One of the most misunderstood aspects of taxes is a “deduction.” In order to understand a deduction, you have to first understand what amount is being taxed – usually in the context of an income tax.
Gross income is the total amount of wages and other income that you earn. However, not all of that income is considered taxable. The difference between taxable income and gross income is the amount that is “deducted” – or considered exempt from taxation – for a variety of reasons.
The “deducted” amount is not taxed. Accordingly, a larger deduction means that your taxable income will be lower, so you pay taxes on a smaller amount of money and therefore pay less in taxes.
Standard vs Itemized Deduction
In the US, taxpayers have two options for calculating the amount of exempt income to subtract from their taxable income: utilize the “standard deduction” or take “itemized deductions.”
The IRS sets a standard deduction each year for different taxpayers. For 2022, that standard deduction is $12,950 for single filers and $25,900 for married couple filing jointly. Accordingly, single individuals who choose to take the standard deduction would reduce their taxable income by $12,950.
However, some filers may have a larger deduction if instead they choose the “itemized deduction”, which is the sum of a variety of eligible expenditures. Some expenses that the IRS recognizes as tax deductible include the following:
- Charitable donations
- Interest paid on a mortgage
- Certain medical / dental expenses
- Certain losses from federally declared disasters
Which deduction to choose?
When deciding between the standard and itemized deduction, the math is straightforward: if you do not have many (or any) qualifying deductions and the standard deduction is a higher amount, most would choose the standard deduction. If you made a large donation or have other qualifying deductions that exceed the standard deduction, most would choose to take the itemized deductions.
