I’m guessing you don’t think of taxes as fun. Let us change your mind with deductions and credits.
Okay, I’m in. Can you explain tax deductions and credits to me?
Let’s begin by defining a few terms.
By subtracting eligible costs you paid during the year, you’ll indirectly lower your tax bill.
These are even better. They are dollar-for-dollar discounts. Hence, a $1,000 tax credit results in a $1,000 reduction in taxes.
I’d like to learn more about deductions.
This is a two-parter:
The standard deduction
Taxable income is what you can deduct from your taxable income, without any questions asked. Individuals are generally entitled to a standard deduction of $12,550 in 2021. Couples filing jointly are entitled to double that amount. There are a number of factors that can affect this amount, like your age, whether you are blind, or if someone claims you as a dependent. You can get a final answer from the IRS by using its Interactive Tax Assistant.
You will need to do some work. During the tax year, make a list of every expense you incurred that may qualify. The question ‘is this deductible?’ will pop up a lot. You might be able to qualify for a medical expense deduction that equals a certain percentage of your income, mortgage interest, property taxes, or certain business expenses.
Would you consider me to be a ‘standard’ person or an ‘itemized’ person?
You should follow the ‘whichever saves more money rule. Standard deductions are easy and convenient. Itemsizing, on the other hand, can help you avoid losing money. Check your receipts to see if you can save money.
You can make an exception for deductibles above the line, which are deductions you can claim without itemizing. Contributions under the traditional IRA program; contributions under the health savings account (HSA); and contributions up to $300 in charitable contributions (given by December 31, 2021); and up to $2,500 in student-loan interest (if you have paid off interest on your federal loans while they are paused).
When it comes to tax breaks, keep in mind there are often income limits. You may be eligible for fewer tax breaks once you reach a certain income level – or, in tax-speak, “phased out.” If you earn more than the uppermost limit, you will not qualify for any tax breaks.
There is a tax deduction for home offices. Am I eligible since I’ve worked from home?
Self-employed people are currently entitled to that tax break. As long as you still have a full-time job, you’re out of luck. Perhaps if you have picked up a side job or turned to freelance or contract work. The answer depends on if you use your home workspace exclusively for business (meaning your kitchen table and office combination doesn’t count). It also depends on whether it’s your primary workspace.
I get it. Let’s get started on tax credits.
Some common credits are as follows:
- You can currently claim a Child Tax Credit of $3,000 for each kid age 17 and under (or $3,600 for each kid under age 6). The child tax credit started coming to you in monthly installments in July for 2021. When you submit your tax return, you can claim the other half.
- Higher education is expensive, so the American Opportunity Tax Credit helps offset this cost. Your household can receive up to $2,500 per eligible student per year. A portion (up to $1,000) is reimbursable.
- Uncle Sam rewards you for planning ahead with the Saver’s Credit. This program gives you a tax deduction of 10-50% of your qualified retirement contributions, worth up to $1,000 for individuals and $2,000 for couples.
Installing solar panels or an energy-efficient water heater can qualify you for state and local tax credits. It pays to be green.
Tax credits and deductions are your secret weapon to save money and get the discounts you deserve during tax season.