With incomes on the rise, the average American now pays $15,322 in federal income taxes. That’s a huge chunk of change that could otherwise be spent on healthcare, housing, or debt reduction. Thankfully, the U.S. tax code allows taxpayers to take advantage of deductions to reduce their taxable income, and ultimately, their tax bill.
Here’s everything you need to know about tax deductions.
Income tax deductions explained
Certain business expenses are considered deductible for income tax purposes. These expenses are subtracted from your taxable income, reducing the amount that is subject to federal income tax. Reducing your taxable income ultimately results in a lower tax bill.
What expenses are tax-deductible
For an expense to be tax-deductible, the Internal Revenue Service (IRS) states that it must be both “ordinary and necessary” to your business. An ordinary expense is one that is “common and expected” for someone in your business niche. Meanwhile, for an expense to be necessary, it must be “helpful and appropriate” for your business.
These definitions are vague enough to confuse many taxpayers, which is why it’s important that you consult a tax expert to clarify your tax situation.
General business expenses such as rent, utilities, insurance premiums, professional dues, vehicle operation and maintenance, and equipment and supplies are considered tax-deductible. You may also deduct your education expenses if they are related to your trade or business.
Other expenses such as meals, state income and sales taxes, charitable donations, childcare costs, and self-employment taxes may also be deducted from your taxable income.
It’s important to note that you must be able to directly connect or prove the expenses to the operation of your trade or business. For instance, childcare costs only become tax-deductible if you are paying someone to watch your children or dependents while you are working.
How to claim tax deductions
There are two primary ways to claim tax deductions: standard deductions and itemized deductions. You can only choose one method, so it pays to know the differences between the two.
Standard deduction
The standard deduction is a set dollar amount a taxpayer can claim to reduce their taxable income. The amount you can deduct from your income depends on your age, filing status, and whether you are disabled.
The Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction for taxpayers. For tax year 2021, the standard deduction is $12,550 for those whose filing status is Single or Married Filing Separately, $25,100 for Married Filing Jointly, and $18,800 for Heads of Households.
Most taxpayers choose to take a standard deduction because it is the easiest way to reduce their taxable income. The amount is pre-determined, with no additional work required on the taxpayer’s part.
Itemized deduction
If you are confident your tax-deductible expenses are higher than the amount offered by a standard deduction, you may significantly lower your taxable income by taking an itemized deduction.
Deductions you can itemize include certain state and local taxes up to $10,000, medical and dental expenses, gambling losses, charitable contributions, and mortgage interest.
However, itemizing your deduction entails additional work and calculations on your part. You must be able to prove all the deductions you intend to claim by showing proof of expenses such as receipts, bills, and bank statements. The Tax and Jobs Act of 2017 also removed many itemized deductions, such as losses from natural disasters and unreimbursed employee expenses.
How to reduce your taxable income
The U.S. tax system is complicated and confusing, and it’s not uncommon for taxpayers to miss out on valuable tax breaks to minimize their tax liability. If you want to make the most of your deductions, your best option is to ask for help from a tax expert.
For over 25 years, the tax experts at TFX have helped many American taxpayers reduce their taxable income and lower their tax bills. With our fast service and expert knowledge, rest easy knowing that your tax return has been taken care of.
Veronica Rhodes from TFX
TFX is a women-owned tax firm that offers all U.S. tax services — for both American citizens and non-citizens with U.S. tax filing requirements. From straightforward expat tax preparation to complex cases involving multiple factors — we’ve handled it all for over 25 years.
