What types of deductions are available on a personal income tax return?
Tax deductions lower your personal income tax by bringing down taxable income.
The 2017 Tax Cuts and Jobs Act made significant changes to deductions to help offset the reduction in tax rates, increased standard deduction, elimination of the personal exemptions, and the higher child care credit. The changes are noted below.
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)
2018-2025: Beginning 2018 through 2025, all the above-the-line miscellaneous deductions (also known as adjustments to income) that exceed 2% of your adjusted gross income are gone.
Pre-2018 law: 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.
Common examples (warning: some of the following remain in place for tax years 2018 and beyond):
1) Certain business expenses for reservists, performing artists and others: These could include travel expenses and certain personal expenses. Performing artist expenses are completely eliminated after 2017.
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. Starting 2018, this is suspended through 2025, unless the relocation is associated with a posting move by an active member of the military.
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. This deduction is in effect through 2018, but disappears for couples divorced in 2019.
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 2016, 2017, and 2018. This deduction was preserved by the 2017 Tax Cuts and Jobs Act.
10) Up to $2,500 student loan interest. This provision was left untouched by the 2017 Tax Cuts and Jobs Act for 2018 and beyond.
11) Domestic production activities deduction: This is a rare deduction for individual filers.
Itemized deductions or “below the line” deductions (on Schedule A)
2018 law changes: Several changes were made in itemized deductions by the 2017 Tax Cuts and Jobs Act:
(1) the overall limit on itemized deductions is suspended for 2018 through 2025;
(2) the threshold for the medical and dental expense deduction is reduced to 7.5% of adjusted gross income (AGI) for 2017 and 2018; it returns to 10% of AGI starting in 2019;
(3) the deduction for state and local income taxes and property taxes is capped at $10,000 ($5,000 for married filing separately) combined;
(4) mortgage interest paid on a home, including a portion of the points paid to reduce the interest rate, is deductible. For mortgages taken out before December 15, 2017, only the first $1,000,000 is deductible; mortgages executed after that date, only the first $750,000 interest on the loan is deductible. Beginning in 2026, the deduction reverts back to $1 million, no matter your mortgage was executed;
(5) interest on home equity loans is not deductible beginning 2018 through 2025;
(6) the deduction for casualty and theft losses is gone for tax years 2018 through 2025, except that losses in federally-declared disaster areas can be claimed; and
(7) the percentage limitation for charitable donations of cash to public charities is increased to 60%, up from 50%.
Pre-2018 law: 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. The 2017 Tax Cuts and Jobs Act almost doubled the standard deduction for all filers starting 2018 and ending 2025.
Download IRS Pub. 501 for more information.