For the second year in a row, the IRS has extended its deadline for filing taxes. You will have until May 17, 2021 to complete your 2020 tax returns. So, have you started? Are all those anxious thoughts swirling around already? Like, do you have all the paperwork? Which form do you still need? Deductions and credits – huh?
The many concerns surrounding tax time can be boiled down to one main question:
1. Are you ready?
2. How can you save more money?
Maybe you’ve decided to hire a tax preparation service or a professional tax preparer to help sort it out. Or maybe you’ve decided to go it alone with tax software or another online tax tool. Either way, you’ve taken the first step towards getting your taxes. But how can you save more money by cutting a few dollars off that tax bill? Two words: tax deductions.
What are tax deductions?
Perhaps you have already heard these phrases: “You can deduct these expenses from your taxes” or “these expenses are deductible”. If you’ve spent time researching the tax return, you’ve certainly come across the term tax deductions. This term can change the amount of taxes you owe and help you pay less on tax day.
Tax deductions have the ability to reduce an individual’s or company’s tax liability by reducing their taxable income. Taxable income is the amount of gross income that the government deems subject to tax – both earned and unearned. In basic mathematical terms: subtracting tax deductions from taxable income reduces that taxable income and, in turn, reduces taxes owed. Simple enough, right?
Standard Deductions vs Itemized Deductions
Now that we have a better understanding of tax deductions, let’s take a look at the two types: Standard deductions and itemized deductions. It is important to note that when filing your tax return, you must choose between these two tax deductions. You cannot choose both. Let’s look at each briefly.
Some say this is the easiest option for claiming deductions. It also involves the least amount of work. The standard deduction is automatically set based on how you file your taxes (married, spouse, or single) and your age. Depending on the type you choose to file, the amount of fees is automatically reduced. For example, here are the standard deductions for 2020 taxes to file in 2021, according to the IRS:
- $12,400 for single taxpayers
- $12,400 for married taxpayers filing separately
- $18,650 for heads of families
- $24,800 for married taxpayers filing jointly
- $24,800 for eligible widows or widowers
Note: These deductions are for federal taxes. Each state has its own tax laws and standard deductions.
Standard deductions are fixed, so there is no need to pull out receipts. However, if you have the time, major expenses, and like to do the math, the itemized deduction might be right for you. Itemizing deductions is much more labor intensive because you have to claim expenses one at a time. In addition, an additional form (Schedule A form) must be filed with your tax return. You must be able to back up any claims you make on your itemized deductions.
Itemized deductions are expenses that are subtracted from adjusted gross income, having the same purpose as the standard deduction of reducing taxable income and reducing the amount of taxes owed. The amount largely depends on the tax bracket in which the filer falls.
Itemized deduction has its advantages. Examples of some expenses that can be itemized would be education expenses, dental and medical expenses (more than 7.5% of adjusted gross income), investment interest, and gambling losses. Examples of Things you can’t itemize as expenses include tax preparation expenses, losses from natural disasters, and unreimbursed employee expenses.
The best tax deductions in 2021
Reduce taxable income, reduce and lower taxes. That’s the name of the game in the tax deduction. Now that we have a better understanding of tax deductions – and the two types that filers should choose from – let’s take a look at the most common tax deductions available to you when preparing your 2020 tax returns.
Student loan interest deduction
Student loan interest is a popular deduction among all college graduates (and their parents), especially among those with massive student loan debt. Paying off student loans can be quite a long and exhausting process, but student loan interest deduction offers a little relief.
This deduction allows filers to deduct up to $2,500 from their taxable income if they paid interest on an eligible student loan, either for themselves or for a dependant.
There are qualifications, of course, the student loan deduction largely depends on the modified adjusted gross income (MAGI) and the respective tax bracket. For example, if a filer’s MAGI is less than $85,000, or $170,000 if filed jointly, student loan interest paid on federal and private student loans may be deducted. Here are some examples of criteria:
- Education of others: If the loan was taken out in your name for another person (for a child or a dependant), a deduction is allowed.
- Tuition fees: If the loan was used for eligible education expenses such as tuition, books, housing, and transportation.
- Forced refund: Even if you are legally obligated to repay the loan or wages are garnished to repay, interest may still be deducted.
Note: Most federal student loans were suspended in March 2020 due to the pandemic, but interest paid before that date can still be deducted from 2020 tax returns.
Deductions for home office and self-employment
The ongoing pandemic has changed the face of work. Due to the circumstances, many employees have been forced to work from home while others have taken the opportunity to start their own home-based businesses. What many don’t know is that there are tax deduction opportunities for self-employed people, freelancers, and other people who work from home.
Let’s take a look at some of these money-saving opportunities this tax season.
Home office: Nowadays, many people use their home as an office. Home office deductions could provide some tax relief. Property taxes, rent or mortgage, utility costs, and repairs could all impact tax savings. According to IRS Publication 587, a percentage of the square footage of your home, the portion used for business-related activities, could be deductible.
For example, if your home office takes up 15% of the square footage of your home, 15% of your home’s expenses could be deducted from taxable income. Make sense ? See the post above for a more in-depth explanation.
Vehicle: Maybe part of your day is meeting with customers or suppliers. Expenses related to the use of your vehicle can also be deducted, approximately $1 for every two miles driven when used for business-related activities. So keep a mileage total. At the end of the year, the number of miles driven for business can be multiplied by the IRS mileage rate and deducted from taxable income.
Credit card and loan interest: Self-employment tax deductions may be hiding on those credit card statements, so keep them handy. Interest accrued on these business-related purchases may be deducted.
Self-employment taxes can become tax deductions: Yes, even self-employment taxes (rate of 15.3% of net income) can be deducted as a business expense, at least half. For example, if you owe $4,000 in self-employment taxes, at tax time $2,000 would be deductible on your Form 1040.
Deductions for medical expenses
Certain medical expenses are also deductible, eligible and non-reimbursed expenses that represent more than 7.5% of your adjusted gross income (AGI). For example, if your AGI is $60,000, all medical bills that exceed the first 7.5% of your AGI — $4,500 — can be deducted as medical expenses. So if you had $10,000 in medical expenses, then $5,500 could be tax deductible.
A complete list of allowable medical expenses is available on the IRS website. Some would include hospital care and nursing homes, payments to doctors, dentists, surgeons and prescription drugs.
During tax season, most people wonder if they are prepared and can save more money. Tax deductions are a way to help you save money during tax, that is, if you understand them, how they work, and which ones apply to you.
Tax deductions can reduce an individual’s tax payable by reducing their taxable income. This reduction in taxable income directly affects and reduces the amount of taxes due. As we have seen, there are only two options for tax deductions; standard deductions and itemized deductions. Standard deductions are deductions set by the government based on filing status, while itemized deductions require more work on the filer’s part as they must calculate various allowable expenses in a given year.
There are many deductions to have and apply to reduce your taxable income. Knowing the best ones can help you save more money during tax season.