Every year, millions of Americans gather up their W2, 1099s, and other various forms to file their federal income tax forms. About 33% of all Americans itemize their deductions. It is important to understand how itemized deductions work to ensure you get the best tax rate possible.
If you are single, you automatically get a standard deduction of $5,800. Couples filing jointly get a standard deduction of $11,600 (2011 rates). The standard deduction acts as a minimum deduction amount if you do not qualify for higher deductions. 66% of taxpayers use the standard deduction.
Here is how it works in practice. If you earn $40,000 and file a standard deduction, your taxable income is $34,200. You deduct that amount from your income and calculate your taxes based on that lower rate, called your taxable income.
If you qualify for deductions higher than the standard deduction, you can itemize your tax deductions. The most common itemizations are listed below.
Principle Residence Mortgage Interest
If you own a home, you can deduct the interest paid on your mortgage. I bought my first home this year, and I have been paying interest on my mortgage payment every month. You will receive a tax form 1098 from your bank giving you the qualified interest amount for deduction.
When you give money to a 501(c)3 non-profit, save your receipts. If you donate anything to a non-profit, save all of the paperwork they give you. Every non-profit donation counts if you are going to itemize your taxes.
Be warned that disproportionately high donation deductions are considered suspicious by the IRS. Keep your receipts in case you are audited.
If you are going to school, you can deduct tuition and related expenses such as books and fees. You cannot deduct room and board. Your school will give you a tax form listing your tuition and fees, but you are responsible for keeping receipts for your textbooks.
If you have a student loan, you can also deduct the interest expense for the life of the loan. While I am about two years out of school, I am still deducting about four hundred dollars from student loan interest in 2011.
This is a tricky area, but very important for the entrepreneurs out there. If you own a small business, you can deduct the expenses directly related to operating it. I deduct the expenses from running my websites, for example, including web registration fees, hosting expenses, design expenses, and a portion of my internet costs.
Just beware that the IRS may consider your business a hobby if you are not profitable for five consecutive years. I lost money on my DJ business in 2011, but that is because of the expenses to start up, I should be profitable in 2012 and will have to pay taxes on that income.
There are tons of deductions, and I can’t write about all of them. Lucky for us, the IRS already did. You can get the details for every type of expense at the IRS website. When in doubt, you can call the IRS or ask your accountant for advice.
Get Started Right Away
If you have not started your taxes yet, you are running out of time. I have used TurboTax in the past and it is an easy and simple way to file your tax return online.
Do you take the standard deduction or itemize? What have you learned from trying to itemize? Did you find out about something you qualified for that surprised you? Please share in the comments.
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