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What expenses are tax-deductible? This is a common question among my clients. Although the answer isn’t simple, it’s important to understand because it can significantly reduce your tax bill.
Whether or not you can deduct an expense depends on what it is for and how it is categorized. Personal expenses differ from business expenses, and within personal expenses, there are different types of deductions.
Tax-Deductible Personal Expenses
There are two types of personal tax-deductible expenses:
- “Above-the-line deductions,” also called adjustments to income. Any taxpayer can claim these if he or she has qualifying expenses, regardless of whether they itemize their tax deductions.
- “Below-the-line deductions.” You must itemize your tax deductions using Schedule A to claim these.
Above-the-line deductions are more powerful than below-the-line deductions because they lower your adjusted gross income. This is helpful because when your adjusted gross income exceeds a certain amount, the total amount of itemized deductions you can take begins to phase out. Several tax breaks are based on your adjusted gross income, so lowering it can reduce your taxes further.
Above-the-line deductions include:
- Educator expenses. Teachers can deduct up to $250 for materials and supplies that they buy for their classrooms
- Health savings account (HSA). If you have a “high-deductible” health insurance plan, you can contribute (and deduct) up to $3,350 to an HSA if you are single, $6,650 if you are married. If you are age 55 or over, you can deduct an additional $1,000 in contributions. As long as you use the money for approved health care expenses, the money that you take out of an HSA is tax-free.
- Moving expenses. If you had to move for work because your new job is more than 50 miles farther from your old home than your previous job, you can deduct certain moving expenses.
- Self-employed retirement plans. Contributions to such a plan are deductible.
- Self-employed health insurance. If you are self-employed and pay for your own health coverage, it is deductible.
- Alimony paid. Payments to your former spouse for alimony are tax-deductible. (Your ex-spouse must report alimony received as taxable income) This does not include child support payments.
- Contributions to a traditional IRA of up to $5,500, or $6,500 if you are age 55 or older, can typically be deducted. Roth IRA contributions are not deductible.
- Student loan interest. If you meet adjusted gross income limitations, you can deduct certain student loan interest.
- Tuition and fees. If you meet certain requirements, you can deduct up to $4,000 of the cost of tuition, fees and certain required materials.
Below-the-line (itemized) deductions include:
- Medical expenses. You can deduct medical expenses and dental expenses that exceed 10% of your adjusted gross income.
- State and local taxes. Income taxes paid to state and local governments are deductible.
- Sales tax. If you live in a state that doesn’t have income tax, you can deduct sales tax instead. (You can also choose to deduct sales taxes rather than state and local income taxes, but you can’t deduct both.)
- Real estate tax. You can deduct property taxes on your main home and any non-business or rental property in the year you paid it.
- Personal property taxes. Taxes that are based on the value of personal property (such as vehicles) are deductible.
- Home mortgage interest and points. Points are interest that you pay upfront to acquire a mortgage (usually to get better terms like a lower rate).
- Cash and other gifts to charity. Generally you can deduct gifts to charity up to 50% of your adjusted gross income (30% for certain types of organizations). These donations can be cash or other property, but restrictions apply.
- Theft and casualty losses. For instance, if your home is burglarized or suffers a fire and your insurance company doesn’t reimburse you for the items stolen or the damage, this would be considered a deductible loss. Calculating these losses can be complex, and certain limits and reductions apply.
- Gambling losses. You can deduct your gambling losses to the extent of your gambling winnings. (Say you win $1,000 and lose $5,000; you can deduct only $1,000 of your losses.)
- Unreimbursed employee expenses and tax preparation fees. These expenses are subject to the “2% limit” — add them up, then subtract 2% of your adjusted gross income. Whatever’s left over is deductible.
Tax-deductible business expenses
Tax deductions for business expenses can be explained with this rule of thumb: Anything that is an ordinary or necessary expense for your business, or that enhances your business, is deductible.
Some business expenses are limited. For instance, if you entertain clients by taking them to lunch, your deduction for the cost of the lunch is limited to 50%. For business gifts to clients, only $25 per person is deductible each year. Auto expenses are also limited.
When you buy equipment, real estate, and tangible property over $500, the deduction must be taken as depreciation rather than as a direct expense. Depreciation spreads the cost of an asset over its useful life. For instance, if you buy a computer for $1,000, you can deduct $1,000 over a period of five years.
The bottom line
Clearly, many expenses are deductible — too many to ever draw up a complete list. Be sure to keep good records, especially when it comes to above-the-line personal expenses. Making sure you get all of the above-the-line deductions you are eligible for may help you get even more below-the-line deductions, too.
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