Tax deductions are important aspects involved in the calculation of the tax liability of any taxpayer. These are legally allowable deductions, as stipulated by different rules and regulations framed by IRS, which are used to calculate Adjusted Gross Income (AGI). The tax liability of the taxpayer is calculated on this AGI.
There are numerous allowable tax deductions that a taxpayer can avail of. However, for the sake of brevity, we have presented here the most common deductions used by individuals. Broadly, a taxpayer has two options about tax deductions, which he/she can exercise at his/her discretion. As a common-sense rule, the taxpayers invariably choose the option that allows maximum tax deductions for them.
Option I: Standard Deduction
Taxpayers have the option to go for itemized deductions if they believe that the itemized deductions will aggregate more than the Standard Deduction. The most common allowable itemized deductions include medical expenditure, education expenses, charitable contributions made to a 501(c)(3) qualified tax-exempt charity, donations to religious institutions (churches, temples, mosques, etc.), casualty and theft loss, mortgage interest, home mortgage points, local and state taxes, and other miscellaneous expenses.
Business Tax Deductions
Businesses are also allowed certain tax deductions that can reduce their tax liability. The most commonly availed business tax deductions include vehicle expenses for trucks, cars, and other vehicles used in connection with the business; travel expenses incurred by the taxpayer for work or business purposes; capital expenditure (other than business expenses); casualty losses; meals, entertainment, and gifts in connection with the business; certain start-up expenses incurred for the establishment of a new business; home-office expenses, where the taxpayer operates an office from home, etc.
The distinction between Tax Deductions and Tax Credits
Tax deductions and tax credits can be confused with each other. Therefore, it’s important to know the difference between the two to appreciate the subtle nuances of these two concepts.
A tax deduction is an expenditure incurred by the taxpayer that is ultimately subtracted from the income to avail tax benefits. A tax credit is a dollar-to-dollar reduction from your actual tax liability unlike the tax deduction, which allows a percentage of the amount expended and also a cap on the deduction amount.
Tax deductions are reduced from the gross income of the taxpayer, but tax credits are allowed on the actual tax liability of the taxpayer.
After all the applicable deductions are subtracted from the gross income, taxpayers’ AGI remains upon which the tax liability is calculated.
Undoubtedly, tax credits translate into a better deal for the taxpayers, but it is equally difficult to qualify for the tax credits, while tax deductions are much easier to apply and claim a reduction in tax liability.
Disclaimer: Every effort was made at the time of publication to ensure the accuracy of this publication. Individual circumstances will vary, and the law may have changed since publication, thus it is not intended to provide legal advice or imply a certain outcome. Readers considering legal action should seek legal advice from an experienced tax attorney to learn about current laws and how they can affect their case.