Tax Deductions 101- Understanding Tax Deductions
Joshua V. Azran, partner/owner of Azran Financial (www.azranfinancial.com) discusses the basics of tax deductions. Learn about deductions to help with tax season from this pro.
- Tax deduction- reduces the amount of income upon which your taxes are calculated
- Deductions for AGI- adjustments applied to your above-the-line taxable income
- Deductions from AGI- below-the-line deductions applied to taxable income
- Deductions from AGI are also known as itemized deductions on Schedule AStandard deduction- deduction that does not fall within itemized deduction
- PRO TIP: Check the IRS website www.IRS.gov
Let’s talk about tax deductions in general. Tax deductions are something that everyone has to have a basic understanding of. If you don’t have a basic understanding of what the deductions are you won’t know to look for them or keep track of those records which you’ll need to be able to take advantage of them.
Of course we want to make sure in all circumstances that we’re only paying that tax which is actually do and deductions is a great way to ensure that we’re getting the most amount back that we can. One of the things that we want to do of course is to start off by defining what a tax deduction is so everyone is on the same page.
And we’re going to define a tax deductions, it’s a reduction of the amount of income upon which are taxes are calculated. Now, that’s kind of complicated but what essentially we’re saying is that this is going to reduce the amount upon which we’re going to calculate your taxable income. So if we’re talking with a very simple example of a tax pair with a $100,000 of income with 20,000 in deductions the taxably based off of the $80,000 remaining.
With this very simple example let’s look at the two major types of deductions so we understand the difference. The two major types of deductions are what we called deductions, for AGI or deductions for adjusted gross income or deductions from AGI, deductions from adjusted gross income.
And this is a very important distinction and we’ll take a look at this after we make a little bit more of a definition. So deductions for AGI is going to be things like all allowable business expenses, certain loses from the sale of property, contributions to certain retirement plans, things like alimony. And these are going to be what we refer to is above-line-deductions.
The reason is this more favorable is in above the line deductions is going to reduce your AGI or adjusted gross income. Your adjusted gross income will have an influence on how certain other tax are calculated down the line, therefore, deductions for AGI are going to be more advantageous.
The second category is what we refer to as deductions from AGI or deductions from adjusted gross income. These are going to be those deductions which are subtracted from the adjusted gross income which we previously calculated to arrive of what we defined as your taxable income. These are going to be those things that as we will refer to or itemized on Schedule A. So if many of you have heard these terms in the past such as itemized deductions or Schedule A deduction this is what they’re referring to.
Alternatively, those tax payers who don’t have enough itemized deductions are still eligible to take a deduction and this is what we refer to is the standard deduction. In such cases where your itemized deductions do not exceed the standard deductions to take we would still have the standard deduction available to us.
Some of the itemized deductions that most people will be familiar with and most people can take advantage of on their taxes are things like medical and dental expenses. Taxes paid these would include both state and local taxes, things like real estate taxes, personal property taxes that much, you may had paid on your vehicle registration for example.
Other things might be deductible interest, so interest paid for investment where interest incurred in the purchase of a home. Your home mortgage interest deductions are good example. Another major area would be things like charitable contributions. These would be both cash and non-cash charitable contributions, of course subject to substantiation by the tax payer.
Finally, we move on to certain other things like employee job expenses, those things which your employer may not have reimburse you for but you still have to incur as part of doing or conducting your business and then finally and hopefully none of you have to experience this casualty or theft loses. Anything ranging from an earthquake to your home burning down, there are opportunities to take deductions based upon this.
Now, we’re going to refer to these deductions from AGI as below the line deductions, remember we defined previously deductions for AGI as above the line deductions. And the difference again is going to be the fact that deductions for AGI, those above the line deductions are going to be generally more advantageous because of the effect that they’re going to have on later calculations for your taxes.
A basic understanding of your deductions and how they might apply to you can end up with a large tax saving which is very important to you and your family and of course to your long-term financial planning. Many of these resources are available on the IRSs website, www.IRS.gov. Alternatively, you should be contacting your tax accountant or other professional adviser for advice with these issues.