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How Do Tax Deductions Work

How Do Tax Deductions Work Photo

©Depositphotos/sepavone

Perhaps you have already heard phrases such as “deductible expenses”, “you can deduct that” and “you can write that off”. But do you understand what these phrases mean? It basically revolves around tax deduction, the legitimate expenditures that can be subtracted under an acknowledged law. This is deducted from the gross income which is adjusted technically by a given period.

Both ordinary people and companies or businesses can have a tax deduction claim. This is often done during the yearly income tax reporting. This report is forwarded to the state, federal and sometimes to the local government revenue bureau. Although there’s a basic step towards cleaning tax deduction, they key remains stable. It is to obtain a strong grasp of what kinds of expenses can be claimed as such.

Kinds of deductions

Standard deduction

This is the amount that the internal revenue service allows you to deduct from your adjusted gross income. All these will be based on your filing state or status. Keep in mind that this will be effective only for the non-itemizers. Hence, if you itemize, there’s less chance for you to claim a basic or standard deduction.

Above the line deduction

The above the line deduction is the one that is usually deducted from your gross income. To obtain the adjusted gross income or AGI, you should minus the above the line deduction from your gross income. Should be visible on your tax form or else you cannot claim this kind of privilege. Unlike the standard deduction, this can be claimed by those who itemize and who don’t.

Itemized deduction

You may assume that this is the total opposite of the standard deduction. Although that’s quite true, there’s more to itemize tax deduction. It is more like a kind of receipts of the stuffs that you paid for, which equally have an effect to your tax status. With itemized deductions, you can only make a claim if its total amount is bigger than the standard deduction.

Examples of tax deduction

Health care expenses

Most people thought that writing off on health expenses is not possible. On the contrary, it is. Although your out-of-pocket expenditures should first exceed 7.5% of your overall AGI before you can make a claim, the fact still remains that it is possible. The only catch though is that the standards are quite high.

Charity

You can also make a tax deduction claim with your charitable donations. If you donated to public organizations, you can make a tax deduction claim of up to 50% of the entire donation. However if your contributions show signs of investment or capital gain, most likely you’ll only have the limit of 30% tax deduction claim.

Credits for the self-employed

If you’re a self-employed such as those who are working online, you can deduct at least half of your tax. You can also make a tax deduction claim that is half of your contributions to a retirement plan like SIMPLE, Roth IRA or SEP as well as to your health insurance premium. Your home rental percentage and electricity service bill alongside phone bills can also count.