Tax deductions lower your taxable income, and they are calculated using the percentage of your marginal tax bracket. For example, if you are in the 25% tax bracket, a $1,000 tax deduction saves you $250 in tax (0.25 x $1,000 = $250).
With the ever-changing tax laws and the temporary nature of most tax credits and deductions, timing is critical when it comes to claiming anything on your income tax return. To make the most of the available benefits, taxpayers generally choose to defer their income and accelerate tax deductions.
As you prepare your income tax return, you may decide between taking the standard deduction or itemizing deductions. You should use whichever tax deduction benefits you the most.
The Standard Deduction
The standard deduction is a dollar amount that reduces your taxable income. It is usually adjusted for inflation every year. Your standard deduction amount is based on your filing status, and it is subtracted from your AGI (adjusted gross income).
For the year 2012, the standard deduction is as follows:
- $5,950 for single filers
- $11,900 for married joint filers
- $5,950 for married taxpayers filing separately
- $8,700 for head of household filers
An additional standard deduction for the elderly (over 65) or visually impaired is as follows:
- $1,450 for single or head of household filers
- $1,150 for married filers
If you do not qualify for the standard deduction, you may choose to itemize your tax deductions. A taxpayer will also typically itemize deductions if it offers them more benefits than the standard deduction (i.e., when the total amount of qualified deductible expenses is greater than the standard deduction).
Certain itemized deductions are based on a minimum (or “floor”) amount. This means that you can only deduct amounts that exceed the specified “floor.”
There is also an income limit for taxpayers who itemize. If your AGI (adjusted gross income) exceeds $166,800 then a portion of itemized deductions is not permitted ― this income limit applies to single and married filers.
If you decide to itemize your tax deductions, it is important to keep detailed records of those tax deductions ― including documentation for medical expenses, property taxes, charitable donations, interest expenses, and non-business state income taxes.
You may use IRS Tax Form 1040 Schedule A to figure your itemized deductions, and attach it to your IRS Tax Form 1040 (but not Form 1040A or Form 1040EZ).
Above-the-line tax deductions are taken before your AGI is calculated (instead of after, like the other deductions). Because of this, many believe this type of tax deduction to be more advantageous to taxpayers. Above-the-line deductions are subtracted from your gross income, and the resulting number is your AGI.
These tax deductions apply whether you itemize or not. They are designed to help protect your personal exemptions and itemized deductions from phaseouts.
Some above-the-line deductions include the following:
- Student loan interest
- Business mileage
- Job-related moving expenses
- Contributions to qualified retirement accounts
- Early withdrawal penalties for CDs and savings accounts
- Qualified tuition and fees