Everyone loves tax deductions—they lower how much you owe to the IRS. But understanding how deductions work, when you can take them, and how much they actually save you can be confusing.
What Are Tax Deductions?
Your income tax is calculated as a percentage of your taxable income. A tax deduction reduces the portion of your income that is subject to that calculation. Unlike a tax credit, which reduces your tax bill dollar-for-dollar, a deduction simply lowers your taxable income.
For example, if you earn $100 and your tax rate is 20%, you owe $20 in taxes. If you qualify for a $20 deduction, your taxable income drops to $80, and your tax bill becomes $16. That deduction saved you $4—not $20.
The Standard Deduction
The IRS allows every taxpayer to take a standard deduction without providing receipts or documentation. Thanks to the Tax Cuts and Jobs Act, the standard deduction increased significantly, making it the most common choice for taxpayers.
For the 2020 tax year, the standard deduction amounts are:
- $12,400 for single filers
- $18,650 for head of household
- $24,800 for married filing jointly
If you take the standard deduction, you skip itemizing altogether.
Itemized Deductions
Itemized deductions are specific expenses the IRS allows you to subtract from your taxable income. Unlike the standard deduction, these must be documented with receipts or statements. You should itemize only if the total of your itemized deductions exceeds the standard deduction.
Common itemized deductions include:
Mortgage Interest
You can deduct interest paid on up to $750,000 of mortgage debt across your primary and secondary homes. Home equity loan interest is deductible only if the funds were used to substantially improve the property.
Property Taxes
You may deduct up to $10,000 in combined state and local taxes, including property taxes, state income taxes, and sales taxes. This cap can limit deductions for taxpayers in high-tax states.
Charitable Contributions
Donations to qualified charities are deductible if properly documented. Under current rules, you can deduct up to 60% of your adjusted gross income (AGI) for charitable contributions.
Medical Expenses
Out-of-pocket medical expenses are deductible only to the extent that they exceed 10% of your AGI. For example, with a $100,000 AGI, only expenses above $10,000 qualify.
Above-the-Line Deductions
Above-the-line deductions reduce your adjusted gross income (AGI) directly and are available whether you itemize or take the standard deduction. These deductions can be especially valuable because they stack with the standard deduction.
Common above-the-line deductions include:
Educator Expenses
Eligible K–12 teachers can deduct up to $250 spent out-of-pocket on classroom supplies.
Student Loan Interest
You can deduct up to $2,500 in student loan interest per year, as long as the loan is in your name and you are legally responsible for repayment.
Retirement Contributions
Contributions to retirement accounts may be deductible:
- Up to $18,500 for a 401(k)
- Up to $6,000 for an IRA
(Eligibility and deductibility depend on income and plan type.)
Self-Employment Tax
Self-employed individuals can deduct half of their self-employment tax, helping offset the full Social Security and Medicare taxes they must pay.
Health Savings Account (HSA) Contributions
HSA contributions are deductible up to:
- $3,500 for individual coverage
- $7,000 for family coverage
(2019 limits)
Which Deductions Should You Take?
Start by identifying all above-the-line deductions you qualify for, since these reduce your AGI regardless of which deduction method you choose.
Next, compare your total itemized deductions to the standard deduction:
- If your itemized deductions are less than the standard deduction, take the standard deduction.
- If they are significantly more, itemizing may be worth the extra effort.
The standard deduction is often appealing because it requires no documentation and provides a substantial reduction automatically.
Deduction Examples
Example 1
You’re a single filer with $11,900 in itemized deductions from mortgage interest, property taxes, and charitable contributions. Since the standard deduction is $12,400, taking the standard deduction saves you more and avoids extra paperwork.
Example 2
You’re a single filer with $25,000 in itemized deductions, plus above-the-line deductions for student loan interest and retirement contributions. In this case, itemizing provides a much larger benefit.
Final Thoughts
Tax deductions are a powerful way to reduce your tax bill, but only if you understand which ones apply to you. Reviewing your options carefully—or working with a qualified tax professional—can help ensure you don’t leave money on the table.
