The American tax code is an extremely complex body of laws and regulations that really requires a degree of expertise to get the most out of the opportunities contained within it. Of course people with very simple tax situations do not necessarily need professional assistance, but then again their ability to maximize their refunds or minimize their liabilities is also very limited. For people with more complicated tax situations, there are a lot of options available to get the most from their annual tax filing.

After the adjustments – or amounts deducted from the gross income in order to give an adjusted gross income (AGI) – the next step is to determine which deductions to claim. Deductions are amounts that are subtracted from the amount due on each person’s tax return. Like everything else related to the American tax system, deductions can be complicated and tricky and claiming deductions that you are not entitled to can be costly if the problem is caught by the Internal Revenue Service (IRS). Therefore it really pays to understand the deductions, how they work, and if the qualifying conditions are met.

The first choice the taxpayer is confronted with is whether to claim the Standard Deduction or if it is more beneficial to itemize deductions. The Standard deduction is much simpler to file for and requires only basic documentation to substantiate if audited by the IRS. Itemized deductions offer a lot more opportunities to save money, but are also more time consuming and demand copious documentation in order to substantiate the claim. The proper way to determine the right option is to work out the total deduction amount available using both the Standard Deduction and itemized and then choosing the appropriate one. However, this is twice as time consuming, so many individuals just opt to take the Standard Deduction and be done with it.

People that have extremely complicated tax situations – high income, multiple financial investments, real estate, and so on – can frequently benefit by itemizing, but few choose to do the work themselves, instead hiring an expert to do it. Similarly, self-employed people, businesses, and other entities usually opt to itemize since there are many deductions that are only available through itemization. One of the consequences of the American tax system being progressive is that it is specifically designed to encourage specific behaviors and investments, and especially things related to small business and entrepreneurship. Therefore, people engaged in such activity should probably itemize, though they should also use the services of a professional to do so.

The real danger of maximizing deductions is that it is very easy to misunderstand or misread how the deduction works, resulting in an erroneous claim. Further, the IRS generally begins with the assumption that all errors are deliberate and thus subject to penalties and interest. The IRS uses a lot of terminology that can be tricky because the strict IRS definition of these common terms is not the same as the popular understanding. For example, the idea of a “business expense” appears fairly straight forward and most people believe they can determine what is – or is not – a ‘business expense.” However, the IRS has a very strict and well documented definition of what constitutes a “business expense” that may not be the same as the common sense definition of the term. Further, not all “business expenses” – as defined by the IRS – are treated the same and can be claimed the same way, so there is a lot of room for error.

Have a tax question? Ask one of our tax professionals.