When it’s tax season, there’s often the mention of tax deductions which are said to lower the tax payable, but what really is a deduction and why is it important?
What Is a Tax Deduction?
A tax deduction is an expense which the IRS lets you subtract from your gross income before calculating the income tax, thus an expense which the IRS gives the benefit of reducing the tax liability through deduction.
Let’s say you earned $50,000 and claimed $2,000 in deductions. Your taxable income would be $48,000. You won’t be saving the whole $2,000, but a portion of it based on your tax slab.
How Much Does a Deduction Save You?
The savings a person accrues from a deduction are based on the marginal tax rate. If you are in the 22% tax bracket, a $1000 deduction would reduce tax payable by $220. If you’re in the 12% bracket, the same deduction would only account for $120 in tax savings.
With each succeeding tax slab, the benefit of deduction increases making it more advantageous for higher income earners.
Types of Deductions
Here are two main types:
- Standard Deduction: This is based on a set dollar amount depending on your filing status: single or married. Accordingly, this is the most common deduction.
- Itemized Deductions: This is based on specific expenses which include mortgage interest, medical expenses, and charitable contributions which are recorded. Usually, you don’t itemize unless your total deductions are higher than the standard deduction.
Why Do Deductions Exist?
Deductions are meant to give a certain allowance for different kinds of expenses, promote beneficial activities like home buying or charity, and lower the amount of taxable income.
The Bottom Line
The main aim is to reduce the income amount on which taxes are calculated, thus reducing the tax bill. Deductions, while complex and multi-step, lead to a lower tax bill although the benefit is not as high as the claimed amount and combined with smart tax strategies can lead to lower tax liability.
In the case of professional assistance requirement, contact Dimov NYC CPA today to get expert aid and maximize your tax-saving opportunities.