As tax time rolls around, there are several questions we hear more regularly. One common query is whether a client should itemize deductions or take the standard deduction. Before answering that, we thought it would be helpful to take a look at the difference between exemptions, credits, and deductions.
- Deductions – also reduce your taxable income and are for things you did like making charitable contributions, student loan interest, tax preparation fees, and retirement contributions.
- Credits – reduce your tax bill for things such as continuing education, earning a low income with the Earned Income Tax credit, child tax credit, improving your home with energy-saving measures, or buying an electric car.
Deductions take the amount of income earned and reduce it, creating a lower overall taxable income. Credits don’t change your taxable income, but they are helpful in reducing the amount owed or increasing the amount of your refund.
The standard deduction is most common for several reasons, but mainly because it is the easiest option. A standard amount is offered, depending on your filing status, and this amount reduces your total taxable income by the following amounts in 2020:
- Single or married filing separately — $12,400
- Married filing jointly or qualifying widow(er) — $24,800
- Head of household — $18,60
Taking the standard deduction saves time throughout the year as it means not needing to save expense paperwork. Standard deductions are also perfect for the taxpayer who does not accrue deductible expenses during the year. Most taxpayers will ultimately take the simpler standard deduction when filing, but itemizing your deductions can result in bigger tax savings. Look at the deductible expenses you paid in 2020. Such expenses include unreimbursed medical expenses, home mortgage interest, property taxes, and gifts to charities. Comparing this number with your standard deduction can help to make the most informed decision.
If you have any questions or concerns regarding the implications of tax deductions, we encourage you to reach out to us here.