Most taxpayers will give anything to reduce what they eventually send to Uncle Sam. An effective way to significantly bring down your tax bill is to be smart and wise about the deductions you want to claim.
In structuring your deduction, there is a choice between two options: You can either itemize or go via the standard deduction route.
Making the wrong move here can translate to more tax on your income than usual. As a result, taxpayers need to know the worth of standard deductions. Even though this is a factor of your filing status, there is a silver lining for all taxpayers – 2020 was and has been a year of a higher standard deduction.
By What Value is the Standard Deduction Going Up?
We will illustrate this better with the table below. It reflects how the standard deduction increased from 2019 to 2020 for every filing status.
Data Source: Internal Revenue Service
How can one Claim the Standard Deduction?
If you want to claim the standard deduction, all you have to do is remove the amounts specified above from your income. The value that is left is what Uncle Sam will tax.
Consider a single filer, for instance, with an income of $15,000. The taxable income will be $15,000 minus $12,400 (the value for single filer) which gives $2,600.
For a head of household with an income of $30,000, the person will subtract $18,650 from $30,000, which gives $11,350. You will only be taxed on $11,350
What to Know about the Standard Deduction method
If you claim the standard deduction, you cannot claim other deductions again. It also prohibits you from dedicating charitable gifts or property taxes that should apply to mortgage interest, for example. There are, however, times when claiming the standard deduction is not a good move. For instance, if for a specific expenditure, your deduction is more than the standard deduction, itemizing is the way to go rather than claiming the standard deduction.
However, the good news is that the standard deduction approach allows you to claim a couple of other deductions. With this, deductions for student loan interest, IRA contributions, and the savings you made to a health account can be claimed.
With this approach, let us consider a married taxpayer filing separately. Assuming such a taxpayer made $5,000 in tax-deductible contribution to a retirement account (IRA), and you qualify for the entire $2,500 student loan interest deduction, you can reduce your taxable income by as much as $20,000.
In taking a deduction, it reduces the total value of the amount you are taxed on. For a taxpayer with $20,000 in deduction with a household income of $25,000, Uncle Sam can only tax $5000 of the entire income.
Taxpayers should note that they are not the same as tax credits. Tax credits are more valuable than deductions as they allow taxpayers to reduce their tax owed using a dollar to dollar reduction approach. A deduction will reduce your tax bill since you will not have to pay tax on the portion you deduct. A credit, on the other hand, cancels some part of your tax. With this, a credit of $1,500 on a tax of $2,500 only leaves you with a total tax of $1,000.
Higher Standard Deduction benefits a Lot of taxpayers.
Due to the high value of the standard deduction, a lot of taxpayers discovered that claiming it is better rather than itemizing. These taxpayers will all benefit from the boost in the standard deduction.
These increases apply every year to cushion the effect of inflation. This gives some soothing feeling knowing that you can reduce something more from your entire taxable income.
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