Tax Deduction Definition: Standard or Itemized?

What Is a Tax Deduction?

A tax deduction is an amount that you can deduct from your taxable income to lower the amount of taxes that you owe. You can choose the standard deduction—a single deduction of a fixed amount—or itemize deductions on Schedule A of your income tax return.

If the total for your itemized expenses is greater than the standard deduction for your filing status, it makes sense to itemize. Allowable itemized deductions include mortgage interest, charitable gifts, unreimbursed medical expenses, and state and local taxes.

Key Takeaways

  • Tax deductions are subtracted from your taxable income, thereby lowering the amount of tax you owe.
  • You can choose the standard deduction or itemize your deductions on Schedule A of Form 1040 or 1040-SR.
  • The Tax Cuts and Jobs Act (TCJA) nearly doubled the standard deduction and improved several tax deductions.
  • The TCJA also eliminated or limited many itemized deductions, including the mortgage interest deduction.
  • If you itemize your deductions, be sure to keep receipts to substantiate your expenses.

Understanding Tax Deductions

Individuals can take the standard deduction—which nearly doubled under the Tax Cuts and Jobs Act—or itemize their deductions. Here's a rundown of the standard deduction amounts for the 2022 and 2023 tax years:

Standard Deduction for the 2022 and 2023 Tax Years
 Filing Status 2022 Standard Deduction 2023 Standard Deduction
Single $12,950 $13,850
Married Filing Separately $12,950 $13,850
Heads of Household $19,400 $20,800
Married Filing Jointly $25,900 $27,700
Surviving Spouses $25,900 $27,700

Taxpayers at least 65 years old or blind can claim an additional standard deduction. For 2022, the extra amount is $1,400 ($1,750 for single filers and heads of households). Those over 65 and blind are entitled to double the additional amount ($2,800 or $3,500, depending on filing status). The amount rises to $1,500 in 2023 and $1,850 for single filers and heads of household.

You can take the standard deduction or itemize your deductions—you can't do both for the same tax year.

Common Tax Deductions

Here are some of the most common tax deductions that you can claim on your federal income tax return:

Most of these deductions should be entered on Schedule A of your 1040, but there are some exceptions. For example, you must use Form 8949 and Schedule D to report investment losses and Form 5498 to record IRA contributions. Contributions to an employer-sponsored 401(k) retirement account are reflected in your paycheck, so you don't need the extra form.

Deductions That Went Away in 2018

Some once-common tax deductions were eliminated or capped by the Tax Cuts and Jobs Act of 2017 (TCJA). You can no longer deduct the following—at least until 2025 when the act is due to expire:

  • Home equity loan interest (unless you spent the money to improve the home)
  • Mortgage interest on more than $750,000 of secured mortgage debt
  • Unreimbursed work expenses
  • State and local taxes above $5,000 (or $10,000 for a couple)
  • Dues for professional societies
  • Moving expenses (except for military personnel)
  • Casualty and theft losses (except in federally declared disaster areas)
  • The personal exemption
  • Tax preparation fees
  • Alimony payments
  • "Miscellaneous" itemized deductions

Tax Deductions for the Self-Employed

The ranks of freelancers and gig workers are growing. According to a Pew Research study, more than 16 million Americans now identify as self-employed.

Luckily for them, they have retained some of the tax deductions that wage earners lost in the 2017 tax reform law. Some deductions are complex because you have to determine how much of every expense is business, thus deductible—and how much is personal and nondeductible.

Some of the most important deductions for the self-employed include those for half of your Medicare and Social Security taxes, the home office deduction, and the health insurance premiums deduction.

One particularly valuable deduction for self-employed people defers taxes on their contributions to retirement plans. Tax-deferred retirement plans—including the SEP-IRA, the SIMPLE IRA, and the solo 401(k)—are designed specifically for the self-employed, solo operators, and small business owners.

Contributions to traditional IRAs and qualified plans such as 401(k)s are an "above the line" deduction. That means the contribution will reduce your taxable income even if you choose to take the standard deduction instead of itemizing.

Small Business Tax Deductions

Businesses large and small pay taxes on their profits, which is their total receipts minus their total business costs. That means recording every single expense and reporting it to the IRS. Some of the top deductions for small business owners include:

  • Advertising and promotion
  • Bad debts
  • Books
  • Business travel
  • Charitable contributions
  • Continuing education
  • Equipment
  • Insurance
  • Legal and professional fees
  • License and regulatory fees
  • Loan interest
  • Pass-through tax deduction
  • Repair and maintenance
  • Taxes (local, sales, and property taxes)
  • Vehicle expenses
  • Startup costs

The rules for many of these deductions are complex, particularly for shoestring operations. Vehicle expenses and travel expenses, for example, must be carefully separated between deductible business use and nondeductible personal or family use.

Tax Deductions vs. Tax Credits

Tax deductions reduce your total taxable income—the amount you use to calculate your tax bill. On the other hand, tax credits are subtracted directly from the taxes you owe. Some tax credits are even refundable, meaning that if the credits reduce your tax bill to below zero, you'll get a refund for the difference.

Even if they aren't refundable, a tax credit is more valuable than a tax deduction. A tax deduction may kick your taxable income down a few notches on the tax tables, but a tax credit reduces the tax you owe, dollar for dollar.

Example of a Tax Deduction

Here's an example. Consider a single taxpayer reporting an earned income of $90,000 in 2022. That puts the person in the 24% tax bracket. So their tax bill for tax year 2022 would be $15,213.50 plus 24% of the excess over $89,075 ($925) which comes out to a total of $15,435.50 ($15,213.50 + $222). Like all taxpayers, this individual can choose to itemize deductions or take the standard deduction.

If the Taxpayer Itemizes

The taxpayer has paid $10,000 in mortgage interest and has contributed $6,000 to a traditional IRA. Both are deductible expenses.

With a total of $16,000 in deductions to report, the taxpayer will owe income taxes on $74,000 ($90,000 - $16,000) of earned income. Therefore, the person will owe $11,897 in taxes for the year ($4807.50 plus 22% of the excess over $41,775). That's less than the original tax owed of $15,435.50 shown above.

If the Taxpayer Takes the Standard Deduction

The standard deduction for a single filer is $12,950 for the 2022 tax year. It's important to note that the taxpayer gets the additional aforementioned $6,000 deduction for the IRA contribution. It's an "above-the-line" deduction, reducing this taxpayer's gross income from $90,000 to $84,000. The standard deduction further reduces the filer's taxable income to $71,050. Thus, with the standard deduction, the taxpayer will owe $11,248 ($4807.50 plus 22% of the excess over $41,775).

That's less than taxes owed after itemizing deductions. So, even with a hefty mortgage interest write-off, the taxpayer would save $649 by taking the standard deduction.

Standard Deductions vs. Itemized Deductions

Generally speaking, U.S. taxpayers will choose to itemize their deductions or take the standard deduction, depending on which most reduces their taxable income.

Contrary to what many taxpayers may think, they might benefit most from the standard deduction because the TCJA nearly doubled the standard deduction amount and eliminated (or capped) many itemized deductions.

If you itemize, you need to keep receipts for eligible expenses throughout the year and organize them into categories. At tax time, you tally and record the expenses on a Schedule A—and hold onto the receipts in case you're audited.

The standard deduction is substantially less work: You simply fill in the amount of your standard deduction on line 12a of Form 1040 or 1040-SR.

State Tax Deductions

Most of the 41 states that impose an income tax follow the format of the federal forms as closely as possible. However, the states set their own tax rates and standard deductions, and they may have additional allowable deductions or different restrictions on deductions.

Some states do not permit taxpayers to itemize state taxes if they take the federal tax deduction.

In any case, it's worth reading your state's tax forms closely to see if there are any additional deductions for which you might qualify. For example, in New Mexico, you are exempt from state income tax when you reach age 100. And Nevada taxpayers can get a free pack of cards for filing their tax returns.

Limits on Tax Deductions

Keep in mind that there are limitations on some deductions. For example, current federal tax law limits the mortgage interest deduction to a maximum of $750,000 of secured mortgage debt (or $1 million if you bought the home prior to Dec. 16, 2017). That 2017 change was a severe blow to the very wealthy and to some not-so-wealthy residents of the cities with the most expensive homes.

Then there's the limit on the healthcare deduction. If you're itemizing healthcare costs, the expenses that you paid (for yourself, your spouse, and your dependents) must exceed a certain percentage of your adjusted gross income (AGI) to be deductible. For your 2022 tax return, the threshold for medical expenses is 7.5% of AGI for all taxpayers.

Capital Loss Carryforward

One additional deduction not included in the standard or itemized tax deductions is the one for capital losses. These are recorded on Schedule D, along with capital gains, rather than on Schedule A.

A tax loss carryforward is a legal way to rearrange earnings for the taxpayer's benefit. You can carry forward individual and business capital losses from previous years. You can claim up to $3,000 ($1,500 if married filing separately) in capital losses as a tax deduction as of the 2022 tax year (the tax return you file in 2023). If your losses were greater than that, you can "carry them forward" to the following year or years.

What Can I Write Off on My Taxes?

There are dozens of tax deductions and credits that can help lower your tax bill. Some of the more common deductions include those for mortgage interest, retirement plan contributions, HSA contributions, student loan interest, charitable contributions, medical and dental expenses, gambling losses, and state and local taxes.

Common credits include the child tax credit, earned income tax credit, child and dependent care credit, saver's credit, foreign tax credit, American opportunity credit, lifetime learning credit, and premium tax credit.

How Can I Maximize My Tax Deductions?

Whether you itemize or take the standard deduction, it helps to contribute the maximum allowable amount to a traditional (i.e., not Roth) retirement account like an IRA or a 401(k). That way, you'll be adding to your retirement savings while reducing your taxes for the year.

If you have substantial mortgage interest, student debt interest, medical expenses, and other deductible expenses, you may find the total exceeds the standard deduction. In that case, you can maximize your deductions by itemizing on Schedule A of Form 1040 or 1040-SR.

What Is the Maximum Tax Refund You Can Get?

There is no maximum. However, the average direct deposit refund for individuals in the 2022 tax filing season was $3,121, according to the IRS.

The Bottom Line

A tax deduction is an amount that the IRS allows taxpayers to deduct from their taxable income, thus reducing the tax that they owe.

Taxpayers can either itemize individual deductions that they're entitled to on their tax returns or opt for the standard deduction allowed (a single amount). The approach you choose will most likely be the one that lowers your tax bill the most.

While many taxpayers may think that itemizing is the better choice, the standard deduction was nearly doubled by the Tax Cuts and Jobs Act of 2017. In certain circumstances, it may reduce your tax bill more than itemizing.

Article Sources
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