Tax Deductions

Overview

Certain expenses allow you to reduce your taxable income. By reducing your taxable income, you are required to pay less in taxes. Some deductions remain consistent every year, and other deductions are available based on economic conditions. Sometimes, tax credits are available as incentives to taxpayers. In any case, it is important to remember that tax credits and tax deductions are different.

How It Works

As a taxpayer, you are eligible to deduct certain expenses in order to reduce the amount that you owe in income taxes. There are many types of deductions according to the United States Tax Code. They are designated as "above the line" and "below the line" deductions depending on your income level. Keeping good records allows you to keep track of the savings that you can earn through your tax deductions.

When you make certain deductions, you reduce your taxable income before applying the tax rate for your income tax bracket. Another term that you might hear is "tax credit." Tax credits are different from deductions and may vary based on the economic conditions that year. The federal government may choose to offer certain tax credits. If you're not sure whether you are eligible for a tax deduction, tax credit, or both, you should consult the tax literature or a certified public accountant (CPA).

After subtracting the appropriate type of deduction from the previously calculated adjusted gross income, the taxpayers then have their taxable income calculated below the line. Every taxpayer has the responsibility to apply the tax table and check if they have paid more or less than what they must pay. If they have paid more, they are eligible for a refund and if they owe more tax, they must write a check to send in with their tax return form.

Examples of deductions include medical expenses, student loan interest, home office expenses, and dependent care expenses.

Benefits

The first and foremost benefit of tax deductions is that they can reduce the actual tax you have to pay to the government. Therefore, it is important to keep good records of the amounts you are spending in case the Internal Revenue Service (IRS) chooses to audit you.

Cost/Pricing

Adjusted gross income is calculated after subtracting above the line deductions. Below the line deductions are then determined and a taxpayer can choose to use standard deductions or itemized deductions. Under standard deductions, everyone gets the same deduction amount if they can claim a particular deduction. Itemized deductions are for individuals or businesses that would be able to substantiate spending more than the standard deduction would allow in each category.

Timing

Deductions are made only for expenses incurred in that financial year. It is suggested that you maintain accurate records on a timely basis.

Companies/Industries

You should look for easier ways to manage the tracking of expenses so that the calculation of deductions is easier. Automated methods are available and should be used when possible. A CPA or tax preparer can review your documentation to help determine what deductions you qualify for and whether standard or itemized deductions are in your best interest.