How Does a Tax Deduction Work?

Amount of Tax Due

Tax deductions are expenses that taxpayers can use to decrease the amount of total income earned for the year, thereby, possibly reducing the amount of tax due. Tax deductible expenses can affect how much income tax you will be required to pay. It's important to remember that not only can taxpayers take advantage of deductions allowable on federal income tax returns, states and many local taxing authorities will allow these same deductions as well.

None of us wants to pay more taxes than we have to; however, taxpayers might not always benefit from itemizing deductions. Depending on what tax deductions will apply, you might not do any better than the standard deduction that you can take. Not everyone necessarily comes out ahead by itemizing deductions. But in some cases, you do, especially if you own a home and can deduct the mortgage interest that you paid; have unreimbursed medical expenses that total more than 7-1/2% of your adjusted gross income for the year; or made significant charitable donations. Medical expenses, which you are allowed to deduct, include fees paid to doctors and dentists, prescription drugs, eyeglasses, laboratory fees, and health insurance premiums paid for medical insurance as long as the premiums were not paid for by your employer. The cost of certain medical supplies might be deductible, too. There are a number of other miscellaneous deductions, which you can take, but the total of these deductions must add up to more than 2% of your adjusted gross income in order for you to benefit.

Paying the IRS too much money in taxes is a more common mistake than you might think. Most taxpayers tend to overlook a lot of potential tax deductions like state income taxes that were paid on the previous year's return; expenses incurred when moving a distance of more than 50 miles to a new location for employment if it is a first job; up to $4,000 paid in college tuition during the tax year; small charitable donations made out-of-pocket; and up to $2,500 student loan interest paid by parents if the taxpayer is not claimed as a dependent on the parents' federal income tax return. In addition, if you work regularly from a home office, you may qualify to deduct some business expenses, particularly if you are self-employed. If you meet the requirements, you might be able to deduct a percentage of the utilities, real estate taxes, mortgage interest, and homeowner insurance that you paid throughout the year.