Claiming tax deductions is a powerful strategy for tax filers. Using appropriate deductions can lower your bill, increase your tax refund or make sure you're taking advantage of tax benefits offered by your federal and state governments.
Want to know how to best use tax deductions? Here's your guide to 2020 tax deductions.
What Is a Tax Deduction?
A tax deduction reduces a filer's taxable income. In other words, a deduction "reduces your income in arriving at taxable income," says Charlene Wehring, certified public accountant, financial advisor and founder of Wehring Wealth Management in Bellville, Texas. "And then you apply your (tax) bracket." That's in contrast to a tax credit, which lowers your tax liability dollar for dollar. Tax deductions typically fall into three main categories:
-- The standard deduction.
-- Itemized deductions.
-- Above-the-line deductions.
A filer must choose between taking the standard deduction or itemizing deductions but can use relevant above-the-line deductions regardless of whether they itemize.
The Standard Deduction
The standard deduction is a set amount of money on which you aren't taxed. It's fixed for each tax year and depends on your filing status, age, spouse's age and whether you or your spouse are blind.
Here are the standard deduction amounts for 2020 income (taxes filed in 2021):
Standard Deduction 2020
65 years and older or blind
Married filing jointly
Head of household
Married filing separately
For those who are age 65 or older and blind, the extra deduction amount is doubled. If you are filing taxes as married filing separately and one spouse itemizes deductions, the other must do so also.
Itemized deductions are qualified expenses subtracted from your adjusted gross income, or AGI, to lower your taxable income. Filers who don't take the standard deduction are typically choosing to itemize deductions because the total of those expenses is greater -- and therefore more beneficial -- than their eligible standard deduction amount.
These are common itemized deductions to consider in 2020:
-- Charitable contribution deduction.
-- Home interest deduction.
-- Medical expense deduction.
-- State and local tax deduction.
Charitable contribution deduction. Filers who are charitably inclined may deduct donations given to qualified charitable organizations. Unlike, say, medical expenses, which can be deductible but unpredictable, charitable giving can be a savvy way to plan ahead to reduce your tax liability. "It probably gives you your only chance to do some tax planning," says Craig Richards, director of tax services at Fiduciary Trust International in New York City.
One strategy filers can use is to double up their donations in a single tax year, perhaps donating once in January and again in December. This technique, called "bunching," can increase their deductible charitable contributions for a single year, causing them to outspend the standard deduction and make itemizing in that year the right tax move.
Home interest deduction. Taxpayers who itemize may deduct the interest accrued on the purchase, building or substantial improvement of a qualified residence. For debt accrued after Dec. 15, 2017, you can deduct home mortgage interest on your first $750,000 of indebtedness ($375,000 for married filing separately). For qualified home loans taken before that December cutoff, the previous maximum of $1 million ($500,000 if married filing separately) still applies.
Additionally, a loan used to refinance your home can only be deducted if it's used to substantially improve your home.
Medical expense deduction. Qualified health care expenses such as those spent on the diagnosis, treatment or prevention of a disease may be subtracted from your adjusted gross income as itemized deductions. You may only deduct those unreimbursed medical expenses that exceed 7.5% of your AGI. Unnecessary procedures, such as cosmetic surgery, aren't eligible.
State and local tax deduction. Filers may deduct taxes paid in 2020 up to $10,000 ($5,000 if married filing separately). Those taxes can include state and local personal property taxes, state and local sales tax and other deductible taxes.
[Read: What's My Tax Bracket?]
Above-the-Line Tax Deductions
Deductions that are taken "above the line" are subtracted to reach your adjusted gross income, or AGI, instead of from your AGI, like itemized deductions. You do not need to itemize your deductions to claim these. They are available if you take the standard deduction.
These are common above-the-line deductions to know for 2020:
-- Educator expenses.
-- Health savings account contributions.
-- IRA contributions.
-- Self-employment deductions.
-- Student loan interest.
-- Charitable contributions.
Alimony. Recent divorcees cannot deduct alimony paid to reach adjusted gross income, but if you're paying alimony from a divorce finalized prior to Dec. 31, 2018, you can still deduct it.
Educator expenses. Eligible educators can deduct up to $250 ($500 if married filing jointly and both spouses are educators) of unreimbursed expenses related to your job, including books, supplies and computer equipment.
Health savings account contributions. A health savings account, or HSA, is a dedicated health care account funded by taxpayers who are enrolled in a qualified high-deductible health insurance plan. Those contributions, which are limited to $3,550 for single filers and $7,100 for families in 2020, are deductible as an above-the-line deduction. An additional $1,000 is available if you're 55 or older.
Note: If you fund an HSA through your employer, your contributions may be deducted directly from your paychecks instead.
IRA contributions. Taxpayers who qualify to make deductible traditional IRA contributions, which are subject to limitations based on income and active participation in an employer retirement plan, can deduct up to $6,000 for themselves and $6,000 for a spouse (with a $1,000 catch-up for those 50 and older) as an above-the-line deduction.
Remember that Roth IRA contributions are not deductible.
Self-employment deductions. Self-employed filers may deduct a portion of their self-employment tax, contributions to certain self-employed retirement plans and health insurance premiums, among other deductions.
Student loan interest. Taxpayers who earn below certain "phaseout" amounts may deduct up to $2,500 of student loan interest.
Charitable contributions. A new deduction for 2020 is for charitable contributions of up to $300 to qualified organizations. This is available even if you don't itemize.
New Tax Deductions for 2020
There are a couple of changes to tax deductions for 2020. They include:
-- The $300 charitable contribution deduction.
-- Charitable deduction limitations based on AGI.
-- Deductible IRA contributions for older workers.
Here is more information on each 2020 deduction:
The $300 charitable contribution deduction. A new deduction for 2020 is for charitable contributions of up to $300 to qualified organizations. This above-the-line deduction applies to cash donations made before Dec. 31, 2020, and is available even if you don't itemize. To determine whether your chosen charity is qualified, search for it on the IRS's tax-exempt organization search tool.
Charitable deduction limitations based on AGI. Taxpayers anticipating making large donations in 2020 may deduct a larger portion of their donation. That's because many charitable deductions were previously limited to up to 60% of adjusted gross income. For 2020, those contributions can be deducted up to 100% of AGI. This applies to large gifts (as a portion of income) and filers who itemize.
Deductible IRA contributions for older workers. Retirement savers no longer need to be younger than age 70 1/2 to take a deduction for IRA contributions. You need earned income to make deductible contributions, Wehring says.
How to Maximize Your Deductions
When claiming deductions, don't forget to keep good records. You'll need a paper trail to back up deductions for certain expenses such as charitable deductions topping $250 and medical expenses.
Keep in mind that a deduction not available under federal law may still be available under state law. "Even though the IRS may not let you deduct it, the state could," Wehring says. So review your state's deductions or call your tax preparer to ensure you're not tossing documents that could still score you a state tax benefit.
Bunching or doubling up on itemized deductions may be a strategy that works to help you qualify to take itemized deductions in a given year. Wehring recommends looking into bunching charitable contributions and making sure to make property tax payments before the year ends. "Pay in January and pay in December, so you bunch your property taxes to get up to the $10,000, and then bunch the charitable contributions to put you over the top."