A tax deduction is an amount you can subtract from your taxable income. A tax credit, by contrast, is an amount you subtract from the total amount of tax you owe. While the IRS offers many tax credits and deductions, many of these are subject to an income ceiling, making them unavailable to high-income taxpayers. A number of them, however, are available no matter how much you earn.
Investment expenses are any expenses you incur to produce or collect investment income, or to manage property you hold for investment purposes. It may include accountant's fees, fees for investment advice and even interest you pay on loans you took out to fund investment activity. You cannot deduct certain types of expenses, such as broker's fees or improvements to real estate, because they should be added to your property's adjusted basis for the purpose of calculating your taxable capital gain or loss whenever you sell the property. Investment expenses are deductible only to the extent that they exceed 2 percent of your adjusted gross income.
You can deduct the value of alimony you paid during the tax year under a divorce decree, a separate maintenance decree or a written separation agreement, as long as you don't file taxes jointly with your spouse. If you are legally separated, you cannot live with your spouse when you make the payment. Payments you make to your spouse are not alimony if the money already belongs to her under state community property law. Likewise, you cannot deduct child support payments or property settlements.
You can deduct gambling losses from your taxable income on Schedule A of Form 1040. Your losses are deductible only to the extent that they offset your gambling winnings. Since this tax deduction is easy to abuse, keep careful documentation of both your winnings and your losses in case the IRS decides to audit you.
If you lose money on the sale of a capital asset you held for investment, you incur a capital loss. You cannot declare a capital loss for the sale of property you held for personal rather than investment purposes, and you cannot declare a capital loss on the sale of certain types of property such as business inventory and accounts receivable. If your capital losses for the year exceed your capital gains, you may deduct up to $3,000 of your net capital loss from your taxable income. This deduction is reduced to only $1,500 if you are married filing separately. If you lose more than the applicable maximum during the tax year, you can carry forward your losses to future tax years.
Foreign Tax Credit
You might pay foreign taxes if you work in a foreign country, for example, or if you sold stock on a foreign stock exchange. To avoid double taxation, the IRS allows you to credit foreign taxes against your taxable income. To qualify for the credit, the foreign tax must be an income tax and you must have actually paid or accrued it during the tax year. You claim the credit by completing Form 1116 in addition to Form 1040. Although a foreign tax deduction is also available, you will probably save more money taking the credit instead.
David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.