Deduction

Annualized Income

What is a deduction?

A deduction is an expense that can be subtracted from the gross income of an individual or a married couple in order to reduce the amount subject to income tax. This is often an authorized deduction.

Key points to remember

  • Taxpayers who use the standard deduction may be able to file the short form 1040-EZ.
  • Taxpayers detailing the deductions should use the longer Form 1040 in Schedule A and list all of their authorized deductions.
  • The standard deductions for 2019 and 2020 are almost double the previous amounts.

For example, if you earn $ 50,000 in a year and donate $ 1,000 to a charity in that year, you can claim a deduction for that donation, which reduces your taxable income to $ 49,000.

A deduction should not be confused with a tax credit.

  • A tax deduction reduces taxable income.
  • A tax credit reduces the amount of taxes due.

Understanding the deduction

In the United States, taxpayers have the choice of claiming the standard deduction or detailing their deductions.

Claiming the standard deduction is easier. In fact, using the standard deduction allows reporters to send the short form 1040-EZ.

88%

The percentage of taxpayers who should use the standard deduction in 2019 and 2020.

The taxpayer who details the deductions uses form 1040 in Appendix A and is required to complete a list of authorized deductions and keep receipts to prove them if they are verified.

This longer form is used by taxfilers who have substantial deductions totaling more than the standard deduction. Common itemized deductions include interest on a mortgage, contributions to retirement accounts, uncovered health care costs, state and local taxes, and charitable contributions.

Standard deduction vs Detailed deductions

The Joint Congress Committee on Taxation estimates that 88% of American taxpayers will benefit from the standard deduction instead of detailing in 2019 and 2020. The reason: the standard deduction has literally almost doubled.

  • For the 2019 taxation year, the standard deduction is set at $ 12,200 for individuals, $ 18,350 for heads of household and $ 24,400 for married couples filing jointly and surviving spouses.
  • For the 2020 taxation year, the standard deduction was set at $ 12,400 for singles, $ 18,650 for heads of household, $ 24,800 for married couples filing jointly and surviving spouses.

(For comparison purposes, for the 2020 taxation year, the standard deduction was $ 6,350 for single tax filers and $ 12,700 for married persons filing jointly.)

If you choose to claim the standard deduction, you can still claim the deductions detailed on your tax return. These include interest on eligible student loans and moving costs.

Business deductions

Small businesses don’t have an EZ way to file their taxes. (Neither do large companies, but they do have accounting services.)

Businesses are required to report all of their gross revenues and then deduct all of their business expenses therefrom. The difference is net taxable income.

So business expenses work in a similar way to deductions.

Deductions against. Credits

A tax credit is subtracted from the amount of tax you owe, not from your declared income. The IRS has refundable and non-refundable credits. Non-refundable credits cannot trigger a tax refund, but refundable credits can.

For example, imagine that after declaring your income and claiming your deductions, you owe $ 500 in income tax. However, you are entitled to a credit of $ 600. If the credit is not refundable, your tax invoice is deleted but you do not receive any additional money. If the credit is refundable, you receive a tax refund of $ 100.

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