The IRS requires taxpayers to file their income tax returns before April 15 to avoid the underpayment penalty. Even those who have no taxable income for the calendar year must fill out the tax forms to claim tax refunds or credits if they are eligible. Preparing for the tax season has become much easier since the tax software has been used for filling out these forms. You don’t have to hire an accountant, even if you have complicated tax returns.
Usually, people with multiple sources of income work with a tax accountant to ensure that all the deductions have been subtracted and the taxable amount is lowered. You can do the taxes on your own if you have done it before and have a basic knowledge of tax deductions. However, it’s best to leave the job either to an accountant or a tax prep software.
Tax deductions are important, as they can save you significant money on your income tax returns. Instead of having to give it away, you can save it using deductions. The tax credit is different, but it does the same — reduce your tax bill. Tax credit refers to the dollar-by-dollar amount reduction from your taxable income. For instance, if you are qualified for a $1000 deduction and your tax amount is $1800, you only have to pay $800.
Understanding Tax Deduction
Every taxpayer has to choose between standard and itemized deductions. Standard deduction involves a fixed amount you can cut from your taxes regardless of expenses. On the other hand, itemized deductions feature a detailed list of things you’d like to manually deduct from your taxable income so that your tax bill is reduced significantly. If you are itemizing deductions, you need to use Schedule A with the standard income tax return form 1040. Below, we have discussed both types of deductions in detail and when it’s best to itemize your deductions.
After the Tax Cuts and Jobs Act was released in 2017, taxpayers have been able to save more instead of paying a significant portion of their income in taxes. Whether you choose itemized or standard deductions, you pay much lesser than what taxpayers used to pay before this act. For 2021 and 2022, the standard deductions have almost doubled. Here’s the breakdown of the standard deductions for different taxpayers:
- If your filing status is single or you are married but file tax separately, you are eligible for a tax deduction of $12,950.
- The head of the family can claim up to $19,400
- A married couple filing their tax returns jointly is eligible for a deduction of $25,900. The surviving spouse can also claim the same deduction amount.
The IRS has allowed an additional standard deduction for seniors above 65 years. Seniors who are blind can claim double the amount of the additional standard deduction.
These were the standard tax deductions, meaning if you choose to deduct a fixed amount from your taxable income, the above conditions are applicable. If you itemize your deductions, you need to mention them separately on Schedule A. It’s also important to keep the receipts and proof of each transaction. If the IRS runs an audit on you, you can use these receipts. While the Tax and Jobs Cut Act favored taxpayers, it also eliminated a few deductions that were commonly used in the past. You can’t use the following as deductions, at least not until the Tax and Jobs Cut Act expire in 2025.
- Interest on home loan
- Interest on a mortgage above $750,000
- Local taxes above $5000
- Personal exemption
- Fee for filing the tax return
- Moving expenses, etc.
Is itemized Deduction Better than Standard Deduction?
The US taxpayers are allowed to select either standard or itemized deduction, depending on which method saves them more on taxes. The best part about the standard deduction is that it’s easy to calculate and usually saves you more than the itemized deduction. Since many itemized deductions have been eliminated after the 2017 act, and the standard deductions almost doubled, it makes sense to take the standard deduction.
That being said, itemized deductions can sometimes save you more. You should consider this option if you have home business expenses and other general expenses that qualify as itemized deductions. The only downside is that you have to use tax prep software or work with an accountant to simplify calculations.
The accountant might charge you a thousand dollars for preparing your tax documents. So, consider this only if your expenses exceed the standard deduction rate. Secondly, you need to keep a receipt for each expense that you add to the Schedule A form. For instance, if you are showing the vehicle used for business purposes as a deduction, you need proof of the number of miles driven for business. Although these are not always necessary, the IRS might ask you to submit proof if you are audited. On the other hand, the standard deduction requires you to fill out line 12a on Form 1040 only.
Besides, one of the biggest limitations for taxpayers is the elimination of mortgage interest beyond $750,000. If you live in a ridiculously expensive home that you bought using a mortgage exceeding this amount, you won’t be eligible for the interest deduction. There is another restriction for people with medical expenses. Your healthcare or dental expenses should exceed a certain percentage of your gross adjusted income to qualify for a tax deduction. The IRS has set a threshold of 7.5% of the gross income for medical expenses. It’s much better to take a standard deduction and save yourself the accountant’s fee instead of itemizing them and paying more in the long run.
Tax Deductions for Self-employed
Employees pay through withholdings. A small portion of their income is withheld from their paycheck every quarter, and the employer issues a W-2 form for the same. But what about self-employed individuals?
If you run a small business or practice a profession as a sole proprietor or in partnership in a limited liability company, you will be liable to pay your taxes on your own every quarter or annually. It’s better to pay quarterly, as exceeding $1000 in taxes owed can result in an underpayment penalty.
A tax reform law was much-needed, with the population of freelancers and gig workers growing exponentially. Fortunately, this group has not lost as many tax deductions as employed people after the Tax and Jobs Cut Act of 2017. Now, calculating some of these deductions is pretty challenging, as you have to identify which expense is business and should be deductible and which is counted as your personal expense. This is especially true for home business owners or those who have dedicated space in their homes for office use.
Relief from Half of the Taxes
The biggest advantage for a self-employed taxpayer is the elimination of half of the tax. Instead of paying the Social Security and Medicare taxes in full, you are only liable for 50% of the taxable amount. Since self-employed people don’t work under an employer and are thus not eligible for withholdings from the paycheck, they get a 50% saving on their taxable income.
Home Business Expenses
As mentioned earlier, if you have a home business, you can deduct the expenses incurred for business purposes. For instance, you can deduct the Wi-Fi used for running your business software, business accounts on social media, and the eCommerce website. Likewise, you can cut your phone bills to the extent to which the phone is used for making business calls. If you have a second phone line solely for business use, you can deduct the phone bills completely (including the international phone calls).
Home business expenses also cover your vehicle use for business. Calculate the miles driven for business and show it as a deduction on Schedule A. Then again, these are the itemized expenses that are to be calculated separately. If you are following the simplified deduction method, you can deduct up to $1500. This means the space you have dedicated to business use must not exceed 300 square feet. For each square foot, you can deduct $5 as a standard rate.
Other than that, you can deduct the repair and maintenance, utility bills, charitable contributions, business travel, vehicle expenses, advertising & marketing, and other costs related to your business.
Learn New Skills without Worrying About Taxes
You can enroll in programs and learning courses to increase your business knowledge. The course fees and the cost you pay for buying study material are tax deductible. Even the newspaper and magazine you have subscribed to is tax-deductible as long as it is relevant to your business niche. You can also consider training programs or take coaching classes (offline or online).
Bottom Line
Whether you use standard deductions or itemized deductions, you can save considerably on your income tax. Hire a professional accountant to simplify the tax return filing procedure or use the tax software app. File your tax returns electronically or send the forms to the IRS through the mail.
