Starting in January, there’s one question on the lips of every person who likes money (so, all of us): How can I save money on my taxes? The easiest way is often by taking advantage of all the tax deductions and credits that you qualify for.
Ellevest isn’t a tax pro, so we can’t tell you which deductions and credits are for you. But we can tell you how they work and which ones are the most common, so you can ask an actual tax pro about them (or double-check that TurboTax catches them, if that’s more your speed). This info is current for tax year 2021 — aka the tax return you’ll file in early 2022. Here goes.*
What’s a tax deduction?
Tax deductions save you money by lowering the total amount of income you have to pay taxes on. Say you made $60,000 last year and qualify for $13,000 in deductions. You’d only pay taxes on $47,000 of your income.
Common tax deductions
To take advantage of many deductions, you have to choose to itemize your taxes. That means you’ll add up the amounts of all the individual deductions you qualify for and take that total off your taxable income. That’s opposed to taking the standard deduction, which for the 2021 tax year is $12,550 for single filers or married filing separately, $18,800 for head of household, and $25,100 for married filing jointly. (The IRS says that in 2018, 87.3% of taxpayers took the standard deduction.) Usually, you’d pick whichever route gets you the biggest deduction.
Here are some common itemized deductions:
Home mortgage interest. If you have a mortgage (or a home equity loan used to buy, build, or substantially improve your home), you can deduct the interest payments on the first $750,000 of the loan(s). (It used to be $1 million, but the 2017 tax law cut it down.) If you currently pay for private mortgage insurance — known as PMI — you can typically deduct that as well.
Property, state, and local taxes. If you’re a homeowner, you can deduct real estate taxes. Also, anyone can deduct state and local (aka city) income taxes (often abbreviated SALT). The 2017 tax law made it so that there’s a maximum deduction of $10,000 for these three things combined, though.
Investment interest expense. If you borrow money so that you can make an investment (btw, generally not advisable unless we’re talking something like real estate), the interest you pay is deductible — up to the amount you earned from the investment. So if you don’t make any money from your investment, you can’t deduct the interest.
Medical expenses. You can deduct certain medical expenses, like the cost of prescriptions, insurance premiums, co-pays, and doctors’ fees. For tax year 2021, it’s limited to your medical expenses that exceed 7.5% of your adjusted gross income.
Charitable contributions. If you itemize your deductions, you can potentially deduct up to 100% of your adjusted gross income for cash donated to qualifying charitable organizations (that’s usually only 60%, but this year’s limit is expanded as part of COVID relief). If you take the standard deduction, you can still deduct up to $300 of cash contributions for single and married filing single, and the max is $600 for married filing jointly returns.
One big change from the 2017 Tax Cuts and Jobs Act that’s still worth pointing out: Almost all the “miscellaneous” itemized deductions that used to be available … aren’t anymore. That includes things like unreimbursed employee expenses, tax preparation expenses, and investment fees and expenses.
There are also some deductions — often called “adjustments to income” or “above-the-line” deductions — that you can take even if you don’t itemize. Here are the most common ones:
Traditional IRA contributions. Contributions you make to a pre-tax (aka traditional) IRA are often deductible.(If your modified adjusted gross income (MAGI) is more than a certain amount, depending on your filing status and whether you’re covered by a retirement plan at work, you may not qualify for part or all of the deduction.) Also, if you’re self-employed, you have to have taxable compensation (wages, salaries, commissions, tips, bonuses, or net income from self-employment, etc.) that’s more or equal to the amount you contribute, up to the maximum annual contribution limits. Good to know: If you file with your spouse, even if you don’t have any earned income, you can still make a contribution based on your spouse's taxable compensation.
Student loan interest. You can deduct up to $2,500 of the interest you paid on your student loans, as long as you used the loan money for school-related expenses like tuition, fees, housing, and transportation. If your MAGI is more than $70,000 as a single filer ($140,000 if you’re married filing jointly), you may not qualify for part or all of the deduction. (Note: If you’re married filing single, you won’t qualify for this deduction.)
Certain expenses if you’re self-employed or own a business.
Self-employment tax. Since you pay the employee and the employer portions of Medicare and Social Security (aka the self-employment tax), the employer half is deductible.
Insurance premiums. Healthcare premiums like medical, dental, and long-term care that you purchase for yourself can be deducted up to the amount you paid. But if you have a spouse who has access to insurance through work, you aren’t eligible.
Qualified business income deduction. Under the 2017 Tax Cuts and Job Act, certain business owners may be able to deduct up to 20% of their net business income. There might also be income limits, depending on the type of business you have. (Definitely consult with a tax professional on this one especially.)
Business-related food and beverage expenses. The Consolidated Appropriations Act (CAA) passed in December of 2020 allows you to deduct 100% of the cost of business-related food and beverage expenses incurred at restaurants in 2021 and 2022. (In the past, deductions for business meals at restaurants were limited to only 50% of the cost.)
Health Savings Account (HSA) contributions. If you have a health savings account (HSA), which is something available to people with high-deductible healthcare plans, any contributions you make into your HSA are tax-deductible. The contribution limit for tax year 2021 is $3,600 for plans covering one person, and $7,200 for plans covering families. (But keep in mind that if you change healthcare plans in the middle of the year, that might impact your limit.)
Educator expenses. If you’re a teacher, you can deduct up to $250 of your 2021 costs for supplies, materials, books, software, etc. (Exciting thing: This limit is increasing to $300 for tax year 2022 — the first time this number has changed in years.)
FYI: The 2017 tax law got rid of the deduction for moving expenses for everyone except those on active duty in the military, and the deduction for college tuition and fees expired in 2017.
What is a tax credit?
Tax credits are your BFF. Rather than lowering the total you’ll need to pay taxes on (like deductions do), they save you money by lowering the total you actually owe in taxes. $1 in tax credit is $1 in tax savings.
There are two types of tax credits: refundable and non-refundable. Non-refundable credits can lower your tax bill, but they can’t lower it past $0 — meaning they can’t push you into tax refund territory. Refundable credits, on the other hand, can actually result in a tax refund.
Common tax credits
Earned Income Credit. If your income is under a certain threshold — depending on your filing status and the number of children you claim as dependents — you may qualify for this credit. Tip: More taxpayers are eligible this year and the amount of the credit also increased, so it’s worth seeing you qualify for this one even if you didn’t last year.
Child and Dependent Care Credit. If you have kids under 13 or care for someone else who can’t care for themselves, you can claim a credit for part of the cost of their care when you’re working (or looking for work). You can claim a credit for up to 50% of the first $8,000 in expenses ($16,000 if you have two or more children). This one is now fully refundable.
Child Tax Credit. If you have at least one dependent child who’s 17 or younger by the end of 2021, you qualify for this one. You can deduct $3,600 for kids up to age 5 and $3,000 for kids ages 6 to 17. The credit starts to phase out at different income levels ($75,000 for single filers, $150,000 for married filing jointly, and $112,500 for heads of households). The credit is fully refundable for 2021. If you received an advance payment for 50% of the credit last year, you’ll get “Letter 6419” to use when you file your taxes. If you’re married, both spouses will receive a separate letter showing their half of the advance credit, so make sure you keep both.
American Opportunity Tax Credit. Students enrolled at least half-time in college can claim a credit of up to $2,500 per year for the first four years of school. If your MAGI is more than $80,000 as a single filer ($160,000 for married filing jointly), you may not qualify for part or all of the credit.
Lifetime Learning Credit. There’s no limit on the number of years you can claim this one, and the income thresholds are the same as the American Opportunity Tax Credit.
Saver’s Credit. Also called the Retirement Savings Contribution Credit, this one is available to people whose adjusted gross income is less than $32,000 as a single filer ($64,000 for married filing jointly) and who also contribute to an IRA or employer-sponsored retirement plan. The amount of the credit depends on your income.
Residential Energy Efficiency Property Credit. This one gives you a credit up to 26% of the cost of a qualified property, like solar electric property, solar water heaters, and geothermal heat pumps.
Nonbusiness Energy Property Credit. This credit’s for 10% of the cost of qualified energy efficiency improvements that you paid for or incurred during 2021, up to $500.
Recovery Rebate. If you’re missing part or all of a stimulus payment, you can get a credit of up to $1,400 per person. Look for Letter 6475 to help you file your tax return.
Employer payments that don’t count as taxable income. These aren’t technically credits, but FYI: You can exclude up to $5,250 in student loan repayments that your employer made on your behalf. You can also exclude dependent care payments of $5,000 for single filers, $5,250 for those married filing separately, and $10,500 for married filing jointly.
So there you have it. May the tax refund odds be ever in your favor.
All information sourced from https://www.irs.gov/ as of January 2022.
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