Every industry has its own jargon, and the income tax establishment is no different. Some of the terminology might have more than one meaning depending on its usage, and some terms might have similar meanings but different applications. For example, tax deductions and exemptions both reduce the amount of your taxable income, but they are applied to different areas of your tax form.
Deduction vs Exemption
Exemptions used to be a set amount of money the Internal Revenue Service allowed you to subtract from your adjusted gross income based on the number of people in your household. But for those filing 2018 taxes, there are no more personal or dependent exemptions, as a result of the Tax Cuts and Jobs Act. There are only deductions and child tax credits. If you're filing your 2017 taxes, the difference between exemption and deduction is still important, and you will still have exemptions. The personal exemption amount is $4,050 each for yourself, your spouse and qualifying dependent children.
What Are Deductions?
Deductions are expenses you can deduct from your taxable income each year. The IRS is very specific about the types of expenses you can deduct and who can claim them. For comprehensive information on tax deductions and IRS rules, the IRS has a handy guide here. The standard deduction will reduce your adjusted gross income. Your standard deduction is based on your filing status, which is determined by your marital status as of the end of the year. Married couples can claim a $24,000 standard deduction. Heads of household (usually single parents with children) can claim $18,000. Single filers can claim the $12,000 standard deduction. Most of us, except for the very wealthy, will be able to receive up to $2,000 in tax credits for each qualifying child (usually children 16 and younger) . This is sort of like a tax deduction for a child, but it's called a credit, because you don't have to itemize to get this. Couples with dependent children 17 and older who do not have gross income over $500 can receive a $500 tax credit.
The IRS lets you decide whether you want to claim the standard deduction or itemize your deductions. More people will choose the standard deduction under the new tax rules, because their itemized deductions will be less than the standard deduction.
If your total itemized deductions -- which include things such as mortgage interest, real estate taxes, uninsured casualty losses and a portion of your medical expenses -- exceeds the amount of your standard deduction, you'll get a bigger tax break from itemizing, although it's more work. But with the new standard deduction at $12,000 for singles and $24,000 for married couples, the IRS expects very few couples will be itemizing deductions on their 2018 taxes.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.