Itemized Deductions – When taxpayers think of deductions, they typically think of the itemized deductions that are claimed on Schedule A. This is the only way to deduct personal expenses such as medical costs, state and local tax payments, investment and home-mortgage interest, charitable contributions, disaster-casualty losses, and various rarely encountered expenses. In some cases, itemized deductions are limited. For instance, medical expenses are only deductible to the extent they exceed 7.5% of the taxpayer’s adjusted gross income (AGI). Similarly, state, and local tax payments (including those for income, sales, and property taxes) are capped at $10,000. On top of that, itemization only reduces taxable income to the extent that the total of the itemized deductions exceeds the standard deduction. When the sum does not exceed the standard deduction, the itemized deductible expenses provide no tax benefits at all.

In 2018 a law change nearly doubled the standard deduction amount, and each year since then only about 10% of taxpayers itemize their deductions because they find using their standard deduction provides a better tax benefit. The enhanced standard deduction is annually adjusted for inflation but only applies through tax year 2025 (unless extended by Congress). The standard deduction amounts for 2023 and 2024 are:

Each taxpayer aged 65 and older, or blind, is allowed an additional standard deduction amount. When filing a joint return, the extra amount applies to each spouse who is at least 65 or blind. A taxpayer (or spouse) who meets the age requirement and is also blind, is entitled to double the extra amount. The additional amounts are:

For 2023: $1,850 for single and head of household status; $1,500 for married (either joint or separate) and qualifying surviving spouse.

For 2024: $1,950 for single and head of household status; $1,550 for married (either joint or separate) and qualifying surviving spouse.

Above-the-Line Deductions – Certain deductions reduce income even when a taxpayer is not itemizing. These are commonly called above-the-line deductions because, when applied, they reduce the income figure that is used to calculate AGI. Hence, the IRS titles these deductions “adjustments to income.” Their benefits apply regardless of whether the taxpayer uses itemized deductions. Above-the-line deductions include educators’ expenses; contributions to health savings accounts and traditional IRAs; deductible alimony payments (only for pre-2019 divorce agreements); and student-loan interest. Most of these deductions have annual maximums. In addition, several above-the-line deductions apply only to self-employed individuals. These are for self-employed health insurance costs, 50% of the self-employment tax, and contributions to certain types of retirement plans. Other, more obscure, above-the-line deductions are listed on Form 1040, Schedule 1.

Business Deductions – Taxpayers who operate noncorporate businesses can deduct from their business income expenses that they incur when operating their businesses. These deductions (which cover advertising fees, employee wages, office-supply costs, etc.) are used to reduce profits, which in turn reduces taxable income and, ultimately, income tax. In addition, most self-employed taxpayers pay Social Security and Medicare taxes on their net business income, so any reduction in their business profits also reduces their Medicare taxes and possibly their Social Security taxes.

While not deductible from business income and not an above-the-line deduction, an individual taxpayer may be able to deduct up to 20% of their “net qualified business income” (QBI) from a trade or business (including income from a pass-through entity such as a partnership or S corporation) when figuring their taxable income. This deduction is limited to 20% of taxable income, calculated before the QBI deduction, minus net capital gain.

Asset-Sale Deductions – An individual who sells an asset is allowed to deduct that asset’s cost from the sale price to determine the taxable profit. Good recordkeeping is helpful here because the original expense may have been incurred years prior, even though it is only deductible when the asset is sold. For example, any improvements that an individual makes to a home over years of ownership are not deductible until the home is sold. At that point, the individual can reduce the taxable gain from the sale by counting the improvements as part of the home’s cost. 

Refundable Credits – A refundable credit offsets current tax liability; it is so called because any amount of unused credit is refunded to the taxpayer. Refundable credits include the Earned Income Tax Credit, the Additional Child Tax Credit, and the Premium Tax Credit (net of any advances received), as well as the American Opportunity Tax Credit (an education credit that is 40% refundable). As a matter of general interest, these credits are subject to significant filing fraud because of their refundability. The IRS also considers prepayments such as income tax withholding and estimated tax payments to be refundable credits.

Nonrefundable Credits – A nonrefundable credit only offsets tax liability; any unused amount is lost (unless it can be carried over to another year; see below). Over time, Congress has become more generous with credits; some credits that are not refundable may carry over for a given period. Nonrefundable credits (not a complete list) include the Saver’s Credit, Child and Dependent Care Credit, Lifetime Learning Credit, Residential Clean Energy Credit, Energy Efficient Home Improvement Credit, and Clean Vehicle Credit.

Exception: For purchases in 2024 or later of vehicles eligible for the Clean Vehicle Credit taxpayers may elect to have the credit transferred to the dealer from whom they purchase the EV. The dealer will then lower the cost of the vehicle by the credit amount or require a reduced down payment. Effectively the taxpayer will be claiming the credit at the time of the purchase rather than waiting until filing their tax return for the purchase year and claiming the nonrefundable credit on it. If a taxpayer successfully transfers the credit to the dealer when purchasing the vehicle, and the amount of credit transferred exceeds the income tax on the taxpayer’s return for the year of the purchase, the IRS has ruled that the taxpayer is not required to pay back the excess credit.

Carryover Credits – For some nonrefundable credits, any unused current-year credit can be carried over to the next tax year (or for a longer period) until the carryover amount is used up against a future year’s tax. These credits include the Adoption Credit (which can carry over for up to five years) and the Residential Clean Energy Credit.

Business-Tax Credits – Numerous business-tax credits are available; however, they are grouped into the General Business Tax Credit, which is nonrefundable, but which carries forward for twenty years and back for one year. (This allows a business owner to amend the prior year’s return to claim the credit.)