Tax Deductions: A 2021 Guide To Reducing Your Taxes
Lauren Nowacki8-minute read
You worked hard all year to earn your income. When tax season comes, you want to be prepared to protect it from taxes. That’s why tax deductions are so important. Read on to learn more about how deductions decrease your taxable income, which can either reduce what you pay in taxes or increase your tax refund. Either way, tax deductions can help keep more money in your pocket this tax season.
What Is A Tax Deduction?
A tax deduction, sometimes called a tax write-off, reduces taxable income by allowing taxpayers to subtract the amount of the deduction from taxable income. The Internal Revenue Code, also called the Tax Code, defines a wide variety of deductions that U.S. taxpayers can take.
These deductions, as defined by the code, are mainly designed to incentivize certain types of behaviors, like buying a home, advancing your career or donating to charity, for example.
These deductions help create your adjusted gross income (AGI), which is used to determine your taxable income.
How Do Tax Deductions Work?
There are two main ways for taxpayers to take advantage of tax deductions: either by taking the standard deduction or itemizing deductions. You must choose one or the other; you cannot choose to do both.
The Standard Deduction
The standard deduction is a flat deduction that can be taken by anyone, regardless of whether they actually spent money on deductible items. Those who elect to take the standard deduction typically don’t have to worry about an IRS audit. The amount of that deduction varies according to filing status only. In 2020, the standard deduction is $12,400 for a single filer and $24,800 for a married couple filing jointly.
Here’s the standard deduction for 2021, compared to 2020.
Married, Filing Separately
Married, Filing Jointly
Head of Household
For many filers, taking the standard deduction is often the best route since, for many, individual deduction totals will not exceed the standard deduction. When that happens, they make out better than if they were to itemize their deductions.
For an additional deduction you can take with the standard deduction, review our section on charitable deductions and the CARES Act, further down in this article.
For single or married filers whose individual deductions exceed the standard deduction, itemizing may be more beneficial. Filers who wish to itemize deductions will need to complete IRS Form 1040 Schedule A for most deductions. There are additional forms for certain deductions, like student loans. We’ll touch on those when we talk about those specific deductions.
Form 1040 Schedule A will list specific deductions you can make. On each line of the expense you choose to deduct, you’ll write the amount you spent. At the end of the form, you’ll add all the expenses together to get your total. For more information on how to fill out this form, review the form instructions provided by the IRS.
Remember, your goal is to lower your taxable income. To do that, you’ll want to take whichever deduction, standard or itemized, is larger. The higher the deduction, the more you can decrease your taxable income.
Keep in mind, too, if you’re hiring a tax professional to do your taxes, it will cost more for them to itemize your deductions. You’ll also need to have physical proof (i.e. receipts) of the expenses you’re deducting from your taxes.
What Are The Most Commonly Claimed Tax Deductions?
Some of the most common itemized deductions are the state and local tax deduction (SALT), the mortgage interest deduction, medical and dental expenses, home office and career expenses, gifts to charity and losses caused by federally declared disasters. Note that there are some seemingly strange tax deductions, but most have related back to one of these categories.
State And Local Taxes, If You Live In A High Tax State
Residents in high-tax states have long benefitted from being able to deduct state and local taxes, but the 2017 Tax Cuts and Jobs Act (TCJA) put a cap on these deductions at $10,000 ($5,000 for married, filing separately). This was especially bad news for residents of New York, New Jersey and California. Prior to the 2017 tax reform bill, the average SALT deduction in New York was $23,804. In New Jersey, it was $19,162, and in California, it was $20,451, according to the Tax Policy Center. For those living in low- or no-income-tax states, the TCJA had much less of an effect on taxes.
You can deduct state and local income taxes or general sales taxes (choose one), real estate taxes and personal property taxes, up to $10,000 ($5,000 if married, filing separately). There are certain state and local taxes you cannot deduct, including those charged on gasoline, car inspection fees and marriage, pet and driver’s license fees. Other taxes you cannot deduct include federal income taxes and foreign personal or real estate property taxes.
Mortgage Interest Deduction
The mortgage interest deduction survived the latest round of tax reform, allowing homeowners to continue to deduct mortgage interest and points.
Your mortgage interest deduction may be limited. For example, if you used mortgage proceeds for purposes other than buying, building or improving your home, interest may not be deductible. Make sure you review the instructions to see if you’ll have limitations on your mortgage interest deductions.
Medical And Dental Expenses
According to the IRS, you can only deduct the amount of medical and dental expenses that are more than 7.5% of your AGI. For example, if your AGI is $100,000 and your medical bill was more than $7,500, you can deduct that expense. If it was less, you cannot deduct it.
You can include medical and dental expenses for you, your spouse and dependents. These expenses include costs associated with diagnostic, preventative and treatment services, supplies and devices paid in the current year. They do not include future expenses or costs associated with diet food, unnecessary cosmetic surgery, illegal drugs or nursing care for a healthy baby.
Americans were ranked No. 1 for charitable giving by the World Giving Institute, but our high amount of giving may not always be because we have big hearts. One driving force behind giving to charities is being able to deduct charitable contributions from taxable income. As a general rule, up to 50% of AGI may be deducted for charitable contributions, though there can be lower limits in certain cases.
If you plan on deducting your charitable contributions, make sure you donate to a qualified organization. Examples of these include religious organizations, war veterans organizations, civil defense organizations or volunteer fire companies. To see if the organization you donated to is eligible, try using the IRS Tax Exempt Organization Search tool.
Charitable Deductions And The CARES Act
Thanks to the Coronavirus Aid, Relief and Economic Stimulus (CARES) Act, you can deduct up to $300 for cash contributions made to qualifying organizations in 2020 when you take the standard deduction. Before this change, you could only deduct charitable contributions when you itemized your deductions.
Student Loan Interest Deduction
Student loan interest charges can be deducted from taxes by you or your spouse. You can also deduct interest on student loans you took out for a child who is a student and a dependent under the age of 24. Since most recent college graduates do not itemize their deductions, this deduction often goes unused.
According to the IRS, you may deduct the amount of interest you paid during the year or $2,500 – whichever is less. If you’re going to itemize your student loan interest, you’ll need to fill out Form 1040 Schedule 1.
Health Savings Account (HSA) Contributions
HSAs are like savings accounts specifically for medical expenses. In 2020, the maximum you can contribute to your HSA is $3,500 as an individual or $7,100 as a family. Whatever amount you decide to contribute to HSA accounts will be tax deductible.
If you’re self-employed or have a side hustle, you can deduct business expenses from your income tax. You may also be able to deduct home office expenses, unlike many remote employees employed by a company. They lost the ability to deduct these expenses in the 2017 TCJA.
To deduct business expenses, use Form 1040 Schedule C.
Keep in mind, if you’re a small-business owner who’s established a business entity apart from yourself, like an LLC or corporation, you must file separate business tax returns on the business entity’s behalf.
Most deductions in this category are generally related to unreimbursed work expenses or career advancement expenses and are limited to 2% of AGI. Examples of miscellaneous costs include educator expenses, work-related travel and costs associated with preparing your tax return.
How Can I Maximize My Tax Deductions?
To maximize the deductions on your tax return, you’ll want to:
- Take advantage of every possible deduction that you’re eligible for.
- Make sure that you keep appropriate documentation for any and all deductions that you claim on your tax return. For example, you’ll want to keep all medical and dental bills and receipts.
- Keep good records of what you donated. For tax purposes, charitable organizations will usually send you a receipt of monetary donations with their tax ID included. If you donate items like clothing, cars and other property, keep a record of each item’s approximate fair market value. The organization you donate these items to will typically offer an itemized receipt listing each donation. Keep these pieces of information together. In the case of an IRS audit, you’ll be glad you have all of your records.
- If you donated to charitable organizations, make sure you take advantage of the CARES Act change, which allows you to deduct up to an additional $300 in charitable donations when you take the standard deduction.
Tax Deduction Vs. Tax Credit
A tax deduction reduces the amount of taxable income, while a tax credit is more like an amount of money that the government owes the taxpayer that can be applied for a dollar-for-dollar reduction of their tax bill. Think of deductions like store coupons, which reduce your bill, and credits as store credits, which pay your bill. A tax credit that exceeds the tax bill will be refunded to the taxpayer, while deductions can’t reduce the tax bill to below zero.
Deductions Are Important Income Tax Minimizers
Tax deductions decrease your taxable income. The standard deduction is a fixed amount that can be taken by anyone regardless of how much they actually spent on deductible items. Itemized deduction amounts will be different for every tax filer because they are the sum of each deductible item you spent money on throughout the year. Itemizing your deductions takes extra work and is more susceptible to an IRS audit. However, if the total of your itemized deductions is more than the standard deduction, it may be in your best interest to itemize your deductions. The more you can decrease your taxable income, the better, so you’ll want to take whichever deduction decreases your income the most.
To get the most out of your tax deductions, we recommend speaking to a finance or tax professional. To learn more about saving money, paying off debt and planning your financial future, read more of our articles on personal finance.
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