Individual and Business Tax Deductions Resource Guide

What Are Tax Deductions?

Tax deductions are reductions in the income that is subject to federal or state taxes. They serve to decrease the amount of taxable income on which these agencies levy their taxes.

Most people have the misperception that the government is trying to squeeze as much as it can out of individuals and companies through taxation. The reality is that this revenue is necessary to fund new development, the maintenance of infrastructure, and the improvement of quality of life for all citizens in the United States. Without these things, our lives would degenerate into chaos.

In drawing up the list of allowable tax deductions, the government includes items that incentivize people to improve society and the world around them. These include deductions for donations to charity; retirement savings; and installing environmentally friendly equipment, systems, and devices in their homes.

The Internal Revenue Service (IRS) makes allowances for tax deductions as well as tax credits in its tax code. There is a fundamental difference between the two. Tax deductions lower your taxable income before tax is calculated, whereas a tax credit comes directly off the amount of tax you owe. For that reason, tax credits have more value but do not appear as frequently in the tax code as tax deductions.

Whether tax deductions or tax credits are applicable to your situation, you need to understand how they work to use them to your best advantage.

In this guide, we discuss the permissible tax deductions and tax credits for individuals, families, entrepreneurs, and businesses.

Tax Deductions for Individuals and Families

Tax deductions are, in effect, the same as tax exemptions and refer to the amount of money that can be deducted from an individual’s adjusted gross income (AGI). Often, families can claim a range of deductions that don’t apply to a single individual and may therefore save more on taxes in the process.

Families

When it comes to tax deductions for families, you can claim deductions for personal and dependent exemptions for yourself and those members of your family who qualify. This enables you to lower the amount of income on which you will be taxed.

Parents with children or dependents may claim tax deductions or tax credits if they meet the qualifying rules defined by the IRS:

  • A dependent is defined as a qualifying child or qualifying relative for whom you can claim a tax deduction.
  • Children may be claimed as a dependent as soon as they are born.
  • Only one parent may claim a tax exemption for each child or dependent.
  • You may claim a child tax credit of $1,000 for each of your qualifying children under the age of 17 to offset the cost of raising them.
  • A child and dependent care credit may be claimed if you hire someone to care for your children under the age of 13 while you work. You may claim up to 35 percent of your expenses for a care provider, based on your annual income and the number of children. The total amount of a claim may not exceed $3,000.
  • You may claim an adoption tax credit to cover your expenses to adopt a child. These must be directly related to the adoption and can include adoption fees, attorney fees, court costs, and travel and accommodation costs. The maximum tax credit for 2018 is $13,840.
  • Low-income people who work for wages or are self-employed may claim an earned income tax credit (EITC) to reduce the amount of tax owed. For 2018, the maximum EITC is $6,444 for taxpayers filing jointly with three or more qualifying children.
  • If a child earns sufficient money from working, the child may be required to file his or her own tax return, especially if tax is withheld from pay by the employer. In this case, you may not be able to claim the child as a dependent, but the child may qualify as a qualifying relative if he or she still lives with you.
  • You may choose to include any income from a child’s investment on your tax return provided the child is younger than 19 and the gross investment income is less than $10,000.

 

A qualifying child does not have to be your child but must be related to you. To qualify for a tax deduction, a child must meet the following criteria:

  • The individual must be under the age of 19, a student under the age of 24, or a person of any age who has a permanent disability.
  • The individual must not have contributed more than 50 percent to his or her own support during the tax year.
  • The individual must have lived with you for more than half the year.

 

A qualifying relative does not have to be related to you but must meet several requirements:

  • The individual must not be classified as a qualifying child as well.
  • The individual must either have lived with you as a dependent for the entire year or be related to you by blood.
  • The individual must have earned less than $4,050 gross income for the year.
  • You must have provided more than 50 percent of the individual’s support during the year.

 

Income and Savings

For the 2018 tax year, the following standard deductions on taxable income will apply:

  • $6,500 for single taxpayers
  • $13,000 for married couples filing jointly
  • $13,000 for a surviving spouse
  • $9,550 for a head of household

 

In the United States, a taxpayer has the option of claiming a standard tax deduction or an itemized deduction. If you elect to file an itemized deduction, you must assign value to a list of allowable items to compute the amount of the itemized deduction that you want to claim and then subtract that from your adjusted gross income (AGI) to arrive at your taxable income. This allows you to choose the greater amount—the standard deduction or the itemized deduction—when filing your tax return.

In claiming an itemized deduction, there is always the risk that the IRS may adjust the values claimed. This could result in your itemized deduction being significantly less than the standard deduction. Most people play it safe by claiming the standard deduction when filing their tax returns.

The IRS considers interest earned on savings accounts to be taxable income, and taxpayers must submit a 1099-INT form along with their income tax returns. Interest on savings accounts is taxed at the same marginal rate as the individual’s income tax bracket.

Homeowners

There are several tax deductions you can claim as a homeowner if you itemize your claim:

  • Home mortgage interest payments
  • Real estate taxes
  • Mortgage points, with each point being equal to 1 percent of the loan amount
  • Mortgage points from refinancing a house
  • Uninsured losses from floods, fires, storm damage, theft, or earthquakes
  • Annual property taxes levied by local authorities
  • Moving costs, if the new location is more than 50 miles from the previous one

 

Homeowners may also deduct property taxes and mortgage interest for vacation or second homes, provided these properties are not rented out for 14 days or more during the year. If they are rented out for longer than that, the IRS considers them to be income property, which would be liable for capital gains tax when sold. Second homes and vacation homes may include the following kinds of dwellings:

  • Houses
  • Apartments
  • Condominiums
  • Mobile homes
  • Boats

 

In addition, you can claim tax credits on the cost of energy-efficient initiatives in your home. These include energy-efficient water heaters, furnaces, home insulation, double glazing, and advanced air-circulating fans. You can also claim for other green initiatives, such as solar equipment, fuel cells, geothermal heat pumps, and wind energy-generating equipment.

Health Care

Medical expenses are deductible only if you elect to itemize your deductions and only if they exceed 10 percent of your AGI. You can claim a deduction for the prevention, diagnosis, or medical treatment of any physical or mental illness but not for cosmetic procedures. The IRS lays down stringent rules for claiming medical expenses for someone else other than a qualifying dependent.

There are a variety of medical expenses that qualify for deduction:

  • Fees paid to doctors, dentists, chiropractors, and psychologists
  • Hospital and nursing services
  • Laser eye surgery
  • False teeth
  • Wheelchairs and guide dogs
  • Prescription drugs
  • Ambulance fees or traveling costs to reach a medical facility
  • Weight-loss programs for obesity

 

Under certain circumstances, you may claim health insurance deductions. Funds deposited into a personal health savings account (HSA) are exempt from federal income tax. To qualify, the funds may be used only to pay for out-of-pocket medical or health care expenses.

Education

The IRS permits you to claim tax credits and tax deductions for education costs. To claim a tax credit, you must verify the following information:

  • You, your dependent, or a third party pays education expenses for higher education.
  • The eligible student is yourself, your spouse, or a dependent listed in your income tax return.
  • The eligible student must be enrolled at a recognized and eligible educational institution.

 

You can claim either the lifetime learning credit or the American opportunity credit but not both.

The following tax deductions may be made for education:

  • Tuition and fees deduction of up to $4,000 for you, your spouse, or your dependent
  • Student loan interest deduction of up to $2,500, if your modified adjusted gross income (MAGI) is less than $80,000, or $160,000 if filing a joint return

 

For calculation of the education deduction, the following amounts may be included:

  • Tuition and fees
  • Room and board
  • Books, supplies, and equipment
  • Other necessary expenses, such as transportation

 

Tax Deductions for Businesses and Entrepreneurs

Taxes are the top expense for many individuals and business owners in the United States, yet many business owners are unaware of the many tax deductions that are permitted by the IRS. It is important that you gain an understanding of all the tax credits and deductions that are available so that you can derive maximum benefit and improve the viability of your business.

One of the quickest ways to increase your bottom line is by paying as little tax as is legally permissible. It is understandable that business owners and entrepreneurs don’t take the time to learn the ins and outs of the U.S. tax code, because the language used is often confusing. In this guide, we attempt to give you a basic outline in plain English of the business tax deductions available to you.

Business Tax Deductions

Sole Proprietors

A sole proprietorship is an unincorporated business owned by a single person. The business as an entity is not taxed, as the net profits of the business are passed through to the owner, who must fill out Schedule C and include it with his or her individual income tax return. A sole proprietor therefore claims any applicable deductions in his or her personal capacity.

If you work and run an office from home, you can claim business expenses and deduct a portion of the home’s costs for the following items:

  • Utilities
  • Home insurance
  • Mortgage interest
  • Property taxes
  • Home repairs
  • Security system installation and maintenance

 

You may also claim for 100 percent of the expenses incurred in renovating your home to accommodate your office.

There are other permissible tax deductions:

  • Startup costs, up to a maximum of $5,000
  • Travel and mileage
  • Meals and entertainment
  • Social Security and Medicare taxes, up to 50 percent of yearly contributions
  • Section 179 depreciation, up to $500,000
  • Health insurance
  • Bad debts
  • Interest on business loans
  • Banking fees

 

Small Businesses

Small businesses, such as partnerships and limited liability companies (LLCs), often overlook items and expenses that they can claim for when filing tax returns. The list of permissible tax deductions is extensive:

  • Employee salaries and wages
  • Contract labor costs
  • Vehicle operating expenses
  • Rent on business property
  • Depreciation
  • Utilities
  • State and local taxes
  • Employer taxes, including FICA, FUTA, and state unemployment taxes
  • Repairs and maintenance
  • Business insurance
  • Commissions
  • Advertising costs
  • Transportation costs
  • Meals and entertainment
  • Legal and professional fees
  • Rent on machinery and equipment
  • Interest on business loans
  • Mortgage interest
  • Contributions to employee benefit programs and retirement plans

 

Corporations

C corporations, as well as S corporations, can claim all of the types of tax deductions that apply to small businesses. Here are some of them in more detail:

  • Operating expenses. These are expenses necessary to keep day-to-day operations of the business running, including payroll, rent, and office supplies.
  • Employee expenses. These include awards, bonuses, tuition reimbursement, sick leave costs, vacations, and contributions to health benefits and retirement savings plans.
  • Travel. Corporations can claim for the cost of travel by air, bus, or train. Entertainment, meals, and accommodation costs incurred while traveling are also fully tax-deductible.
  • Insurance. Types of insurance include those for fire, theft, workers’ compensation, and public liability.
  • Bad debts. Corporations may write off bad debts that they are unable to recover and claim them as tax deductions.
  • Interest. Companies can claim tax deductions on the interest on business loans or other forms of credit.
  • Depreciation. This includes depreciation on property and equipment.
  • Taxes. Corporations may deduct taxes on sales, excise, fuel, real estate for business purposes, and federal income.

 

Tax Deduction Resources and Tools

Most people find filling out a tax return tedious and want to get it done in the shortest time possible. This leads most people to opt for the standard tax deduction permitted according to their status instead of itemizing their claims for deductions.

The good news is that there are software tools available to do all the hard work for you. They calculate the value of various permissible tax deductions and make the entire process of completing your tax return much easier.

Itemized Deduction Tools

There are many software tools available that help with itemized tax deductions, including the following examples:

  • H&R Block. H&R Block has a free offering that supports income tax return, Form 1040, and Schedule A, which is used for itemizing deductions. It also offers the option of completing forms via an interview process.
  • Credit Karma Tax. This is also a free service that supports all the major tax forms and schedules.
  • TurboTax from Intuit. This software has won many awards, although it doesn’t have a free offering. In addition to being a complete tax package, it enables the completion of Schedule A for itemized deductions.
  • TaxAct Online Premium. TaxAct provides phone and email help with tax return completion. This is a very affordable service at $37.

 

Mortgage Tax Deduction Calculator

There are several online tools to enable you to calculate your mortgage tax deduction:

  • Money-zine.com’s Mortgage Tax Deduction Calculator
  • Mortgage Tax Deduction Calculator from Bankrate.com
  • Mortgage Tax-Savings Calculator from MortgageCalculator.biz

 

These tools allow you to plug in all the values pertaining to your property to enable the calculator to determine both federal and state tax deductions.

Tax Brackets

These are the tax brackets and applicable tax rates for each bracket for 2018:

 

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Sources:

https://www.thebalance.com/an-introduction-to-tax-deductions-and-retirement-planning-2894618

https://turbotax.intuit.com/tax-tips/family/tax-exemptions-and-deductions-for-families/L0Nx5Tnxi

https://www.forbes.com/sites/kellyphillipserb/2017/10/19/irs-announces-2018-tax-brackets-standard-deduction-amounts-and-more/#72f724f6273b

https://www.investopedia.com/ask/answers/052515/how-savings-account-taxed.asp

https://www.efile.com/tax-deduction/income-deduction/home-deductions/

https://www.irs.com/articles/tax-deductions-for-medical-expenses-and-health-insurance

https://www.irs.gov/newsroom/tax-benefits-for-education-information-center

https://www.thebalance.com/sole-proprietorship-tax-benefits-3515867

https://lessaccounting.com/blog/the-tax-deductions-every-sole-proprietor-should-know/

https://smallbiztrends.com/2016/02/top-tax-deductions-for-small-business.html

http://smallbusiness.chron.com/top-10-corporate-tax-deductions-10403.html

https://www.money-zine.com/calculators/mortgage-calculators/mortgage-tax-deduction-calculator/

https://www.bankrate.com/calculators/mortgages/loan-tax-deduction-calculator.aspx

https://www.mortgagecalculator.biz/c/tax-savings.php