The Basics
Congress has created two types of write-offs you can use to reduce your tax bill. One is a deduction, which is a subtraction from your reportable income. The other is a tax credit, which is a subtraction from your tax liability. On a dollar-for-dollar basis, a tax credit produces greater tax savings than a deduction.
The savings from a deduction depends on your tax bracket. For someone in the 25% tax bracket, a $100 deduction saves $25. In contrast, every tax credit saves one dollar in taxes, so a $25 tax credit cuts the tax bill by $25 (regardless of your tax bracket).
There are two classes of tax deductions:
- Deductions from gross income. These are commonly referred to as "above-the-line deductions." They are taken into account on page 1 of Form 1040 and are used to determine your adjusted gross income. Deductions from gross income include such write-offs as losses from business and investments, alimony payments, moving expenses, and contributions to health savings accounts and deductible IRAs.
- Itemized deductions. These are personal deductions that are claimed in lieu of the standard deduction. Itemized deductions include deductions for charitable contributions, interest payments, state and local taxes, medical expenses, casualty and theft losses, and various miscellaneous itemized expenses. Several itemized deductions have limits based on adjusted gross income.
Miscellaneous itemized expenses include a wide array of costs. These can relate to investment activities or work-related expenses not covered by your employer. Examples of unreimbursed employee business expenses include:
- Business use of your personal car or truck
- Union dues and work clothes
- Travel and entertainment expenses
If you don't itemize deductions, you can claim a standard deduction amount (in addition to any deductions from gross income). The standard deduction amount is tied to your filing status and whether you are age 65 or older and/or legally blind.
Some write-offs don't fit neatly into a particular deduction category. For example, you may be able to deduct some education costs from gross income or you may have to deduct the costs as an itemized deduction.
