What are Tax Deductions?

by | Sep 23, 2022

What are Tax Deductions?

Let’s be honest: tax season can be incredibly confusing. Everyone has to do it, but a small few really know how and why taxes work the way they do. In this article, we will explore the basics of taxes, and specifically understand what tax deductions are and how you can use them to benefit yourself.

Taxes 101

We are going to start at the very beginning. Income taxes were first introduced to the United States during the Civil War. In order to pay for the war effort, the government needed to increase its income. This initial push was repealed, and it was not until 1909 when the 16th Amendment passed congress, requiring individuals to pay personal income taxes. In 1913, the Amendment was ratified, and taxes became official. Americans earning over $10,000 in gross income must pay taxes. 

How much do you pay?

There is no universal number for how much an individual pays. It depends on how much money you make. The system we use in the United States relies on tax brackets, meaning that different amounts of money are taxed at different rates. Let’s say that you made $25,000 in taxable income (more on this later) in one year. Under a marginal tax bracket system, the first $10,000 of your income might be taxed at only 10%, but the additional $15,000 is taxed at a higher rate, say 12%. Those numbers may be made up, but it gives you a general idea of how the system breaks down your earnings. If someone making $100,000 is taxed in the 25% tax bracket, that does not mean they end up paying $25,000, it would probably be much less, because a good deal of that would be taxed at a lower rate. For the full comprehensive list of tax brackets and an explanation, explore the Forbes page on tax brackets.

What are taxable income and deductions?

Taxable income is defined as total income minus tax deductions. The idea is, the more you can leverage tax deductions, the less taxable income you have, and the less taxes you pay. Some people are able to leverage this to benefit themselves and save some money during tax season. To bring it down to basics, there are two kinds of deductions, the standard deduction and an itemized deduction. The standard deduction is a set number that you can subtract from your taxable income if you do not choose to itemize. This helps to alleviate the tax burden without doing the tedious work of combing through your itemized tax deductions. However, if you choose to itemize deductions, you join the 30% of people who have enough tax deductible expenses to make it worth it. Typically, when you choose to itemize your deductions, that includes things like taxes paid, contributions to charity or individual retirement accounts, mortgage interest, and medical and dental expenses. This starts to get confusing, but it is important to know that for the average person, taking the standard deduction is a better deal. In 2022, the standard deduction is $12,950 for individuals and $24,900 for married couples filing jointly. Unless you pay serious mortgage interest in a year, standard deductions are simpler and more common. 

How do tax credits work?

Credits, like deductions, adjust your taxable income. Unlike deductions, tax credits are subtracted from the taxes you owe. If you owe $13,000 in taxes, but have 2 children, each worth $2,000 in child tax credit, your owed tax amount drops to $9,000. There are many other kinds of tax credits, some of which are even refundable (meaning that if the reduction brings your total taxes due to a number less than 0, the IRS will send you a refund check). 

There are a lot of ways to save money before and after paying taxes. Lowering your expenses can end up saving you even more money than trying to figure out the tax system. If you get thrifty and start utilizing saving hacks, you can bump the number in your bank account up and keep it there. Another great way to increase your accounts is by picking up a side job. Although you do have to pay more taxes, you end up with more money, because taxes only claim a fraction of your earned income. Consider taking a job at home to cover bills or add to your (tax deductible!) savings accounts. Employers are finding increasing wages more and more effective at attracting employees in the midst of the inflation nowadays. 

Interested in learning more about how we can help your employee population improve their steps and sleep while reducing burnout?

Related Posts