Money Girl helps you understand how tax deductions work, plus smart strategies to reduce your taxes.
One of the best ways to save money is to understand how to pay less in taxes. This is the second episode in a 2-part series about legal strategies to lower your tax bill.
In Part 1 I covered tax credits and reviewed 5 common ones that you might qualify for. Today, we’ll cover how tax deductions work and who can use them. Plus, you’ll learn 4 additional strategies to reduce your taxes.
What Is a Tax Deduction?
A tax deduction is an amount you can subtract from your taxable income, which reduces the amount of tax you have to pay. For example, if your taxable income is $40,000 and you’re eligible to claim $5,000 in deductions, then you’re only taxed on $35,000.
Many Americans are too lazy to itemize deductions and end up overpaying taxes every year.
What Are Itemized Deductions?
Some tax deductions require you to itemize your tax return and some don’t. So let’s make sure you understand how to itemize.
When you file your tax return you can choose between listing out specific deductions or claiming the standard deduction. You should always choose the method that gives you the largest deduction and saves you the most money.
If you add up your allowable deductions and they total more than the standard deduction, be sure to itemize. However, you must keep records, such as receipts and invoices, to substantiate your itemized deductions. Unfortunately, many Americans are too lazy to do this and end up overpaying taxes every year.
Don’t be one of them!
The best way to make sure that you never miss an itemized tax deduction is to review Schedule A of Form 1040. You’ll see the entire list that you can claim for the tax year. There’s also an instruction sheet for Schedule A, which gives you details about each of the deductions.
What Are Adjustment to Income Deductions?
I mentioned that some deductions don’t require you to itemize on Schedule A. These are called adjustments to income because they adjust or reduce your gross taxable income directly on the main tax form.
Here are some examples of adjustment deductions:
Contributions to a Heath Savings Account (HSA)
Self-employed health insurance
Contributions to retirement plans
Student loan interest
Claiming these deductions means that you don’t have to complete Schedule A; however, some of them do require you to fill out another IRS form or worksheet. Don’t let tax paperwork keep you from saving money. Take the time each year to maintain records and complete forms that will help you cut your tax bill.