Getting a tax deduction or credit helps you keep more money in your pocket come tax time. But they both work in completely different ways. Here’s a cheat sheet on how they work and an overview of 36 tax deductions and credits you could use to lower your tax bill this year.
What is a tax deduction?
The US uses a tiered tax bracket system, so the more you earn, the more you pay. Tax deductions are expenses that you subtract from your total taxable income. They usually reduce your tax bill by a percentage. For example, if you’re in the 22% income bracket and you’ve got a tax deduction of $1,000, you’d save $220.
Standard deductions vs. itemized deductions
Standard and itemized are two major categories of deductions available to US citizens. Here’s what you need to know about each:
Every US citizen is eligible for this deduction, regardless of the purchases they’ve made in a year. A standard deduction is meant to reduce your overall tax bill. It’s estimated that 95% of Americans will use standard deductions this year.
If you choose to list every single deductible expense you’ve made throughout the year, those are itemized deductions. Typically, you’d only choose to itemize deductions if the sum is more than what your standard deduction would be.
Standard deductions for 2020 include:
|Tax filing status||2020 standard deduction|
Married filing jointly
Head of household
Married filing separately
Should I itemize or take the standard deduction?
You should choose whichever method saves you the most money. To figure this out, add up all your itemized deductions, including mortgage interest, property taxes, state income or sales tax, charitable contributions, medical expenses and more. If the total of your itemized deductions exceeds your standard deduction limit, you’re better off itemizing. But if your itemized total is below this limit, you’ll save more money if you stick with the standard deduction.
What is a tax credit?
Tax credits are rare gems of the tax world because they reduce your tax bill dollar-for-dollar. If you get a tax credit worth $500, then your tax bill would be reduced by exactly $500.
There are two major types of tax credits: refundable and non-refundable. If a credit is refundable, you receive a refund if the credit reduces your tax bill to $0 and there’s still some leftover. Non-refundable tax credits only reduce your tax bill by the amount owed. If you owe $500 but your tax credit is worth $1,000, you don’t receive a refund for the extra amount.
21 tax deductions and credits for individuals
There are tons of deductions and credits you may qualify for as an individual. Here’s a look at 21 popular tax breaks:
- Earned income tax credit. If your adjusted gross income is less than $56,845, you could get a credit worth $538 to $6,660 depending on your filing status and number of dependents.
- Child and dependent care credit. If you pay for dependent care for a child under 13 or an incapacitated spouse or parent, you could be entitled to a credit up to 35% of your care expenses.
- Child tax credit. The child tax credit pays $2,000 for each qualifying dependent under age 17 and $500 for each qualifying child age 17 to 24.
- Adoption credit. For 2020, you could get a refund for up to $14,300 in adoption costs per child depending on your adjusted gross income.
- Saver’s credit. You could get a credit worth up to $1,000 if you contributed to an IRA or ABLE account this year.
- Electric vehicle tax credit. If you bought a new electric or plug-in vehicle, you could get a credit worth up to $7,500 depending on the size of your car’s battery.
- Residential energy credit. Taxpayers who make qualified energy efficiency improvements could get a credit of up to $500.
- American opportunity tax credit. Undergraduate students and their parents can claim 100% of the first $2,000 they spent on tuition, books and fees and 25% of the next $2,000 they spent, making this credit worth $2,500 in total.
- Lifetime learning credit. Undergraduate, graduate and vocational students can get a refund for 20% of the first $10,000 they spend on tuition, fees, books and supplies. But you can’t claim both the American Opportunity tax credit and the Lifetime Learning credit in the same year.
- SALT deductions (state and local taxes). For 2020, you can write off up to $10,000 in state and local income tax or state and local sales tax. If you’re married and filing separately, you can deduct up to $5,000.
- Personal property tax. Those who itemize their taxes can deduct up to $10,000 worth of state and local property taxes they paid for real estate, cars, boats, planes, land and more. Taxpayers who are married and filing separately can deduct up to $5,000.
- Charitable contributions. Generally, you can deduct all of your qualified charitable contributions as long as they don’t exceed 100% of your adjusted gross income. Although there may be some exceptions.
- Gambling loss deduction. You can deduct gambling losses up to the amount equal to your gambling winnings. So, if you bought $500 worth of lottery tickets, you can deduct those expenses if you have at least $500 in winnings.
- Mortgage interest deduction. Homeowners who itemize their taxes can write off mortgage interest on the first $750,000 to $1 million of their secured loan depending on when they bought the home.
- Moving expenses. As of 2018, only members of the military can deduct moving expenses.
- Student loan interest. You can deduct what you paid during the year up to $2,500 with this deduction.
- Teacher educational expenses. Teachers can deduct up to $250 worth of classroom expenses each year. And under the COVID-related Tax Relief Act of 2020, teachers can now deduct out-of-pocket expenses for items like hand sanitizer, soap, face masks, air purifiers and more if classroom purchases were made after March 12, 2020.
- Medical and dental expenses. If your medical expenses exceeded 7.5% of your adjusted gross income for the year, you may be able to claim these expenses using the medical expense deduction.
- Health savings account (HSA) deduction. You may be able to deduct 100% of your health savings contributions, which are capped at $3,550 for individual plans and $7,100 for family plans in 2020.
- IRA contribution deduction. If you contributed to an IRA this year, you may qualify for a full or partial deduction depending on your income and whether you or your spouse had access to an employer-sponsored retirement plan.
- Capital losses. If your capital losses were more than your capital gains, you could write off up to $3,000 in 2020. If you’re married filing separately, you can write off up to $1,500. If your losses are over these limits, you may be able to carry them over into future tax years.
17 tax deductions and credits for businesses
As a business owner, there are several deductions and credits you can take advantage of to reduce your tax bill.
- Paid sick leave credit. If you have an employee who is unable to work due to COVID-19 symptoms or self-quarantine, you may be eligible to receive a refundable credit for the employee’s regular rate of pay, up to $511 a day for a total of 10 days. To qualify, you must have an American business with fewer than 500 employees.
- Child care leave credit. If an employee is unable to work because their child’s school was closed due to the coronavirus outbreak, you may receive a refundable credit equal to two-thirds of the employee’s regular pay for up to 10 weeks of qualifying leave. The credit is capped at $200 a day or $10,000 total for each employee. You must have an American business with fewer than 500 employees to qualify.
- Manufacturers’ energy-efficient appliance credit. You could receive a credit for select dishwashers, clothes washers and refrigerators manufactured in 2011 or later.
- Plug-in electric drive vehicle credit. You could get a credit worth up to $7,500 if you bought an electric or plug-in vehicle in 2010 or later and used it for your business.
- Research credit. Businesses can use the research credit to deduct the cost of qualified research and offset the FICA portion of payroll taxes.
- Home office deduction. Small business owners, freelancers and self-employed workers can deduct mortgage interest, rent, utility bills, insurance and more under the home office deduction.
- Self-employed health insurance deduction. Self-employed workers who aren’t eligible for health insurance through their employer or their spouse’s employer can deduct 100% of health care premiums for themselves, their spouses and their dependents.
- Start-up costs. New business owners can deduct up to $5,000 in start-up and organizational costs.
- Employee business expenses. If you have any full-time or part-time employees, you can deduct their wages from your taxes.
- Retirement plans. If you set aside money for you or your employees’ retirement accounts, you may be able to deduct these expenses.
- Interest. Any interest you paid on borrowed money needed to run your business is tax deductible.
- Taxes. If you paid any federal, state, local or foreign taxes on behalf of your business, you can deduct these as a business expense.
- Insurance. If you bought any insurance for your trade, business or profession, you can deduct these from your taxes.
- Vehicle expenses. If you use your vehicle for business purposes, you can deduct the price of gas, maintenance, parking, tolls and more.
- Business meals and entertainment deduction. If you’ve spent any time wining and dining your clients this year, you can generally deduct 50% to 100% of those expenses.
- Office supplies and expenses. Routine office expenses such as computer software, phone lines, website services, merchant account fees and more are tax deductible. Office supplies, such as pens, paper and cleaning supplies are also deductible as long as you use them during the year they’re purchased.
- Unreimbursed employee expenses. In the past, employees could write off cash they spent buying a uniform for the workplace. But the Tax Cuts and Jobs Act of 2018 eliminated this deduction.
Qualified business income
Business owners can deduct up to 20% of their QBI, or qualified business income, as a pass-through deduction. That means you can write off 20% of income earned as a result of a business, though you must be an owner through either a sole proprietorship, partnership, S corporation, trust or estate.
More guides on tax deductions
What’s not claimable as a tax deduction?
Eligible tax deductions get updated by the US government from time to time, and the 2018 Tax Cuts and Jobs Act rendered the following deductions obsolete:
- Tuition and fees deduction
- Casualty and theft losses deduction (unless losses were caused by a disaster officially declared by the federal government)
- Unreimbursed employee expenses
- Tax preparation costs
- Hobby expenses
- Employer-subsidized parking and transportation reimbursement
- Above-the-line deduction for moving expenses related to a job
- Above-the-line deduction for alimony payments related to divorces that happened after December 31, 2018
Finally, all deductions that had previously been listed under the IRS’s “miscellaneous deductions” category no longer exist.
How do income tax deductions work in the US?
Your taxable income is the total amount of money that you’re required to pay tax on. By claiming an expense as a tax deduction, you are reducing your taxable income and therefore reducing the amount of tax you’re legally required to pay.
The US uses a tiered tax bracket, so the more money you make the more taxes you’re required to pay.
Taxable income table for 2020
|Taxable income||Tax on this income|
10% of taxable income
$987.50 + 12% of the amount over $9,875
$4,617.50 + 22% of the amount over $40,125
$14,605.50 + 24% of the amount over $85,525
$33,271.50 + 32% of the amount over $163,300
$47,367.50 + 35% of the amount over $207,350
$156,235 + 37% of the amount over $518,400
Case study: Tax deductions in action
For example, if you made $45,000 and don’t make any deductions you would owe:
$4,617.50 + ((45,000 – 40,125) x .22) = $5,690.
However, if you made $45,000 but your student loan interest deduction is $2,000, that equation would look more like:
$4,617.50 + ((43,000 – 40,125) x .22) = $5,250.
In that case, you’d save $440 on taxes in a given year due to your deduction.
What are above-the-line deductions?
Above-the-line deductions are essentially adjustments to your income — expenses you subtract before calculating the adjusted gross income (AGI). Some common examples include educator expenses, student loan interest, the health savings account deduction and the IRA deduction. Below the AGI line are the standard deduction and itemized deductions.
Income tax deductions are meant to alleviate the burden of what you owe the government. It’s worth exploring all avenues where you might save. For more help, check with an accountant or compare tax software that can guide you through filing your income tax return.
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