What Are the Most Commonly Missed Tax Deductions
From charitable giving to job-hunting costs — even items that aren't really tax deductions but can save you money like reinvested dividends — we look at ways to save money on taxes.
Despite the fact that our tax dollars are used to pay for the local, state and federal services we need and enjoy, few Americans actively enjoy writing a check to Uncle Sam come April 15. Well, there are a number of ways that you can save money on taxes. Here we explain six commonly missed tax deductions and credits and three other strategies that could help to lighten your tax burden.
First, it’s important to understand the difference between tax deductions and tax credits. A tax deduction reduces the amount of income that is subject to tax. For example, a taxpayer with $50,000 in income and $500 in qualified business expenses could reduce the amount of her income subject to tax to $49,500. A tax credit, in contrast, reduces the total amount of tax owed. For example, a taxpayer with a $1,200 liability who is eligible for a $600 mortgage tax credit would have her tax liability reduced to $600.
It’s also important to understand that deductions are only available to taxpayers who itemize their returns. The IRS offers every taxpayer a standard deduction. In 2011, single filers could deduct $5,800; married filers $11,600; and heads of household $8,500. If your total qualifying expenses (deductions of the kind listed below) exceed the standard deduction, it makes sense to itemize your return. A taxpayer taking the standard deduction may still receive tax credits.
Six Commonly Missed Tax Deductions And Credits
1. Child and dependent care credit– If you pay child care expenses for children under age 13 so that you can work or go to school, you may be eligible for a credit of 20-35 percent of those expenses, up to $3,000 for one child and $6,000 for two or more children. Depending on your income, if you pay $6,000 in child care costs per year for two or more children you could end up with a credit of about $2,000. To note, the credit is nonrefundable, meaning that it can reduce your income tax liability to zero; after that, any additional credit is lost.
2. Mortgage tax credit – This is not a commonly missed tax credit (in fact, it’s one of the most popular), but it’s worth mentioning here because it is typically one of the most significant tax credits for most taxpayers. Of the 40 million American taxpayers that take advantage of the mortgage tax credit, the average savings is $600 per year.
3. Home office deduction – Whether you are self-employed or an employee, if you use a portion of your home for business, you may be able to take a home office deduction. Expenses to consider include rent or mortgage, utilities and homeowners or renters insurance. Generally, the amount you may be able to deduct is a function of the percentage of your home used for business.
4. Business expenses for the self-employed – If you are self-employed, in addition to the home office deduction (if you work at home), you may be able to deduct other business-related expenses, including the cost of equipment (computer, printer, etc.), office furniture, office supplies, phone and internet (if they’re dedicated to your business), marketing expenses and travel (including auto expenses for travel to and from business meetings).
5. Job hunting and job-related expenses – If you spent more than two percent of your adjusted gross income (AGI) in 2012 on expenses related to a job search, you can deduct those expenses from your total income. You can also deduct a variety of miscellaneous job-related expenses, including professional memberships, journal subscriptions and the cost to purchase uniforms and keep them clean.
6. State sales or income tax deduction – If you itemize your deductions, you can choose to deduct either the state and local income taxes you paid or state and local sales taxes. Most taxpayers typically find that deducting income taxes yields a larger tax break, but if you made a big purchase (such as a car), it is worthwhile to see if deducting sales tax will yield you a bigger break.
Three Other Ways To Save Money On Taxes
1. Max out your retirement contributions – One of the best ways to save money on taxes is to contribute as much as the IRS allows to tax-deferred retirement plans like a 401(k), traditional IRA or SEP IRA. Not only does maxing out your contributions allow you to potentially reduce your tax liability (income used to invest in qualified plans is not taxed), but it also sets you up for a financially sound retirement. With certain exceptions, for 2013 the IRS allows a full deduction of IRA contributions up to $5,500 and of qualifying employer retirement plans (such as 401(k)s and 403(b)s) up to $17,500.
2. Take full advantage of a flexible spending account (FSA) or health savings account (HSA) – A flexible spending account is a place to save pre-tax income (up to a certain limit) that you can use for qualified medical expenses. Funds left in the FSA at the end of the year are forfeited (use it or lose it). A health savings account serves the same purpose (a place to put non-taxed income to spend on healthcare) but functions a bit differently: you can keep funds in the HSA indefinitely, but the account must be coupled with a high-deductible health plan. Regardless of whether you choose a FSA or HSA, you can reap significant tax advantages. A married couple with income of $80,000, for example, could shave $500 off their tax bill by contributing $2,000 to a FSA or HSA.
3. Donate to charity – If you itemize your taxes, you can deduct donations to qualified charities (up to a limit, generally 50 percent of your adjusted gross income). When thinking about donations you’ve made, include gifts of cash and noncash donations like clothing, household items, vehicles, food, etc. You can also include out-of-pocket expenses you incur doing charitable work, such as mileage to and from a location where you volunteer.
By taking advantage of all of the tax credits and deductions you are be eligible for and the other ways to save money on taxes, you could shave a tidy sum off your April 15 tax bill.
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