Only two things in life are certain — death and taxes. But, what if you could lighten your financial burden by reducing the amount of taxes you pay?
Strategies to cut down your tax bill work to reduce either your annual taxable income (what you bring in) or your total tax liability (what you owe). In other words, to watch your taxes decrease without taking a pay cut, you must qualify for tax deductions and tax credits.
Deductions vs. Credits
Tax deductions and credits can both save you money, but there are some key differences to keep in mind. While deductions are calculated based on a percentage of your annual income, credits are taken directly from the amount you owe on a dollar-to-dollar basis. If you qualify for $500 in refundable tax credits, for example, you will receive $500 back unless your tax liability is greater than that amount.
Although you will save more through tax credits than deductions, many credits are nonrefundable and cannot reduce your tax liability below zero. This means some low-to-moderate income households may not be able to take advantage of all credits, even if they qualify for them.
Despite this, you must take advantage of both credits and deductions to save money on your taxes and maximize your refund. In addition to the examples below, you can find more information on credits and deductions you may qualify for on the IRS’ official website. You can also get your accountant or tax accountant nyc (CPA) to take a look at these methods and work with you to manage them if you need some extra support. If you don’t have an accountant, your search shouldn’t be too strenuous as there are firms everywhere. Taunton accountants can certainly help if you are struggling to find anyone suitable.
Earned Income Tax Credit
The most popular and most substantial tax credit available is the Earned Income Tax Credit. Designed to help working parents earning a low-to-middle class income, the value of this credit equals a fixed percentage of the household’s earnings, up to a maximum amount. The more children and dependents you can claim, the higher that number is. Single wage earners with no children can also qualify for this credit, but their return will be significantly less.
Child and Dependent Care Credit
The Child and Dependent Care Credit can cover up to 35 percent of childcare costs, including daycare and babysitting expenses. It’s important to note that a dependent doesn’t have to be a child; an individual of any age who is physically or mentally unable to care for him or herself can also qualify.
Savers Tax Credit
It’s always a good strategy to contribute to a 401(k); none of the money you invest into it is taxable, so each deposit will reduce your annual taxable income. But the benefits don’t end there. Low-income earners who contribute to a retirement account, 401(k), or health savings account with their employer could qualify for a tax credit of up to $1,000 for single taxpayers, and $2,000 for those filing jointly. This credit comes on top of the money already invested in their account tax-free.
Standard or Itemized Deductions
There are two primary kinds of deductions: standard and itemized. As a taxpayer, you are able to claim whichever one lowers your taxes more, but not both.
Approximately two-thirds of all households choose the standard deduction, which will reduce your tax liability to a fixed amount determined by your tax bracket. If you do not have any expenses that qualify for an itemized deduction, or you just don’t want to keep strict records and receipts, this could be the best option for you.
If you have the expenses to justify doing so, itemizing can maximize the potential of your deductions. Below are some of the most common expenses that qualify as itemized deductions.
Home Mortgage Interest
To help taxpayers become homeowners, the IRS will allow you to deduct the interest paid on your mortgage from your taxable income. For low-income homeowners, there is also a mortgage interest tax credit available, but you must obtain a Mortgage Credit Certificate before applying for the loan to qualify.
Donations given to a government-approved charitable cause are another popular deduction, especially for those in higher tax brackets. To check if your donation qualifies as a tax deduction, the IRS offers a searchable database of eligible organizations.
Not all charitable contributions have to be money; the value of a donated asset can also be deducted. If you donate a vehicle, for example, you might be able to deduct the value of that vehicle from your total income.
Medical and Dental Expenses
Taxpayers can deduct qualified medical expenses that exceed 10 percent (or 7.5 percent if you’re over 65) of your adjusted gross income, which is your annual income minus any deductions already taken. Costs for preventive care, prescriptions, mental health treatments, surgeries, dental care, and vision care all qualify. If your medical care requires travel costs including car mileage, bus tickets, and parking fees not reimbursed by your employer or insurance company, you can also add these to your medical expenses.
Unreimbursed Business Expenses
There are several deductions available for workers who have to pay out-of-pocket costs not reimbursed by their employer. For example, you can deduct 53.5 cents for every mile driven for work outside of your standard commute. If you have a home office where you regularly conduct daily business, you could also deduct expenses such as mortgage interest, insurance, utilities, and repairs needed to maintain its upkeep. Under certain circumstances, you can even deduct 50 percent of food and entertainment costs, as long as you can prove the purchases were made on behalf of your business.
Keep Your Receipts
The decision to itemize deductions comes with a degree of responsibility on the taxpayer’s part. You must save every single receipt that could potentially count toward a tax deduction, document them weekly in a spreadsheet or account book, and stash them away in a folder if they ever need to be referred to again. By opting to itemize your deductions, you are also opening yourself up to a potential audit by the IRS. Should this happen, having all your ducks in a row will make the process far easier on both you and the auditor.
The Bottom Line
Our tax system may appear complex, even intimidating, but it’s a system that rewards research and dedication. The more work you put in, the more benefit you will see. If you find yourself lost in the numbers, seek out an accountant to develop a tax strategy that works for you.