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With the holidays all wrapped up, tax season has made its way back around. From Jan. 14, 2023 when IRS Free File opens, up to April 15, 2023, you can file your 2022 tax return.
Due to inflation reaching all-time highs, filers can look forward to a welcomed surplus of benefits, including higher deductions. Wondering where you fall on this scale or even how to decipher tax deductions? Here’s the breakdown of the key points you need to know.
A Guide to 2023 Small Business Tax Deductions
How Do Tax Deductions Work?
Tax deductions reduce your taxable income for the year, which is another way of saying it subtracts expenses from your earnings. For example, if you made $50,000 and got a $5,000 tax deduction then you will only be taxed for $45,000.
The main takeaway to remember is deduction = subtraction, and there are only two ways to take deductions on a federal tax return; itemized deductions or the standard deduction.
Standard vs. Itemized Deductions
A standard deduction is a maximum lump sum you can subtract from your adjusted gross income (taxable income). It's based on your age, earnings, and filing status. Itemizing your deductions allows you to subtract individual eligible expenses.
You can choose either the standard or the itemized deduction, but not both. The wise choice is whichever lowers your tax bill the most.
Example: Think of the deductions as two restaurants; the standard deduction has a three-course meal for one set price. The itemized deduction offers that same meal but you pay for each course individually. Sometimes it's best to go with the itemized and for others the standard deduction gives you more bang for your buck.
What are Itemized Deductions?
Itemized deductions are eligible expenses that taxpayers can deduct from their total taxable income. Many see this as the more difficult option because it requires you to annually track and list out each expense on your tax return. Also, these deductions are very specific.
Not all expenses count as deductions, they have to fall in line with what the IRS deems an “eligible deduction.” Below are some common examples of individual and business deductions.
Any money or property that you donate to a charitable organization.
Tax deductible education expenses include; tuition, student loan interest, educational assistance and continuing education courses.
Tax deductible health related expenses are expenses that you paid out-of-pocket towards for healthcare and not covered by your insurance provider. Some examples are; prescriptions, insurance premiums for long-term-care or contributions to an HSA (health savings account).
Some investment expenses are tax deductible, such as; the expense of investment interest, any capital losses incurred, or the cost basis after you sell.
Business owners can write off expenses that are incurred to support the operation of their company. These include advertising, travel expenses and supplies to name a few.
If you work from home and have a home office or a space where you conduct business, you are eligible to write off a portion of your home as a tax deductible expense. The same applies to a vehicle used for work related purposes.
Who Qualifies for an Itemized Deduction?
The IRS details that taxpayers who are poised to receive a bigger tax deduction through writing off expenses individually should itemize. They also list some clear candidates that would benefit most:
- Can't use the standard deduction or the amount you can claim is limited
- Had large unreimbursed medical and dental expenses
- Paid mortgage interest or real property taxes on your home
- Had large "Other Itemized Deductions" (line 16 on Schedule A (Form 1040))
- Had large unreimbursed casualty or theft losses from a Federally declared disaster, or
- Made large contributions to qualified charities
What is a Standard Deduction?
A standard deduction is a pre-determined, flat-rate amount of your income that is counted as tax-free by the Internal Revenue Service (IRS). This is also known as the “simple” way to take tax deductions due to it being less time intensive than individually tracking annual expenses.
Who Qualifies for a Standard Deduction?
Anyone can opt for a standard deduction, even those who could benefit more from itemizing (which obviously isn’t the optimal choice). The better question would be “who is not allowed to take the standard deduction?”. The IRS has clear rules we’ll list below
- A married individual filing as married filing separately whose spouse itemizes deductions.
- An individual who files a tax return for a period of less than 12 months because of a change in his or her annual accounting period.
- An individual who was a nonresident alien or a dual-status alien during the year. However, nonresident aliens who are married to a U.S. citizen or resident alien at the end of the year and who choose to be treated as U.S. residents for tax purposes can take the standard deduction.
- An estate or trust, common trust fund, or partnership.
What's New in 2023?
2022 brought in a wave of inflation as a result of the pandemic, war, and market fluctuations. In turn, the cost of living skyrocketed. As an attempt to lessen the blow on consumers, Congress will incrementally increase allotted deductions and credits.
Here’s an overview of what changed.
Standard Deduction Increase
The standard deduction amount made a substantial 7% increase for individuals (now up to $13,850), married couples filed jointly (now $27,700), and heads of household ($20,800).
Typically we wouldn’t see such a big jump, Congress tends to only increase the standard deduction gradually to meet inflation. Looking at recent years there was only a small 2.5% increase in 2020 followed by a 1.6% increase in 2021.
However, due to the massive inflation surge, the big push up to a 7% increase was well warranted.
Small business owners currently have the opportunity to deduct up to 20% of their income known as their qualified business income (QBI). However, in 2023 the limit rises by about 7% for both single and joint filers.
- Single: $182,100 up from $170,050
- Joint: $364,200 up from $340,100
Note: This is only for “eligible” small businesses that are registered as S Corporations, Partnerships, Limited Liability Companies (LLCs)m or Sole Proprietorships.
Additional 2023 Tax Changes To Consider
Here are some other popular 2023 tax changes to be aware of.
Updated Tax Brackets
Tax brackets are a representation of the different tax rates that are enforced based on your income. With America having a progressive tax system, the higher the income you have, the higher taxes you will be required to pay.
Here are the updated tax brackets for 2023:
- 10%: All income below $11,000 Individual | $22,000 Married
- 12%: $11,000 Individual | $22,000 Married
- 22%: $44,725 Individual | $89,450 Married
- 24%: $95,375 Individual | $190,750 Married
- 32%: $182,100 Individual | $364,200 Married
- 35%: $231,250 Individual | $462,500 Married
- 37%: All income above $578,125 Individual | $693,750 Married
Adjustments to Capital Gains Taxes
Capital Gains are the amount you earn from the sale of an asset like property or stocks. For example, if you bought a home and sold it for a $15,000 profit, that profit is now subject to a capital gains tax. How much you pay is determined by how long you owned the asset. If it was a year or less, you typically pay a higher tax known as short-term capital gains. If you held it for over a year you pay a less expensive long-term capital gains tax.
Here are the adjustments to capital gains taxes for 2023:
- 0%: All earnings below $44,625 Individual/$89,250 Married
- 15%: $44,625 Individual/$89,250 Married, an increase of $2,950/$5,900
- 20%: $492,300 Individual/$553,850 Married, an increase of $32,550/$36,650
Maximizing your Tax Deductions
Having an optimized tax strategy gives you an advantage when it comes time to file your tax return. In order to receive the highest potential refund or the lowest tax bill you need to understand tax deductions and how they apply to you.
Staying abreast of what deductions are available to you is only half of the battle, for the full benefit you also need to be up to date with any annual changes the government makes.
Frequently Asked Questions
Yes, donations to thrift stores are tax deductible as charitable contributions if they are a charitable organization. This applies only if you are itemizing your deductions, have written statement from them and donated $250 or more.
Yes, landlords get income tax deductions for multiple properties. Deductions include expenses deemed “ordinary and necessary” to operate the properties such a property taxes, insurance, and repairs.
10%: All income below $11,000 Individual | $22,000 Married
12%: $11,000 Individual | $22,000 Married
22%: $44,725 Individual | $89,450 Married
24%: $95,375 Individual | $190,750 Married
32%: $182,100 Individual | $364,200 Married
35%: $231,250 Individual | $462,500 Married
37%: All income above $578,125 Individual | $693,750 Married
Adjusted Gross Income is the income you earn actively from working (salaries, tips, etc.) or passively from other sources (investment properties, dividend incomes etc. ) minus any allowed deductions. Some qualified deduction examples include retirement contributions or student loan interest.