What types of deductions are available on a personal income tax return?
Tax deductions lower your personal income tax by bringing down taxable income. There are four main types of deductions:
Those are deductions for the cost of operating a business or being self-employed. Basically, they are the typical day-to-day costs of running a business. The list of business expenses is very long, but some of the most common are: cost of materials, cost of goods sold, supplies, rent, utilities, taxes, advertising, legal and professional costs, etc.
To be deductible, the expenses must be both ordinary and necessary. They must be the typical types of expenses that a business of that specific nature would incur in order to be able to do business. For example, a plumber would have business miles as an expense because his or her work must be performed at their customer’s location. However, someone engaged in web design would be unlikely to have legitimate business miles as their work would be done at their office location.
If you have both personal and business expenses, you can deduct the business portion. The most common types of expenses that have both a personal and business element are cell phones, internet service, big box club memberships, etc.
They are deducted either on Schedule C (Form 1040 or Form 1040NR) or on the return for the type of business entity that is being operated (i.e., 1120, 1120S, or 1065)
Above-the-line deductions (even though you do not itemize)
Above-the-line deductions directly reduce gross income. They appear on the front page of IRS Form 1040. You can take the deductions regardless of whether you itemize deductions or take the standard deduction.
1) Certain business expenses for reservists, performing artists and others: These could include travel expenses and certain personal expenses.
2) Health savings account deduction: A health savings account is pretax dollars that are allocated to medical expenses when you have a high deductible medical insurance policy.
3) Job-based moving expenses: Must be a minimum of 50 miles from your previous employer to your new employer.
4) One-half of self-employment tax: Self employment tax covers social security and Medicare taxes for self employed taxpayers.
5) Contributions by self-employed to SEP, Simple, Keogh, MSAs and HSAs plans
6) Self-employed health insurance deduction: Covers health insurance for the self employed taxpayer and their family.
7) Penalty on early withdrawal of savings: Example: The fee charged by your bank for cashing in a CD early.
8) Alimony paid: Must be court ordered alimony, spousal support or maintenance.
9) IRA deduction: Up to $5,500 per person if you are under 50, and $6,500 per person if you are over 50, for 2015, 2016 and 2017.
10) Up to $2,500 student loan interest
11) Domestic production activities deduction: This is a rare deduction for individual filers.
Itemized deductions or “below the line” deductions
These are itemized deductions that you may use in place of your standard deduction. They are considered to be below the line deductions because they do not reduce your AGI (Adjusted Gross Income) and therefore are not as valuable as above the line deductions, which do reduce AGI. Many state tax calculations begin with your AGI, therefore these deductions also do not help with your state taxes in many states. That is why they are called “below the line”.
Most common are:
a) State and local income taxes (or sales taxes)
b) Real estate and personal property taxes
c) Home mortgage interest and points
d) Mortgage insurance premiums
e) Investment interest
f) Charitable donations and miles that are less than 50% of your AGI
g) Casualty and theft losses that exceed 10% of your AGI
h) Job expenses and miscellaneous deductions that exceed 2% of your AGI
i) Medical and dental expenses that exceed 7.5% of your AGI
An “average deduction" is available to all taxpayers who either cannot or choose not to itemize deductions. Called the standard deduction, it is a flat amount--adjusted each year for inflation--and varies based on filing status. Download IRS Pub. 501 for more information.