Tax Deductions
What is a "deduction"?
A deduction is something that you can deduct from your income to arrive at taxable income. Taxable income is a term that's used; that's the bottom line of the second page of the 1040 before you compute your income tax. A deduction is going to reduce your overall income. After the deduction has been taken away from your overall income, you're going to arrive at the taxable income, which you calculate your tax on. So, you want to use deductions to reduce it as much as legally possible.
What is a "standard deduction" and how much is it?
When we talk about deductions, there's something called a "standard deduction" that comes up. When you're looking at your tax return, on the second page of the 1040 - or even on the 1040EZ or the 1040A - there's a standard deduction. This is where the IRS or congress has built into our tax law a standard deduction. If you don't have enough to itemize your deductions - you don't have any medical expenses, own a home, have any interest and taxes on the home, give a lot of money to charities - the standard deduction as a single person for 2006 is $5,150. You get a standard deduction off your income of $5,150. If you're a married couple, double that standard deduction to $10,300. That number gets increased every year. It's indexed based on the cost of living, or whatever congress comes up with, but it goes up each year a little bit.
What is an "itemized deduction"?
Itemized deductions are those items that you claim on your tax return on Schedule A. It's medical expenses up to a seven and a half percent limit built into the figure that will be calculated when you're completing your tax return; another itemised deduction is interest on real estate and on taxes, all taxes that you pay - including real estate taxes and motor vehicle taxes. Itemised deductions are contributions to charity and interest on your home mortgage - all of those items are tagged and considered itemized deductions.
What are some commonly overlooked charity deductions?
Now, part of your charitable deductions are also donations of used clothing, furniture, etc. to a charity such as "Good Will", "Salvation Army"; those types of charities. You can donate those goods to the "Good Will", to charity, and you need to have a list of what you donated. The donation value is going to be the fair market value; thrift shop prices, and these charities have a list as to what those used clothing or used furniture is worth. You need to maintain a receipt from the charity saying that they received the goods, and you should also maintain a list of all the items that you gave with an extended price on those donations.
What are the restrictions on deducting charitable contributions?
If you're looking at charitable contributions and wondering how much you can write off for a charity, the tax law allows you to write off 50% of your adjusted gross income as charitable contribution, which is the number that will appear at the bottom of the front page of the 1040. The likelihood that you're going to get to that 50% charitable contribution limit is highly unusual, but it's available if you want it.
What are common mistakes people make in itemizing deductions?
You know the question comes up as you are thinking about it. You think you have got everything put together. You are ready to process the tax return and send it off to the government and you are thinking to yourself, "Hey, did I make a mistake? Did I miss something?" Are there lists of common mistakes? Yeah. The IRS puts out a list of common mistakes, usually there because somebody added something wrong or put something on the wrong line. I think the common mistakes that you should look at as you are preparing your return are just missing things. Take your time. Look through it. If you are unsure of what's deductible and what is not deductible, again, seek the help of a professional. Read the instructions. When we are talking about deductions folks, bear in mind that not everything is deductible. As much as we would like to deduct averything under the sun, there are certain things that are not deductible. It's going to depend on your particular situation, the business that you are in, the employment that you have. Things may be deductible for one person that are not going to be deductible for the next. Just be cautious that when you are coming up with items that you think are deductible, if you are unsure, it doesn't mean they are not deductible but you may want to question a professional or talk to your peers and find out what are they deducting and what are you deducting but even though bear in mind to that, people over the years have convinced themselves that certain things are deductible just because they believe that it should be.
What are the differences between deductions, exemptions and credits?
The exemption is the children, yourself, your spouse that you are able to claim. It's printed on the front page of the tax return, and you get the benefit of that exemption on the second page of your tax return in computing your taxable income. A credit is a dollar-for-dollar reduction of your tax liability, whereas a deduction, unlike a credit, reduces your taxable income, which is subject to the tax rate. Depending on where you are on that tax rate schedule is to how much benefit you get from a deduction.
