The money you earn each year is taxed by the federal government. But you can keep some of that money from being taxed by taking deductions and claiming exemptions. The two are completely different things, but they serve the same purpose. Prior to the Tax Cuts and Jobs Act, taxpayers were allowed to claim a certain number of personal exemptions each year. This reduced the amount of their income that was subject to taxes.
Tax deductions are items you claim to reduce your tax liability while exemptions refer to the people you claim to reduce tax liability, such as dependents.
Deduction Vs. Exemption
One of the easiest ways to differentiate between the two is to think of personal exemptions as relating to people. Your exemptions are your spouse, children and anyone else you claim as a dependent on your tax return. Each taxpayer could claim one exemption for themselves and one for a spouse. Taxpayers with children could claim one exemption for each dependent. In 2017, the personal exemption for each taxpayer was $4,050, so a family of four could see a personal exemption of $16,200. That was $16,200 of income that wouldn’t be taxed.
Deductions, however, work differently. Taxpayers who itemize can claim certain expenses as deductions on their taxes. For most individual taxpayers, though, itemizing isn’t worth it, since they would have to exceed the standard deduction. In 2017, that standard deduction was $6,350 for individuals and $12,700 for married couples filing jointly. That standard deduction goes up to $12,000 for singles and $24,000 for couples filing jointly. That means that even taxpayers who don’t itemize will be able to enjoy $12,000 to lower their taxable income, even if they don’t track their expenses throughout the year.
Elimination of Personal Exemptions
The new tax laws bring bad news to families accustomed to personal exemptions. The GOP put a pause on personal exemptions for the tax years 2018 to 2025. In 2025, Congress will decide what happens next. This means no matter how many children you have, you won’t be able to count on a personal exemption for your tax relief this year.
The personal exemptions pause isn’t the only bad news for taxpayers in 2018, with the elimination of state and local tax deductions and alimony payment deductions. However, in addition to nearly doubling the standard deduction, the IRS has shifted tax brackets in a way that benefits many taxpayers. This may result in a better situation for many families.
Deductions for Salaried Workers
Salaried workers have always had the option of itemizing their deductions. If you’ve never itemized, though, it’s likely because you’ve found the standard deduction doesn’t make it worth it. The IRS realizes this, too. By issuing a standard amount, the agency can save everyone time and effort, including their own workers. The standard deduction has nearly doubled this year, to $12,000, but at the same time, the IRS has eliminated the deductibility of some things itemizers could have claimed in past years.
You may not have realized it, but you can claim some state, local and property taxes when you file your federal taxes. Under the tax law changes, though, the amount cannot exceed $5,000 for single filers and $10,000 for couples. Before the tax changes, you could claim unreimbursed job expenses if you were a salaried employee, as long as they exceeded 2 percent of your adjusted gross income. You can, however, continue to deduct medical expenses, although you’ll only be able to claim those that exceed 7.5 percent of your adjusted gross income. In 2019, that floor increases to 10 percent.
You also can claim your charitable deductions, so if you’ll have enough deductions to exceed the $12,000 standard deduction, make sure you save every receipt. Every charitable contribution doesn’t qualify for an IRS deduction. The IRS maintains a list of tax-exempt organizations called Tax Exempt Organization Search. There you can check to make sure you’re giving to an eligible organization. You also can only claim the fair market value for a material item you donate. So that shirt you paid $60 for a year ago will not count as $60 when you give it to charity. Goodwill provides a listing to help you determine fair market value on your donations, but shirts are generally valued in the $4 to $9 price range.
Deductions for the Self-Employed
For those who aren’t on salary, deductions take on a much higher importance. Self-employed professionals pay taxes, too, but they tend to be more aware of it. If they don’t submit payment to the IRS four times a year, they owe taxes plus penalties in April on what they made. At one time, they also paid higher taxes than anyone else, but the tax law changes are shifting things in their favor.
Self-employed taxpayers and business owners won’t see as big a hit with the tax law changes. They can still deduct their various business expenses, whereas salaried employees no longer can, and they aren’t required to exceed a percentage of their earnings to do so. Here are a few items you can deduct if you’re self-employed:
- Self-employment tax – You can deduct 50 percent of the self-employment tax you pay.
- Home office – You can claim $5 per square foot, up to 300 feet for an area of your home you use exclusively for business.
- Electronics and office supplies – You can deduct anything you use for your business, including computers and mobile devices. If you mix use between business and pleasure, you can deduct the percentage used for work.
- Utilities – The money you spend on your cellphone bill and internet are deductible. If you split use between personal and business, you’ll only be able to deduct the percentage you use for business.
- Education and training – If you attend conferences and other learning or networking events, you can deduct the cost of those.
- Travel expenses – If you travel for business, you can deduct some of the costs, including transportation and accommodations. You can claim only 50 percent of the money you spend on meals.
- Marketing – Any funds you spend to grow your business can be tax deductible, including memberships to crowdsourcing freelance sites and costs associated with your website.
Blind and Senior Standard Deductions
Seniors get a bonus on top of the standard deduction. Those over 65 and married already could each claim a $1,300 additional standard deduction, and that continues in 2018. For two married taxpayers over the age of 65, the standard deduction increases to $26,600 ($24,000+$2,600), assuming they file jointly. Single taxpayers can add $1,600 to their $12,000 deduction for a total of $13,600.
Blind taxpayers get the same extra benefit, even if they aren’t over 65. They can claim a $1,300 standard deduction if they’re married or $1,600 if they aren’t. To qualify as blind, the taxpayer must either be totally blind or have a doctor’s statement certifying that they can’t see better than 20/200 in the eye with the best vision even with the aid of glasses or contact lenses. You may also provide certification that your field of vision is 20 degrees or less.
Understanding Tax Credits
While exemptions and deductions are used to reduce your tax liability, tax credits directly reduce the amount of taxes you owe. This means if you get a tax credit of $1,000 and you owe the IRS $1,000, you will owe $0. Some of these tax credits are nonrefundable, which means that you won’t get a refund check if you don’t owe that amount. So, if you get a $500 nonrefundable tax credit, but you only owe $100, you won’t owe anything, but you also won’t get a check from the IRS for the $400 you didn’t use.
One tax credit that applies to many taxpayers is the Earned Income Tax Credit, which issues a credit based on the number of children you have and the income you bring in from employment. For 2018, you’ll get a credit of $6,431 for three or more children, $5,716 for two children, $3,461 for one child and $519 with no children. However, your income must fall below a certain range, which is $15,270 if you file singly and have no children. Your children must also meet the IRS’s qualifications for the credit, including living with you for more than half the year and being younger than age 19, if not a college student. The Earned Income Tax Credit is refundable, which means if you get $3,461 and you only owe $100, you’ll get a check for $3,361.
Dependents Still Reduce Taxes
You may not be able to claim exemptions this year, but you can still claim your dependents. You just won’t see an automatic reduction of your tax liability for it. You will, however, get a tax credit for children equal to $2,000 for each child under the age of 17. This is double the $1,000 credit you got in 2017. Up to $1,400 of that credit can be refundable, so it could lead to a more generous refund check. Prior to the tax law change, if you made $110,000 or more as a married couple or $75,000 singly, you wouldn’t get the credit. From 2018 to 2025, that phaseout has been increased to $400,000 for those filing jointly or $200,000 for single filers.
One other benefit to parents of young dependents is the Child and Dependent Care Credit, which can cover up to 20 to 35 percent of some or all of the money you spent on care for your children. The amount of credit you get depends on your salary. Those earning $15,000 will get a 35 percent credit, with the percentage dropping 1 percent for every $2,000 of income until you reach 20 percent, which is an income of $43,000 or more. The credit is intended to credit you for care you use so that you can work, so it won’t credit you for your baby sitter on date night. This credit is nonrefundable, so you won’t get any money back if you don’t owe any taxes.
Other Qualifying Dependents
Your tax credits aren’t limited to underage dependents. In addition to claiming your children under the age of 24, as long as they’re in college, you can claim a child that qualifies as permanently and totally disabled, as defined by the IRS. For IRS purposes, the disability must prevent the dependent from engaging in gainful activity, and a physician must certify that the condition will last at least one year or result in death.
A dependent doesn’t need to even be your child to be claimed on your taxes. You can also claim parents, siblings, nieces and nephews and other relatives if they meet the IRS’s test as a qualifying relative. The person must have made less than $4,050 in gross income and you must have provided more than half the person’s support for the tax year. Even a nonrelative may qualify if the person lived with you as a member of your household and met the income and dependency requirements.
- IRS: Claiming Personal and Dependent Exemptions
- Forbes: IRS Announces 2017 Tax Rates, Standard Deductions, Exemption Amounts And More
- Forbes: New: IRS Announces 2018 Tax Rates, Standard Deductions, Exemption Amounts And More
- Saving to Invest: Losing the $4,050 Personal Exemption in 2018 But Doubling The Standard Deduction
- Forbes: What Your Itemized Deductions On Schedule A Will Look Like After Tax Reform
- IRS: Topic Number 506 - Charitable Contributions
- Goodwill NNE: Donation Value Guide - What is my Donation Worth?
- Corporate Monkey CPA: Contracting Is Now a Better Tax Choice Than a Salary
- MoneyTips: Top 15 Tax Deductions For The Self-Employed
- AARP: Higher Standard Deduction Means Fewer Taxpayers to Itemize
- NerdWallet: Tax Credits vs. Tax Deductions
- EITC: Do I Qualify for EITC?
- MarketWatch: Have kids? 5 ways the new tax law affects you
- IRS: 2017 Instructions for Schedule R (Form 1040A or 1040) (2017)
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.