Every year, Americans scramble to get their paper work together to go file their taxes. It is a stressful time, leaving tax payers wondering how their tax situation will effect their financial situation overall. With new healthcare penalties being carried out this year, taxpayers are more uncertain than usual; however, they still harbor a little faith in the role deductions play within the tax process.
What Is a Tax Deduction?
If this is the first time you have ever paid taxes, then it is critical that you know what a deduction is. Deductions are a mechanism used by taxpayers to save themselves from having to pay hefty taxes. It is important to understand the difference between a tax deduction and a tax credit. A tax credit directly reduces the amount of taxes you are said to have to pay. For example, if you owe the IRS 2,500-dollars in taxes, a tax credit of 500-dollars will reduce that amount down to 2000-dollars. A tax deduction, on the other hand, directly reduces the amount of taxable income you are bringing to the table. In other words, if you earned 40,000 in income, but you have 5,000 in tax deductions, this means that the IRS can only tax you on 35,000-dollars of your income, rather than the full amount. After all your tax deductions are factored in, the amount of income you will have to pay taxes on will typically be far less than the amount you actually earned as income. What taxpayers truly like to see are a lot of tax deductions and tax credits at the same time. In this situation, both the amount of money you can be taxed on and the amount of actual taxes you owe are being reduced to a more manageable value. This means, after all tax issues have been factored in, that you get to keep more of the money you earned.
Types of Deductions
There are two primary types of deductions. These are the Standard Deduction and Itemized deductions. The most straight forward deduction a person can take is the Standard Deduction. It is a set figure that a single income earner, or that people filing jointly, are able to deduct from their earned income. Once this deduction is subtracted from their income, what is left over is taxable income. Alternatively, a person, or people filing jointly, are able to refuse the Standard deduction and take an Itemized deduction instead. An Itemized deduction allows the person filing their taxes to claim deductions, item by item, from a number of different categories that they may qualify for. Generally, it is best to take the option that best reduces your taxable income.
Smart Tax Deductions
When a person gets to know the tax code better, it becomes evident that there are quite a few different deductions that can be taken during an itemization. For this reason, savvy taxpayers tend to like to itemize their taxes to try and maximize their savings. Taking deductions for healthcare costs, interest paid on certain investments and even job related expenses are all smart deductions to claim. If a person digs deeper, they will often find tax deductions that some tax professionals are not aware exist. Provided that they can document these deductions as being a legitimate part of the tax code and demonstrate why they qualify to take them, it is a smart idea to make the effort. When you get a handle on how to effectively use deductions, then you will be able to save money on your taxes like a pro.