Preparing your taxes can be an overwhelming to start with, but drop in some financial jargon — like tax deductions and tax credits — and it could really leave your head spinning. Before you calculate the amount of taxes you owe it is worth your time to discover what these two terms mean and how they can save you money.
What are common Income tax deductions and tax credits?
There are everyday financial decisions you have made throughout the year that may entitle you to a reduction in the amount of taxes you owe.
With a multitude of tax deductions/tax credits available to tax payers, below, we clarify the difference between each term then list some common tax deductions and tax credits you may qualify for — some may even surprise you.
What is a Tax Deduction?
An Income tax deduction lowers your taxable income which reduces your tax liability. There are two categories when it comes to tax deductions, above the line Income Tax Deduction or Deduction before AGI (Adjusted Gross Income), and below the line Income Tax Deduction or Deduction after AGI:
Above the Line Income tax Deduction: Theses are deductions after configuring the gross income and before reaching the AGI , here are the common above the line Income Tax Deduction:
- Student Loan Interest: You can deduct up to $2,500 of the interest you paid on a loan for higher education. To qualify for this, your income must be under a certain amount
- Deductible Part of Self-Employed Tax: Half of the self employment tax (15.3%), 7.65% of the net self employed income (after deducting all the eligible expenses)
- Educator Expenses: up to $250 deduction of qualified expenses (Books, classroom supplies) from the income of eligible educators ( K-12 teachers)
- Penalty of Early Withdrawal of Savings: 10% penalty of early withdrawal (for individuals who are younger than 59 and a half year) from retirement plan.
Below the Line Income tax Deduction: Theses are deductions after configuring the AGI and before reaching the Taxable Income. There are two below the line deductions:
• Standard Deduction: This is cut-and-dry where you decrease your taxable income by taking the standard dollar amount from your financial status, set by the IRS. There are no receipts to collect and no further forms to prepare. While an easy route, this avenue can lead to owing more in taxes. Here is the standard deductions for 2020:
- For Single: $12,400
- Married Filing Jointly & Surviving Spouse: $24,800
- Married Filing Separate: $12,400
- Heads of Household: $18,650
The additional standard deduction amount for aged or blind taxpayers is $1,300 and for unmarried taxpayers $1,650
• Itemized Deductions: You can deduct certain expenses in order to reduce your taxable income. For example, if you own a home or made charitable donation it may make sense to itemize. While a more comprehensive route, itemized deductions can bring you greater amount of tax savings than the standard deduction. To figure out the total Itemized deduction, The IRS has created a schedule A, the following are the major components of this schedule:
- Charitable Giving: If you make a donation to a 501(c) (3) charitable organization you are eligible for an income tax charitable deduction. So, if your income is $60,000 and you donated $2,000 to your favorite charity, you will only be taxed on $58,000.
- Medical Expenses: You can deduct qualified, unreimbursed medical expenses that are more than 7.5% of your adjusted gross income for the tax year.
- Mortgage Interest Tax: It cuts the federal income tax that qualifying homeowners pay by reducing their taxable income by the amount of mortgage interest they pay.
- State and Local personal and real property tax, and State and local Income tax: Income taxes paid to the State and Local added to personal property tax (i.e. vehicle plate fee… ) and Real Property taxes, and the summation should not exceed $10,000 (TCJA 2018)
What Is a Tax Credit?
A tax credit is the amount of money taxpayers can subtract from taxes owed. Tax credits are designed to encourage or reward actions that are considered beneficial to the economy, the environment or to further any other purpose the government deems important.
What Are Some Common Tax Credits?
- Residential Energy Credit: You can get back up to 30% of the installation cost of solar energy systems. This includes solar water heaters and solar panels you purchased.
- Child Tax Credit: You can receive $2,000 per child and $500 for a non-child dependent with this credit.
- Earned Income Tax Credit: Individuals with low to moderate income can qualify for this credit. Depending on how many kids you have, marital status and how much you earn, this credit can keep hundreds to thousands of dollars in your pocket.
- Federal Adoption Credit: Families that want to adopt a child, the federal adoption credit can reduce your tax bill to offset some of the costs you incur during the adoption process.
- Child and Dependent Care Credit: Provides credit up to $600 (20% of $3,000 the maximum expenses for daycare or other child care expenses) the day care for one child or dependent, and $1,200 of tax credit for 2 or more children or dependents.
What Are Some Surprising Tax Deductions/Tax Credits?
There are scores of tax deductions that are offered to tax payers, many of which you may not have thought possible, including:
- Gambling Losses: Gambling losses and costs are tax deductible, but only up to the amount of your winnings. To receive this deduction, you must report your winnings as taxable income.
- Lifetime Learning Credit: Provides up to $2,000 per year, taking off 20% of the first $10,000 you spend for higher education. LLC is a non refundable credit.
- American Opportunity Credit: Provides up to $2,500 per year, only for the first 4 years of the post secondary education. AOC part of it is refundable.
- Babysitter Expenses: You can deduct the cost of a babysitter if you’re paying them to watch your kids while you are working, looking for work, or if you’re a full-time student.
- Health Insurance Premiums: Deductible medical expenses have to exceed 10% of your adjusted gross income (AGI) to be claimed as an itemized deduction for 2020.
Is a Tax Write-Off the Same As a Tax Deduction?
A tax write-off is slang for a tax deduction. So, any expense that is tax deductible could be referred to as a tax write-off.
There are many tax deductions and tax credits you may be entitled to that can lower the amount of taxes you must pay and keep money in your pocket.
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