Financial Word of the Week: Tax Deductions
Tax season is upon us. Have you filed your taxes yet? Our April series on tax terms will help you navigate the filing process, even if it’s for next year. Let’s start with tax deductions.
There are several types of tax deductions. A deduction is an expense or other amount that the IRS allows you to use to offset against your income to ultimately reduce the amount of income tax that you owe. Certain expenses are considered “above-the-line deductions” and are deducted from your gross income. These might include certain business expenses, alimony paid, or if you make contributions to a Traditional IRA, among others. The income remaining is called your Adjusted Gross Income. You can now look at another set of possible deductions, sometimes called “below-the-line deductions”.
You have two options when it comes to below-the-line deductions. These deductions are subtracted from your Adjusted Gross Income to arrive at Taxable Income. You simply choose the option that will reduce your Taxable Income the most:
- Standard deduction – the standard deduction was created to simplify the life of the “average” taxpayer. Instead of making everyone responsible for documenting their deductible expenses, the IRS allows taxpayers to deduct a fixed amount as a standard deduction. The amount of the standard deduction will depend on your filing status (single, married filing joint, etc), whether you are 65 or older, or blind. The amount might change each year. The standard deduction would likely apply to you if your tax situation is relatively simple.
- Itemized deduction – there are certain expenses that the IRS allows you to deduct from your Adjusted Gross Income such as mortgage interest, charitable contributions, and uninsured medical expenses to name a few. When you add up all these itemized deductions and the amount is greater than the standard deduction amount, you should use the itemized deduction amount to reduce your Adjusted Gross Income. Just make sure you have proper documentation of these expenses or the IRS might disallow them, causing you to pay more in taxes than you otherwise would have to.
The Internal Revenue Service website has a list‡ of potential deductions. This list details what can be deducted and the limits that apply to certain deductions.
For more advice on taking advantage of your tax credits, check out our recent blog post.
*This post is not meant to replace the advice of a tax professional.
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UMB Financial Corporation (Nasdaq: UMBF) is a diversified financial holding company headquartered in Kansas City, Mo., offering complete banking services, payment solutions, asset servicing and institutional investment management to customers. UMB operates banking and wealth management centers throughout Missouri, Illinois, Colorado, Kansas, Oklahoma, Nebraska, Arizona and Texas, as well as two national specialty-lending businesses. Subsidiaries of the holding company include companies that offer services to mutual funds and alternative-investment entities and registered investment advisors that offer equity and fixed income strategies to institutions and individual investors.