Tax Deductions

If you've ever filled out a tax form, then you understand the entire process is focused on taxable income and tax deductions. You start your 1040 by identifying all sources of income such as wages, salaries and tips; from your form W-2. Then figure out how much income you had from other sources. This includes rents, interest income, capital gains, pensions, and other similar types of earnings

Finding Tax Deductions

The next step is to figure out if you can lower your taxable income through direct adjustments. For the vast majority of taxpayers, this adjustment can be allowable contributions to an IRA. When the adjustments are added to your sources of income, you have your Adjusted Gross Income or AGI.

Additional Resources

Now comes the best part of the tax return process: Tax Deductions. You see, the more deductions we can find, the lower our tax bill for a given year. Income sources are fairly easy to identify because most people know where their money comes from each year. But our spending activities that are tax deductible are not all that obvious.

What are Tax Deductions?

A tax deduction is defined as a tax-deductible expense paid by a taxpayer. This deduction is subtracted from gross income, thereby lowering the taxpayer's taxable income and overall tax liability.

The federal income tax system in the United States is both a tiered and progressive tax. There are a total of six federal income tax brackets ranging from 10 to 35%. As income increases, a taxpayer may find themselves in progressively higher tax brackets. They pay a higher percentage of income tax on each incremental dollar earned.

Since tax deductions lower gross income, each dollar deducted results in a percentage savings to the taxpayer. For example, a person in the 10% tax bracket will save 10 cents for every deductible dollar they can take on their income tax return. While someone in the 35% tax bracket will save 35 cents for every dollar of deduction found.

Tax Credits versus Tax Deductions

A tax credit is more valuable to taxpayers than a tax deduction. That's because a tax credit is equivalent to a dollar of additional taxes paid. For example a $1,000 tax deduction for someone in the 28% tax bracket reduces their total tax liability by $280, while a tax credit of $1,000 reduces their liability by $1,000.

Standard Deductions

In general, there are two methods for determining tax deductions: Standard Deductions and Itemized Deductions. Knowing this information, you should understand the challenge we all face when doing our taxes. We'd like to beat the Standard Deduction with your Itemized Deductions. For 2011, the Standard Deductions are:

Single or Married Filing Separately: $5,800
Married Filing Jointly or Qualifying Widow(er): $11,600
Head of Household: $8,500

In 2012, the Standard Deductions increase to:

Single or Married Filing Separately: $5,950
Married Filing Jointly or Qualifying Widow(er): $11,900
Head of Household : $8,700

Itemized Deductions

So what exactly are these Itemized Deductions? For most of us, there are six broad categories of itemized deductions:

Medical and Dental Expenses

If you've paid for qualifying medical and dental expenses that are in excess of 7.5% of your Adjusted Gross Income, then you can deduct the amount in excess of that 7.5%.

Taxes You've Paid

Here is where you can start to understand just how much money you pay to the government to provide essential services. The big deductions are state and local income taxes, real estate taxes, and personal property taxes.

Interest You've Paid

If you have a mortgage or another qualifying loan, here is where the IRS gives you a break, and allows you to deduct the interest portion of your loans.

Gifts to Charity

This is one of those tax deduction sections that can get you into trouble during an audit. Read the directions carefully about what you can deduct, and the proof you will need when donating to charity. If you've made gifts by check, then you have an automatic paper trail. If you're going to deduct that truck full of clothes you've donated, then make sure you get a receipt and an estimated value from the organization.

Job Expenses

Many of us are reimbursed by our employers for expenses associated with our jobs. But you might pay Union dues that qualify for a deduction.

Miscellaneous Expenses

The IRS has an entire publication dedicated to Miscellaneous Expenses: Publication 529. In this publication, you will find 29 pages of instructions about categories of deductions that you might never think of on your own. If you are in the military, an educator, or in the performing arts, it is worth the time to look at this publication.

Common Tax Deductions

Some of the more common tax deductions for both individuals and small businesses are contained in the following two lists. Keep in mind these lists are meant as a guide. The exact deductions an individual can claim depends on many factors including their filing status, income level, as well as passing certain deductibility thresholds.

Common Individual Tax Deductions

Mortgage interest paid on a home
Property or real estate taxes
Local and state income taxes
Interest paid on home equity loans
Charitable contributions
Union and / or professional dues
Capital losses, limited to offsetting of capital gains, associated with items such as the sale of common stock
Certain expenses associated with finding a job
Certain educational expenses, for example expenses associated with your current career
Gambling losses, as an offset to gains
Work uniforms or clothing including safety eyewear and shoes
Costs associated with preparing your income taxes including software, professional advice, and filing fees
Some moving expenses
Casualty and theft losses not covered by auto or homeowners insurance

Common Business Tax Deductions

Depreciation of assets
Deductions related to an employee's expenses
Start-up and operating costs or expenses
Business-related meals and travel

Beating the Standard Deduction

Once you have these itemized deductions gathered together, all that is left to do is add them up. The bigger the number, the lower your taxes paid. If you can beat the Standard Deduction, then you're one step closer to getting an even larger tax refund.

About the Author - Tax Deductions

Tax Resources on the Web