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Tax Deductions and Tax Breaks
Tax deductions enable taxpayers to reduce their taxable income and, consequently, their tax bills; however, these deductions also introduce inefficiencies into the system.
With the increase in standard deduction under Tax Cuts and Jobs Act, fewer people will itemize their deductions; nonetheless, some common ones still exist.
1. Mortgage Interest Deduction
Mortgage interest deduction is one of the most sought-after itemized tax deductions, helping households reduce taxable incomes and ultimately the total taxes paid.
Mortgage interest deductions are limited to the amount of debt qualifying as home acquisition debt - such as loans taken out to purchase, build or substantially improve a qualified home. Please refer to Table 1 to identify your limits.
Points can also be deducted, which are prepayments of interest. However, they must generally be distributed proportionately over the life of your loan agreement.
2. Medical Expenses Deduction
Medical expenses you pay or reimburse for yourself, your spouse and any dependents can be deducted on your taxes. Expenses should cover the diagnosis, cure, mitigation, treatment or prevention of disease.
Eligible expenses may include prescription drugs and eyeglasses; dental care; wheelchair; as well as transportation to and from medical treatment (including meals and lodging expenses).
Unallowable expenses include dance and swimming lessons (unless they help alleviate symptoms associated with medical conditions), cosmetic surgery costs and household employment taxes - these items don't count towards medical expenses, which will be discussed later.
3. Child Care Expenses Deduction
Family care expenses are a financial strain for many families, and when filed correctly IRS Form 2441--formerly known as the Child and Dependent Care Tax Credit--can help ease that strain. Qualifying expenses include fees paid to day care centers, nannies or babysitters in caring for qualifying children or dependents, but costs for overnight camps or tutoring do not qualify as qualifying expenses.
As opposed to deductions, tax credits reduce your taxes dollar-for-dollar - this option can also help families combine state tax credits and deductions with federal ones for maximum efficiency.
4. Business Expenses Deduction
Businesses must carefully track all expenses and verify they qualify as tax deductions during tax season. Utilizing expense categories can help organize these expenditures and save money.
Operating costs associated with running a business are tax deductible as long as they qualify as "ordinary and necessary," subtracted from revenue to arrive at taxable income. Examples of business expenses are:
5. Education Expenses Deduction
As you save for college tuition for either yourself or your children, it is essential to understand all available tax breaks. These may include deductions that reduce taxable income as well as credits that reduce what taxes you owe dollar-by-dollar.
Tuition and fees required to enroll or attend an educational institution qualify as eligible expenses, while equipment, course-related software, and academic materials may also qualify.
6. Medical Insurance Deduction
Health care costs may be tax deductible; to qualify, itemize your taxes and show medical expenses that exceed 7.5% of adjusted gross income. Understand the management of healthcare costs relative to financial goals.
Deductible expenses reduce both federal and state taxes directly; however, the intricate rules, accounting methods and limits on what can be deducted can make understanding them a daunting task; ultimately leading to errors that burden taxpayers as well as businesses alike.
7. Retirement Expenses Deduction
Subtracting deductions reduces taxable income, thus decreasing how much taxes you owe. Depending on your filing status, either take the standard deduction or itemize your deductions to get maximum tax savings.
Popular tax deductions include charitable donations, mortgage interest deduction, state and local taxes paid, as well as medical expenses exceeding 7.5% of your adjusted gross income.
The IRS allows taxpayers to make tax-deductible contributions to traditional and Roth IRAs, 401(k)s and other qualified retirement plans - known as above-the-line deductions - regardless of whether they opt for the standard or itemized method of reporting their income tax returns.
8. Charitable Contributions Deduction
The charitable contribution deduction allows individuals to deduct contributions of cash or property donated to certain public charities and private foundations. Individuals who itemize can deduct up to 60 percent of their adjusted gross income for donations; any surplus can be carried forward for up to five years.
Taxpayers must keep detailed records to substantiate charitable donation deductions, including contemporaneous written acknowledgment for donations of $75 or more and details of goods or services received in return. Donors who receive state or local tax credits in return for their gift should reduce it accordingly.
9. Business Expenses Deduction
Tax write-offs or business deductions help lower taxable income by deducting expenses that are both common and necessary to your trade or business from its total revenue.
Deductible business expenses include office supplies, food for client meetings and utilities if your home serves as your office space. Other deductible expenses include travel-related costs, employee payments and retirement savings plans.
Your costs associated with producing products such as raw materials, freight and storage costs as well as direct labor can all be deducted.
10. Personal Expenses Deduction
The personal expenses deduction allows you to lower your taxable income by deducting eligible below-the-line deductions from your adjusted gross income, such as utilities used for business, tax preparation fees and mileage deduction for vehicles used for business use. Examples may include percentage of utilities used by business, tax preparation fees or mileage allowance for vehicles used during the course of doing business.
Keep accurate records of your deductible expenses throughout the year, regardless of whether you opt to itemize or take the standard deduction. Maintaining separate lists for personal and business expenses is especially essential as the IRS can audit returns based on incomplete or inaccurate documentation.
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