When it comes to income taxes, there are a lot of terms that are heard a lot but are rarely well understood. The idea of "deducting it" is one of those oft-heard but misunderstood terms. So, what is a deduction, and how do you use them to lower your taxes?
What is a Deduction?
A deduction is simply an amount of money that you use to reduce your taxable income. For example, if you earn $50,000 and are able to deduct $10,000, your taxes are calculated on the lower amount of $40,000, thus making your tax bill lower.
There are categories of deductions and specific rules about where they can be applied on Form 1040.
What Types of Deductions Are There?
For most taxpayers, deductions come in two flavors: Schedule A deductions and Schedule C deductions. Some categories can cross over between the two, but they each have different rules.
Schedule A deductions affect your overall income, reducing gross income before taxes are calculated. Each taxpayer has the choice to either use a standard amount ($6,300 for single taxpayers in 2016) or to gather together ("itemize") allowed deductions from their own records and enter this number on Line 40 of Form 1040.
Schedule C deductions, on the other hand, reduce business income only. These are business expenses, and the more of them you can deduct, the lower your self employment taxes will be. The IRS expects each self employed person to use all the available business deductions they are allowed.
What Can You Deduct From Personal Income?
Schedule A deductions are varied and commonly include things like:
- Mortgage interest and points
- Charitable contributions
- Unreimbursed employee expenses
- Medical expenses
- Property and real estate taxes
- State and local income (or sales) tax
- Gambling losses
- Job hunting expenses
Some Schedule A deductions have special rules about how much of the expense you may deduct. Medical expenses, for example, cannot include an amount equal to 10% of your adjusted gross income.
What Can You Deduct From Business Income?
Generally, most business-related costs are deductible as business expenses, at least to some extent. Common categories have their own line on Form 1040, including advertising, vehicle expenses, fees, insurance, contract labor, supplies, and depreciation. If you have legitimate business expenses that don't fit these categories, you may list them on Schedule C Line 27 (Other Expenses).
Like Schedule A deductions, some business deductions have special rules. Meals and entertainment, mileage costs, and using a home office all have specific methods to figure what you can claim.
Deductions are an important part of filing your tax return, but they can get somewhat complicated for some taxpayers. If you are unsure how to use deductions -- especially if you have a small business -- it's a good idea to work with a qualified accountant or tax preparation service.