There are many types of interest expenses you can deduct on your personal tax return, and the amount of each deduction will directly reduce your taxable income. Reducing your taxable income is key, because it ultimately reduces your tax bill for the year. However, if you want to determine the precise amount in taxes that you are saving as a result of claiming interest deductions, it's necessary to calculate your tax bill twice.
1. Determine which interest deductions for which you are eligible. The Internal Revenue Code provides ample opportunities for you to claim a deduction for the interest payments you make during the year. Deductions are available for the mortgage and home equity loan interest payments you make, and some of the interest you pay to purchase investments. However, these deductions are only available if you itemize on schedule A. In addition, the IRS allows you to deduct the interest portion of your student loan payments as an adjustment to income. This is available to all taxpayers, regardless of whether you choose to itemize or claim the standard deduction.
2. Sum up all interest deductions. You must separately evaluate your eligibility for each interest deduction you claim. Once you determine the amount of each deduction, add them together to arrive at your total interest deduction for the year. Although your interest deductions may end up in different sections of your tax return, they all reduce your taxable income in the same way.
3. Calculate your tax liability without claiming the interest deductions. To calculate the tax you will owe on your taxable income that doesn't include your interest deductions, fill out your tax return with all other information except for those deductions. When you complete the return, the IRS requires you to look up your tax liability using the tax tables in the instructions to your tax form. This requires you to find the appropriate table that includes your taxable income within the range, and locate the appropriate column for your filing status. Where your taxable income and filing status intersect is the amount of tax you owe before claiming interest deductions.
4. Calculate your tax liability after claiming the interest deductions. Rather than prepare an entire tax return again, you can simply reduce the taxable income you calculate on the return by the total amount of interest deductions you are claiming. You can then access the tax tables in the instructions again, but this time use the table that includes your reduced taxable income.
5. Compare the two tax liabilities. You can now calculate the tax savings from claiming interest deductions by subtracting the smaller tax bill from the larger one.
Items you will need
- IRS Form 1040 and its instructions
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