Taxpayer, Know Thy Deductions: Tax Deductible Basics and Tips

Tax deductions have long been near and dear to American taxpayers for many reasons, not the least of which is that they involve family, homes, charities, and other things we value highly.

What is a tax deduction? Simply stated, a tax deduction is a legal means to reduce your taxable income, and in turn, what you owe the Internal Revenue Service (IRS) in taxes. Tax deductions are taken out of taxable income (also known as adjusted gross income), thus lowering a taxpayer's overall tax liability.

One thing tax deductions are definitely not is a direct reduction of taxes you owe (that’s a tax credit).

Tax deductions can result from a variety of transactions and other events over the course of the year. As another annual IRS deadline looms (tax returns are due April 17 this year), it’s important to grasp how tax deductions work and how they may or may not apply to you.

Two Major Tax Deduction Flavors: Standard and Itemized

When reporting federal income taxes, individuals and households typically choose between taking the standard deduction or itemizing deductions.

The standard deduction is just that—a standard dollar amount set by the IRS each year. This is the easiest deduction to take because there are no calculations to make, no receipts to gather, and no additional tax forms to prepare, according to the Intuit TurboTax Blog.

For 2017, the standard deduction for single taxpayers and married couples filing separately is $6,350, up from $6,300 in 2016; for married couples filing jointly, the standard deduction is $12,700, up from $12,600; and for heads of households, the standard deduction is $9,350, up from $9,300. (Under the Tax Cuts and Jobs Act, signed into law late last year, standard deductions in 2018 will double to $12,000 for single filers and $24,000 for those filing jointly.)

When Itemizing Makes Sense

Most taxpayers claim the standard deduction when filing federal tax returns because it’s often larger than deductions they could itemize. It’s also relatively easy. Still, it may not always be the best route.

Itemizing tax deductions requires a little more work, but it can also mean a big savings on your total tax bill. In 2014, about 30% of taxpayers itemized deductions, or 44 million out of 148.6 million returns, according to the Tax Policy Center.

The 2017 standard deduction for a married couple filing jointly, at $12,700, may pale in comparison once you add up certain expenses from the past year: mortgage interest, property taxes, retirement plan or charitable contributions, and more.

Mortgage Interest, Personal Property Taxes

You may be able to deduct home mortgage interest, points, and mortgage insurance premiums, although the new tax law imposes some limits. Under the new law, homeowners can deduct interest on mortgage amounts up to $750,000, down from the previous limit of $1 million (interest is reflected in form 1098, sent by the mortgage holder to you and the IRS).

Deductible personal property taxes are based on the value of personal property, such as a boat or car. The tax must be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year. Under the new law, the amount of deductible property and other state and local taxes is capped at $10,000.

Donations to Charity

Charitable contributions to qualified organizations may be deductible. Check with the IRS’s Exempt Organizations Select Check or with a tax professional to see if the organization you contributed to qualifies as a charitable organization for income tax deductions.

Education Expenses, Student Loan Interest

You may be able to deduct up to $2,500 of the interest you paid on a qualified student loan. Other situations may also qualify, such as work-related educational expenses for education that maintains or improves your job skills or is required by your employer or by law to keep your salary, status, or job.

For example, the “Lifetime Learning” credit can provide up to $2,000 per year, taking off 20% of the first $10,000 you spend for education after high school, according to Intuit TurboTax. (This is phased out at higher income levels, but doesn’t discriminate based on age.)

Medical and Dental Expenses

You may deduct only the amount by which your total qualified medical expenses exceed 7.5% of your adjusted gross income. This threshold was lowered from 10% in the recent tax law. The 7.5% threshold was made retroactive to January 1, 2017.

Home Office and Business Travel Expenses

If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The home office deduction is available for homeowners and renters, and applies to all types of homes. You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.

Some deductible expenses when you travel away from home include the cost of travel between your home and your business destination, using your car while at your business destination, taxi fare, meals, lodging, tips, and even dry cleaning.

Gambling Losses

If you win a big hand in Las Vegas, you can deduct any amount that you lost while playing, as long as the amount doesn't exceed how much you won. Gambling includes lottery tickets.

“Junkyard Cats,” Body Oil, and Other Deductible Oddities

If something is used to benefit your business and you can document the reasons for it, you can generally deduct it off your business income. For example, a junkyard owner might be able to deduct the cost of cat food that encourages stray cats to hang around and keep rats away, according to Intuit TurboTax. A bodybuilder may be able to deduct body oil used in competition.

Whatever your income or family situation, tax deductions can get complicated quickly, so consulting with a tax professional on any questions is always wise.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.