part of their mortgage interest deduction while the self-employed and business owners gained additional deduction opportunities.
To understand how the TCJA impacts your taxes, it’s important to first understand what a tax deduction is and the benefits of claiming them on your tax return.
What Is a Tax Deduction?
In a nutshell, a tax deduction is a legally allowable reduction of your taxable income. The government provides these tax breaks to incentivize certain activities. For example, the mortgage interest deduction encourages home ownership while the Qualified Business Income (QBI) deduction fosters entrepreneurship. Many deductions also help taxpayers afford extraordinary expenses, such as the medical expense deduction.
Tax Deductions Versus Tax Credits
Whereas tax deductions reduce taxable income, tax credits reduce the tax itself. As a result, a tax credit that is worth the same amount as a tax deduction saves the taxpayer more.
For example, many business owners have expenses related to their company that are tax deductible. If a business owner has a gross income of $50,000 and spent $5,000 in business expenses, taxable income would be reduced from $50,000 to $45,000, so the tax is based on the $45,000.
To take a tax credit, a taxpayer first applies all deductions and calculates the tax based on his or her tax rate. Then the taxpayer deducts the amount of the credit from the dollar amount of tax due. For example, if a taxpayer owed $2,000 in taxes and qualified for an Earned Income Tax Credit of $1,000, the tax due is reduced to $1,000.
The Standard Deduction Vs. Itemized Deductions
Everyone is eligible for the standard deduction. This deduction is designed for taxpayers who do not itemize deductions. Itemized deductions include special deduction categories, such as the following:
• Home mortgage interest
• Property, state and local income taxes
• Investment interest expense
• Medical expenses
• Charitable contributions
Taxpayers must choose between the standard deduction and itemizing. If the standard deduction outweighs the taxpayer’s itemized deductions, then the taxpayer saves by taking the standard deduction and vice versa.
For the 2019 tax year, the IRS set the standard deduction at the following levels:
Married Filing Jointly $24,400
Married Filing Separately $12,200
Head of Household $18,350
Above-the-Line Tax Deductions
All taxpayers remain eligible for above-the-live deductions regardless of whether they itemize or not. These are known as above-the-line deductions because they appear above the adjusted gross income (AGI) line on your tax return. Therefore, these deductions are subtracted from gross income while calculating AGI. Standard or itemized deductions are then subtracted from AGI. Above-the-line deductions include the following:
Qualified Retirement Contributions
Retirement account contributions that qualify for tax deferred status offer one of the most lucrative above-the-line deductions. Eligible accounts include 401(k)s, 403(b)s and IRAs. Self-employed individuals are eligible for SEP-IRAs, SIMPLE IRAs and solo 401(k)s.
Health Savings Account (HSA) and Flexible Spending Account (FSA) Contributions
HSAs provide a great tax savings vehicle, as contributions are deductible. Funds from an HSA may be used to pay medical expenses or health insurance premiums. Money left over can be carried from year to year and even used as supplemental retirement funds.
FSAs are similar to HSAs except they are offered as an employee benefit. Funds cannot be carried over year to year. Dependent care FSAs are also available.
Teacher Classroom Expenses
Full time K-12 teachers can deduct out-of-pocket classroom expenses.
Student Loan Interest
The IRS allows the deduction of up to $2,500 in student loan interest paid within the tax year.
Half of the Self-Employment Tax
The self-employed must pay nearly twice what W2 employees pay to support Social Security, Medicare and Medicaid. One consolation is that they can deduct half of the total from gross income.
Home Office Deduction
If you work from home, you can deduct the cost of maintaining a home office. To calculate the amount, you must determine the percentage of the home devoted to the office. You can then deduct the proportionate share from the cost of the home and utilities.
Tax deductions are an important part of the tax code. Eligibility for deductions saves taxpayers hundreds, thousands or even tens of thousands of dollars. Being familiar with the deductions you qualify for is very important for tax filing and tax planning. If you have questions about tax deductions, it’s always worth it to consult a tax professional or CPA.
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