What is a Tax Deduction?
A tax deduction is a credit that is subtracted from your income, which lowers your taxable income. The Internal Revenue Service (IRS) allows taxpayers to take a standard deduction or an itemized deduction.
A standard tax deduction is set by the IRS each year. Taking a standard tax deduction doesn’t require any record keeping or proof of deductions. It’s the simplest way to take deductions. Standard deductions are only available on personal taxes.
While the standard deduction is easy, it’s not always the best option. An itemized tax deduction allows you to calculate all of the deductibles that you qualify for, which could be higher than the standard deduction. The IRS offers deductions for the following categories:
- Health care costs (medical, dental, prescription drugs)
- Income taxes or sales taxes
- Property taxes
- Mortgage interest
- Personal property taxes (like vehicle registration fees)
- Interest on investments
- Charitable contributions
- Losses due to theft or casualty
- Job-related expenses
- Union dues
- Tax preparation fees
- Home office expenses
- Gambling losses
In order to take an itemized tax deduction, you must keep detailed records so that you can prove you are eligible for the deductions. For business tax deductions you must do an itemized deduction; there is not a standard deduction.
Tax Deduction Scenario
Doug Chambers is a small business owner, who runs a creative business out of his home.
Doug takes advantage of tax deductions each year to lower his taxable income and to save money. Because he is a home owner, Doug can take a deduction on his property taxes and his mortgage interest. He also has a family insurance plan. All of these can be claimed as deductions on his personal taxes. Because Doug runs his business out of his home, he can claim his home office as a tax deduction. He can also claim his marketing & advertising costs and unpaid invoices as business deductions.
Doug has two options for his personal taxes, he can take the standard deduction of $9,350, which is the standard the head of household deduction. Or because Doug qualifies for several deductions he can choose to do an itemized deduction.
If Doug chooses to do an itemized deduction he needs to provide his accountant with all his records so that they can determine if claiming the itemized deduction will be more beneficial.
Because business taxes only allow standardized deductions, Doug must provide documentation for each of the deductions he wants to take.
Overall, Doug is able to lower his taxable income for his personal and business taxes.
