A couple of weeks ago I wrote about the first step in understanding taxes: knowing which tax bracket you fall in. The next part of understanding taxes is to learn about TAX DEDUCTIONS!
A tax deduction is different from a tax credit. A DEDUCTION (most common) simply allows you to reduce the amount of income that is going to be taxed by the Federal government (and in most cases your state government).
For instance, if you made $30,000 in 2011, but have $7,500 worth of deductions, then you’re only going to get taxed (Federal taxes) on $22,500.
A tax credit on the other hand deducts a specific amount that you owe in taxes. For instance, if you have a child and qualify for the child tax credit, then you will owe $1,000 less in Federal taxes.
So, if you made $30,000, you’d still pay taxes on $30,000 (less deductions) but you’d also have the $1,000 credit that would lessen the total amount you owe or may increase the amount you get back dollar-for-dollar.
I talk to people on a consistant basis that have a couple thousand dollars worth of deductions, however they’re not sure if they should keep track of them all and list them in their tax filings.
Well, the first thing you must know is that if you have $0 worth of deductions or $4000, you’re entitled (as long as you qualify) to the Standard Deduction.
If you’re a single person (and you had enough earned income), you’re going to automatically get a $5,800 tax deduction for your 2011 tax return!
So, if you’re wondering whether or not you should “itemize” then you first must answer the question: ‘Do I have more deductions than $5,800?’
You don’t get to itemize UNLESS your deductions amount to more than the standard deduction of $5,800. Now there are a few deductions you can claim without having to itemize – more on that next week.
Knowing whether or not you only qualify for the Standard Deduction is important for a few reasons:
1. It saves you time. If you know you don’t need to be keeping track of all of the forms that come in around January 31st, then you won’t be wasting any time keeping track of useless information.
2. It saves you money. If you only qualify for the Standard Deduction, then it’s likely you’ll only have to use form 1040EZ which you can do on your own or use a company like Turbo Tax and file your Federal Taxes for free.
Now, if you’re married and file taxes “Married Filing Jointly” then your standard tax deduction is $11,600! ($5800 x 2)
All of the principles I mentioned above work for you too…now you just have a larger amount to get to if you want to itemize.
Frankly, it’s important to know this first step in understanding tax deductions because it helps you fight the ridiculous statement of ‘this is good debt because you can deduct the interest.’
Having $11,600 worth of deductions is difficult – especially if you don’t have children and day care expenses! Certainly, if you don’t own a home (and sometimes even if you do) it will be unlikely you’ll need to itemize and you’ll simply only need to use the STANDARD DEDUCTION.
So, contrary to popular belief, you might not be able to deduct any of the interest your paying on your mortgage!
Check back next week as I’ll be detailing many of the common tax deductions you may have if you itemize. More importantly, I’ll detail a few “above the line deductions” that you can claim even if you don’t itemize and use the Standard Deduction.
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