Deductions and exemptions, two tasty tax peas in a pod. Getting as many deductions as possible is essentially winning at the game of life taxes.
As the dawn of the new era of tax reform is finally upon us, we’re going to see a large shift in how people do their taxes. The standard deduction is doubling, and many tax havens found within exemptions and deductions are going away. But that doesn’t mean they aren’t still important.
Let’s take a look-see on what deductions are all about, how they work, and the different types that exist.
What are deductions
Deductions work in exactly the same manner as an exemption. In that, the purpose of them is to reduce your total income so you don’t have to pay taxes on it.
Wanna learn more about exemptions? Check our article on them!
A deduction refers to things you’ve paid for that year, which can be “removed” from your income, so that you don’t have to pay taxes on it. Consider things like health insurance premiums, work expenses, student loans, taxes on a new car, etc…
Standard vs Itemized deductions
When you finally decide to do your taxes, you’ve got an important decision to make. Do you take the standard deduction, or itemized deduction?
First, what the heck do they even mean?
Basically, going with the standard deduction is like choosing easy mode in a video game. Itemizing deductions is like picking the tedious and challenging hardcore mode.
Here’s how they work, and what’s best for you.
By going with the standard deduction, you’ll skim off a flat amount from your total income that you need to pay taxes on. In 2018, this amount doubled in each category, giving a sizable reduction in what most households owe.
Here’s the new standard deduction amount, based on filing status:
On the other hand, itemized deductions require you to toil through endless amounts receipts and bank records. Good record keeping essential, as you need to categorize and file every deduction you qualify for. All with the hope that you’ll be able to reduce your income more than the standard deduction will.
Note that even if you decide to itemize, it’s always worth checking to see what the standard deduction would do for you.
Did you know? It’s estimated that 95% of all taxpayers will take the standard deduction in 2018, up from 70% in 2017.
Which one is better for me?
Times are changing, and itemizing deductions is on the back-burner for most Americans. The standard deduction simply provides a better return, and is significantly easier to file.
But that doesn’t mean it’s gone just yet. Let’s see what goes into itemizing your deductions and if you’d benefit from traveling the harder road.
SALT – State and Local Taxes
If you’ve chosen to itemize taxes, you’ll be able to deduct from state and local taxes (SALT). On top of that, you must pick between deducting from either sales tax, or income tax.
Big money makers in states with high income tax, such as NY and CA, would see huge benefits by choosing to deduct their income tax. Likewise, those who live in states that have no income tax, would see significant gains by choosing to deduct sales tax.
In the past there were no limits on how much you could itemize through state and local taxes. For the most part, this only helped high wage earners, who, of course, pay a higher percentage on taxes. However, that’s all changed as of 2018. The new tax reform act has placed a cap of $10,000 on SALT deductions, vastly reducing its potential.
To put it simply, the process of itemizing deductions is largely starting to disappear for most Americans. For the most part, itemized deductions are likely only going to be used by high wage earners.
What kind of deductions are there
Oh, you were probably looking for more info than that. Why don’t we take a gander at the most popular deductions while we’re here?
Sales tax (no, really)
As was mentioned earlier, you’ll have a rather significant choice to make if you’ve decided to itemize. Though it’s typically more beneficial for people to deduct income tax, there’s always an exception to the rule. Consider deducting sales tax if you live in a state that doesn’t collect any income taxes.
Here’s a list of the last few remaining states with no income tax.
Wyoming – Washington – Texas – South Dakota – Nevada – Florida – Alaska
If you’re racking up extensive health insurance costs, you may be able to avoid paying taxes on it!
In order to qualify, your healthcare costs must be greater than 7.5% of your AGI (adjusted growth income). Gotta love tax jargon!
Originally this was the big kahuna when it came to itemized deductions. Property taxes can become extremely high on large plots of land and/or expensive homes.
As of 2018, it’s kinda-sorta still here. You can still itemize your property taxes. The problem is, due to the new SALT cap of $10,000, it’s not really worth it. It’s unlikely itemized deductions on personal property will be able to compete, as the standard deduction has doubled in 2018.
Most student tax breaks come in the form of credits, but this guy settles in with deductions. Depending on your income, you can deduct up to $4,000 of your learnin’ expenses.
That’s not all, you can also deduct the interest paid on student loans, up to a maximum of $2,500. It’s not huge, but every little bit helps. Especially when you’re surviving off of Ramen and Bud Lite every night.Note that you can qualify for these deductions even if you went with the standard deduction.
You can qualify for some deductions (such as student benefits), even if you chose the standard deduction!
Social security self-employment
The tax woes of self-employment come in many shapes and sizes. Here we have our next contestant, entering the ring at over 15.3% of your income!
For those who are self employed, social security and medicare are the heavyweight taxes they’ll face. In the case of a “normal” job, this is shared between the employer and employee. As for those who run our own business, it’s up to you to fight your tax battles all on your own… sort of.
You can choose to deduct around half of the tax (7.5%), but only if you’re itemizing deductions.
Home mortgages used to be the bread and butter of itemized deductions. However, when it comes to mortgages, the 2018 tax reform has left much to be desired. The new tax reform is similar to your very passive aggressive Aunt Julie’s “suggestions”. Take the standard deduction, or else!
To illustrate this, take a look at the examples below. As you can see, you need to have a rather significant mortgage just to break even on these deductions.
- For a single filer, you can deduct interest on a home mortgage up to $750,000. The break even point to itemize your mortgage would be roughly $285,000.
- For a married couple filing together, you can deduct interest on up to $375,000. The break even point would be right around a $580,000 mortgage.
As we’ve mentioned previously, it’s highly recommended for most people to use the standard deduction. That is, unless you’re rolling in high-end cars and expensive homes!
Though deductions may become less important as the majority of Americans switch to the standard deduction. It’s still important to understand exactly how they work, and what sort of deductions are out there.
You never know, someday you may find that itemized deductions will save you money!
While you’re here… Learn about the two siblings of tax deductions – Exemptions and Credits.
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We’re not tax specialists, nor are we trying to be! The information in this article is purely for educational purposes, and should not be treated as professional guidance. Taxes are extremely complicated and different for every individual. Always consult with a tax professional before messing with your taxes.