Everyone is looking for ways to save money. This can be accomplished in a number of ways, including knowing how to legally reduce the amount you have to pay the IRS in taxes each year. To do this, it is important to understand how to reduce your tax liability. Tax credits and tax deductions are the easiest way to save money on your IRS tax bill, however contrary to what many taxpayers believe there is a difference between the two. A tax credit actually reduces your tax bill dollar for dollar, where as a tax deduction reduces the amount of taxable income. Here we look tax deductions and the four basic categories in which they fall.
- Standard tax deduction – For many taxpayers, the standard deduction is the simplest and most convenient deduction to take when filing their tax return. According to the United States tax law, the standard deduction is the dollar amount that individuals who chose not to itemize may deduct from their income. This is a fixed amount that is based on the filing status. For 2010, the standard deduction remains unchanged from 2009 with the exception of a $50 increase for those filing Head of Household. Most taxpayers opt for the standard deduction unless additional savings can be realized through other deductions.
- Itemized tax deductions– In some cases, itemized tax deductions can result in more savings than taking the easy route with the standard deduction. People who have purchased a home can deduct interest, mortgage insurance premiums and real estate tax. Other deductions that are popular among itemizers yet still overlooked by many taxpayers include; certain medical expenses, state and local income taxes, charitable contributions, casualty losses, out-of-pocket job expenses that are not reimbursed and dozens of miscellaneous expenses.
- Schedule C deductions – Business owners can claim additional deductions relating to their business. These deductions are claimed on the business Schedule C (or Schedule F for farmers, Schedule E for rental property). These deductions include; business liability insurance, vehicle expenses, home office expenses, advertising expenses, legal services, professional services, and compensation paid as a result of the business.
- Above-the-line deductions – The name describes these deductions, they are deductions you can claim above or in addition to standard or itemized deductions. Ask your tax preparer about above-the-line deductions to ensure you qualify. They may include student loan interest, tuition and fees, moving expenses, paid alimony, military reservists deduction, traditional IRA contributions and contributions to health savings accounts. Self employed individuals can also claim the following above-the-line tax deductions; half of self-employment tax, health insurance premiums and contributions to SEPs and SIMPLE plans.
When you understand the different types of deductions and who can utilize each, it becomes easier to save money on your tax bill. The IRS frowns upon taxpayers who attempt to reduce their tax liability in illegal ways, therefore it is imperative to know what strategies are acceptable and what actions may be illegal. When you claim qualified tax deductions on your tax return, they offer a safe, convenient and easy way to reduce how much money you owe the IRS.