The goal of every American should be to pay every penny of tax they owe -- but not a cent more. With that in mind, one of the best things you can do to make sure your tax bill is as low as possible is to understand how tax deductions work.
With that in mind, here's a guide to tax deductions in the United States for 2020. We'll take a look at the standard deduction, itemized deductions, and some deductions that are available to all Americans.
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How do tax deductions work?
The term tax deduction refers to any expense that can be used to reduce your taxable income. As an example, if your gross income is $80,000 and you have $20,000 in various tax deductions, you can use them to reduce your taxable income to $60,000.
A tax deduction and tax credit are two different things. While a tax deduction reduces your taxable income, a tax credit reduces the amount of tax you owe the IRS. In other words, a tax credit is applied to your tax bill after your federal income tax has been calculated.
Standard deduction versus itemized deductions
When it comes to tax deductions, U.S. households have one basic choice -- take the standard deduction or itemize their deductions.
Itemizing deductions simply refers to the process of figuring out and adding together all of your deductible expenses. On the other hand, the standard deduction is a fixed amount that U.S. taxpayers can choose to subtract from their income, regardless of how many deductible expenses they incurred throughout the year. Taxpayers can choose whichever method they want to use.
For the vast majority of households, the standard deduction is the best way to go. Thanks to the Tax Cuts and Jobs Act, the standard deduction became much higher beginning with the 2018 tax year, and as a result, most Americans don't have enough itemized deductions to make the process worthwhile. In fact, while we don't have finalized data from any tax year with the higher standard deduction just yet, most estimates project that 90%-95% of all tax returns currently use the standard deduction.
One important point before we go on is that the tax return you'll file during 2020 is for the 2019 tax year, while any 2020-specific deduction amounts refer to the tax return you'll file in 2021. For deductions with maximums and thresholds that change from year-to-year, we've included the figures from both the 2019 and 2020 tax years so that you have the information for whichever year you're curious about.
The standard deduction for 2020
First, let's take a look at the standard deduction. Remember, this is the amount that American taxpayers can choose to use instead of itemizing their deductions.
Here's a look at the standard deduction for the 2019 and 2020 tax years:
Tax Filing Status
2019 Standard Deduction
2020 Standard Deduction
Married Filing Jointly
Head of Household
Married Filing Separately
Data source: IRS.
To be perfectly clear, if your itemized deductions (which we'll list in the next section) are greater than the standard deduction for your tax filing status, it's worthwhile to itemize. If not, you'll get a lower tax bill (and save time) by using the standard deduction.
2020 itemized deductions
The Tax Cuts and Jobs Act got rid of quite a few itemized deductions. For example, the deduction for unreimbursed employee expenses was eliminated, as was the deduction for tax preparation fees, just to name a few. The Act wasn't just designed to give most Americans a tax cut, but to also simplify the tax code. And in the case of deductions, things have certainly become more straightforward.
For most Americans (we'll discuss some special deductions later on), there are just a few itemized deductions that are still available:
- Mortgage interest
- Charitable contributions
- Medical expenses
- State and local taxes
One quick way to gauge whether itemizing deductions might be worthwhile for you is to estimate your qualifying expenses from these four categories. If the total is at least close to your standard deduction, it's worth calculating your itemized deductions on your tax return to see which is the better method for you.
Each of these deductions has its own restrictions, rules, and qualifications, so let's take a closer look at each one.
The 2020 mortgage interest deduction
Mortgage interest is still deductible, but with a few caveats:
- Taxpayers can deduct mortgage interest on up to $750,000 in principal.
- The debt must be "qualified personal residence debt," which generally means the mortgage is backed by either a primary residence, second/vacation home, or by home equity debt that was used to substantially improve one of these residences.
- Investment property mortgages are not eligible for the mortgage interest deduction, although mortgage interest can be used to reduce taxable rental income.
- Home equity debt that was incurred for any other reason than making improvements to your home is not eligible for the deduction.
Deducting charitable donations
There are quite a few rules when it comes to deducting your charitable contributions, especially when it comes to documentation requirements, so be sure to check out this guide to the charitable deduction if you need more information.
The general idea is that charitable contributions are deductible (with a few exceptions) up to 60% of the taxpayer's adjusted gross income, or AGI. In practice, few taxpayers need to worry about the limit -- this means that someone with AGI of $100,000 could deduct as much as $60,000 in charitable donations.
Deducting medical expenses in 2020
Medical expenses are tax deductible, but only to the extent by which they exceed 10% of the taxpayer's adjusted gross income. The Tax Cuts and Jobs Act lowered this threshold to just 7.5% of AGI, but this was only through the 2018 tax year. This was extended for the 2019 tax year, but the threshold is set to return to 10% for 2020. It's entirely possible that it will be extended once again, but it hasn't happened as of early 2020. https://www.irs.gov/pub/irs-pdf/f1040sa.pdf
Here's how it works. Let's say that your AGI is $100,000 in 2020 and that you have $15,000 of qualified medical expenses for the year. Since 10% of your AGI would be $10,000, you can deduct the portion of your medical expenses ($5,000) that exceeds this amount.
The 2020 SALT deduction
The SALT deduction (which stands for State and Local Taxes) was perhaps the most controversial part of the changes to the individual tax code made by the Tax Cuts and Jobs Act.
There are two components to the SALT deduction:
- Property taxes-If you paid property taxes on real estate, a car, or any other personal property, it can be included as part of the SALT deduction.
- State taxes-Taxpayers can choose to deduct their state and local income taxes or their state and local sales taxes. In most cases the state income tax deduction is more beneficial, but this can be a big benefit for taxpayers in states that don't have an income tax.
Here's where the controversial part comes in. The SALT deduction is limited to a total of $10,000 per return, per year. Taxpayers in high-tax states such as California or New York can easily exceed this limit, even if they have a relatively modest income.
You might have noticed that there are some well-known deductions I haven't discussed yet, such as the student loan interest deduction and the deduction for IRA contributions. There's a good reason for that. These deductions fall into a different category, and taxpayers can use them whether they itemize deductions or choose to take the standard deduction.
In fact, these technically aren't deductions at all, but are considered to be "adjustments to income." This is where the term adjusted gross income, or AGI comes from. These adjustments are subtracted from your gross income to calculate -- you guessed it -- your adjusted gross income.
These are informally known as above-the-line tax deductions, and here are some of the most common:
- Traditional IRA deduction
- HSA/FSA deduction
- Dependent care FSA contributions
- Student loan interest deduction
- Teacher classroom expenses
- Self-employed tax deductions
- Alimony deduction
- Moving expense deduction (for armed forces)
Like the itemized deductions discusses earlier, each of these has its own rules, and some have changed dramatically in recent years, so let's take a closer look at the above-the-line deductions for 2020.
Traditional IRA deduction
Taxpayers can deduct contributions to a traditional IRA. For the 2019 and 2020 tax years, the traditional IRA contribution limit is $6,000 per person, with an additional $1,000 catch-up contribution allowed for individuals who are 50 years old or older.
While anybody can contribute to a traditional IRA, the ability to take this deduction is income-restricted for taxpayers who are also covered by a retirement plan at work, or whose spouses are. The IRS publishes the income limitations each year, so check out the limits for the 2019 tax year and the 2020 tax year if you're curious about qualifying.
HSA and FSA contributions
Depending on your health plan, you might be eligible to contribute to a health savings account (HSA) or flexible spending account (FSA) to help cover healthcare expenses.
The HSA is by far the more beneficial of the two. Eligible individuals can contribute to an account and money in the account can be rolled over from year to year, unlike an FSA which only allows for up to $500 to carry over from year to year. What's more, HSA contributions can be invested, similarly to money in a 401(k), which makes them excellent ways to save for healthcare costs later in life. HSAs enjoy a unique double tax benefit -- not only are contributions tax-deductible, but withdrawals used for qualifying medical expenses are completely tax-free, even if your account has earned tons of investment returns.
The caveat is that in order to contribute to an HSA, you need to be covered by a qualifying high-deductible health plan. If you don't qualify for an HSA, a FSA can still be a great way to shelter some of your income from taxes -- just keep in mind that the funds (mostly) don't roll over from year-to-year, so it's not a good idea to contribute more than you know you'll be able to use.
2019/2020 HSA and FSA contribution limits
Since both types of accounts can be great tax shelters, here's a quick guide to the HSA and FSA contribution limits for the 2019 and 2020 tax years.
HSA Contribution Limit (single coverage)
HSA Contribution Limit (family coverage)
FSA Contribution Limit
Data source: IRS. HSAs have a $1,000 catch-up contribution allowed for participants age 55 and older, in addition to the applicable limit in the chart.
Dependent care FSA contributions
In addition to the healthcare FSA discussed in the previous section, there's another type of flexible spending account designed to mitigate the high costs of child care. Known as a dependent care FSA, parents can set aside as much as $5,000 if filing a joint tax return ($2,500 for single filers) that can be spent on qualifying dependent care expenses.
One major caveat. There's a tax credit for dependent care expenses (known as the Child and Dependent Care credit), and you can't use both the credit and money from your dependent care FSA for the same expenses. However, with annual child care costs exceeding $10,000 per child in many parts of the country, it's safe to say that many parents will be able to take advantage of both.
Teacher classroom expenses
Full-time teachers who work in K-12 education can deduct as much as $250 in out-of-pocket classroom expenses as an above-the-line deduction. If filing a joint return and both spouses are teachers, the deduction can be as much as $500.
Student loan interest
There is an above-the-line deduction that allows taxpayers with qualifying student loans to deduct as much as $2,500 in student loan interest per year. There are a few rules you should know -- specifically that the loan(s) must be in your name, cannot be someone else's dependent, and can't use the "married filing separately" status.
It's also important to note that unfortunately for married couples who both have qualifying loans, the $2,500 limit is per return, not per person. In other words, the deductible amount is $2,500 for single taxpayers and married couples alike.
Self-employment tax deductions
If you're self-employed, or if any portion of your income comes from self-employment (Hint: Is any of your income reported on a 1099 as opposed to a W-2?), there are a bunch of deductions you might be able to use. Just to name some of the most common:
- The Tax Cuts and Jobs Act created a Qualified Business Income deduction (also known as the pass-through deduction), which allows most self-employed taxpayers to deduct 20% of their income.
- The home office deduction applies if part of your home is used exclusively for business purposes.
- While self-employed individuals are required to pay both the employer and employee portions of Social Security and Medicare taxes (collectively known as the self-employment tax), half of this tax is deductible as a business expense.
- Self-employed individuals have access to several unique retirement plans with higher contribution limits than IRAs, including SIMPLE IRAs, SEP-IRAs, and solo 401(k)s.
- Travel expenses, office supplies, advertising expenses, and mileage driven for business purposes are just a few of the many other expenses that can be deducted by self-employed taxpayers.
Here's one that has changed quite a bit in recent years. The alimony deduction was eliminated as part of the Tax Cuts and Jobs Act, but only in the cases of new divorces. Alimony payments that resulted from pre-2018 divorces are still deductible as an adjustment to income.
Moving expenses (armed forces)
Prior to 2018, taxpayers could deduct expenses from any job-related move. However, the Tax Cuts and Jobs Act eliminated the moving expenses deduction for all Americans except those who are in the U.S. armed forces.
Can gambling losses be deducted?
Did you lose a few hundred dollars at the slots last time you went to Las Vegas? The good news is that you might be able to deduct this loss on your taxes. The bad news is that you can only deduct gambling losses if they are less than or equal to your gambling winnings.
In other words, if you were paid $1,000 from a lottery ticket, but lost $400 at a casino in 2019, you can use the loss to reduce your taxable gambling winnings to $600.
Deducting investment losses
Investment losses can be used to reduce capital gains from other investments. Short-term losses must be used to offset any short-term gains first, and the same is true with long-term investment losses. Any extra can be used to reduce other capital gains. For example, if you sell one stock you invested in for a $1,000 loss and another for a $3,000 gain, you can use the loss to reduce your taxable gain to $2,000.
If your investment losses exceed your capital gains for the year, you can use the excess to reduce your other taxable income, up to a $3,000 maximum. Any excess losses can be carried over to the following tax year.
Ask for professional help if you're unsure
As a final point, although the Tax Cuts and Jobs Act did simply the U.S. tax code, there's still quite a bit of grey area and potentially confusing tax topics. For example, does a computer cart in the corner of your dining room qualify for the home office deduction? Can you pay some of your 2021 mortgage interest in 2020 in order to maximize that deduction?
The answer to both of these questions is "maybe" and that's the point. If you're unsure about your ability to take any of these tax deductions, it's a smart idea to seek the help of a qualified and experienced tax professional to be sure you're doing it right.