Here's How Tax Deductions Are Similar to a Salary Increase
Many people dread tax season because of the hard work and money it takes to do taxes. However, those individuals may not understand the array of benefits that they can get during tax season. Tax deductions are one of the great gifts that come with being or knowing a qualified tax professional. Qualifying for the right tax deductions each year is almost like receiving a salary increase. Here's some information about the topic so that you can better understand deductions. You might be able to make them work well for you.
What Is a Tax Deduction?
The government taxes your income based on many factors that include your filing status and income amount. The government taxes your gross income or the raw total amount of money that you earn for the year. Each tax deduction that you claim reduces the amount from your gross income. For example, you earn $50,000 in one year, but you legitimately qualify for $10,000 worth of tax deductions that year. The tax deductions will reduce your taxable income to $40,000.
How Tax Deductions Are Like a Salary Increase
You could think of tax deductions as if they are salary increases in a way. Think about a different person in the above scenario who earned $50,000 in a year. Without the tax deductions, his "tangible" income would have dropped by thousands of dollars because he would have had to give that money to the government. The tax deductions will give the money back to the worker. Therefore, it's similar to a pay increase. As a hardworking consumer, you have to do everything you can to maximize your income potential. Talking to a reputable tax specialist or using the right tax tools can really help you to put things into proper perspective.
List of Tax Deductions
A myriad of tax deductions is available for you to take advantage of during your next tax filing session. These are a few of the deductions you should look into to see if you qualify for them. Be sure to ask your tax specialist about any additional ones that could help you. If you have trouble submitting your taxes by the deadline, you can file tax extension paperwork to extend the amount of time you'll have to finish the paperwork.
- Retirment (401K) Contributions
You can receive a tax deduction on the money you have taken out of your check for each pay period to put in your 401K. However, this deduction isn't one you claim at the end of the year on your income tax year. You'll receive the deduction automatically.
Any of the funds you put toward the account will be deducted from your income before the payroll department applies your taxes. - Home Office Deduction
The home office deduction is a wonderful benefit for which you may qualify if you are a self-employed person who works from your home. Some stringent rules apply to the deduction, however. First, you have to dedicate a portion of your home to the workspace. You can't qualify for the benefit if you're using your doing work inside of your living room. You have to cut off (not necessarily physically) a truly dedicated part of your home to the office work. Your home must also be your principal place of business.
You can choose a long or short way to calculate your home office deduction. The regular method requires you to enter your actual expenses for a variety of things. The simplified option is much easier, and it may eliminate the burden of recordkeeping for you. - Student Loan Interest Deduction
You may receive a deduction on your taxes if you have student loans and pay interest on them. You will receive Form 1098-E from the entity you paid. It will tell you exactly how much interest you paid on your student loans that year. You can take up to $2,500 in deductions for a single year. That should help you with a fair amount of your taxes.
- Car-Related Deductions
You might be in luck if you're self-employed, you own a car, and you use the car for any reason related to the business you run. You can deduct certain expenses for using your car. The deduction will be greater if you use your vehicle for business 100 percent of the time. You will only get a percentage of the deduction if you use your vehicle for both work-related and personal purposes.
There are two methods you can use to calculate your expenses: actual expenses and standard mileage expense. You must use the standard mileage expense the first year if you intend to use it in subsequent years. Otherwise, you will have to use the actual expense method, which means that you should keep records on your person for at least three years afterward. You are allowed to claim expenses such as gas and oil, lease payments, depreciation, tires, repairs and tune-ups, insurance registration fees, and the like. This deduction can be quite helpful in reducing your overall taxes. - Health Savings Account Deduction
Your employer may offer you a health savings account that you can put money into to set aside for health-related expenses. This HSA account is eligible for pre-tax deductions. That means that you won't claim this on your income taxes at the end of the year. Like the 401K contributions, the payroll department will remove this money from your paycheck before imposing any taxes on you.
- Medical Expense Deduction
The medical expense deduction might be excellent for you if you've had a particularly rough year where you spend a lot of money on your health. You can claim medical expenses that are more than 10 percent of your adjusted gross income if you are under age 65.
For example, you can claim medical expenses that were more than $5,000 if your AGI for the year is $50,000. This may work very well for you if you have a surgical procedure that year that cost you $7,000, for example. You would have the right to claim a $2,000 deduction. The medical expenses must be qualified expenses. Such expenses include treatment, preventive care, surgeries, dental and vision care, psychiatric visits, prescription medications, and more.
You should only use the medical expense deduction if it is greater than the standard deduction. - Charitable Contributions Deduction
You might qualify for a deduction if you give money or material items away to charity at some point during the tax year. The amount that you can claim will depend on your qualifications. Certain corporations can only claim up to 25 percent of their AGI. Other parties can claim 60 or 100 percent of their AGIs. Qualifying contributions include cash and property given to certain organizations or entities.
- Home Mortgage Interest Deductions
You can claim the mortgage interest deduction if you own a home. You can claim up to $750,000 in interest payments each year if you are married filing a joint return. You may also claim prepaid interest, late payment fees, and prepayment penalties.
- Property Tax Deduction
You can claim up to $10,000 in deductions in property taxes and state and local taxes. You will find the information you need in your tax records that the government entity will send you.
- Employee Business Expense Deduction
Employee business expenses are another category of expenses that will only work for you if they are greater than your standard deduction allowance. If you qualify, you can deduct expenses such as union dues, fuel for business-related travels, work clothing and uniforms, and work-related passport attainment charges.
You can also deduct expenses related to a job search expense. These deductions will apply even if you do not obtain a new job from your search efforts. Furthermore, you may be able to claim legal expenses that you accrue during a battle that involves trying to keep your job. Other expenses may be eligible for the deduction. You would fare well by contacting a tax specialist and talking to that person to find out how many other situations might help you. - Moving Expense Deduction
You might qualify for a moving expense deduction if you have to relocate because of your job. To be eligible for the deduction, your new location has to be farther away from your job than the previous location was. You must also move into your new home or apartment within one year of starting the new site's job. Furthermore, you must be able to work at the new site for at least one year after you move.
How to Get the Most Deductions
There's only one good way to ensure that you get all tax deductions for which you qualify. That's to speak to a tax professional who has years of experience in the field. This person will know the ins and outs of taxes as well as any new developments in recent tax law. It might be well worth the small expenses to talk to such a person. You could end up having the easiest tax year of your life just because you took the time to talk to someone who knows about taxes. A reliable tax professional can do your taxes for an amount that's only a portion of what you'll get back that year.
Tax Deduction vs Credit?
You might have heard the term "tax credit" before and gotten it confused with the term "tax deduction." These are two very different concepts. Tax deductions reduce the amount of taxable income, while tax credits reduce the total amount you owe. Let's take that same $50,000 income from the first example, and we'll say that all your income is taxable, and you end up owing the IRS $5,000 for the year. Let's say that you qualify for tax credits of $3,000. The tax credits will directly reduce that $5,000 to $2,000. The result is that you would only have to pay the IRS $2,000 in that scenario. That's a nice decrease from a pretty hefty tax obligation, isn't it?
The IRS may owe you a refund if the amount of credit for which you qualify is greater than the amount of money that you owe. For that reason, refund eligibility is another main factor that differentiates tax deductions from tax credits. Tax deductions will never cause a refund situation, but some tax credits will.
Examples of Tax Credits
We won't spend too much time discussing tax credits since the topic is mostly about deductions. However, we thought you might be interested in learning about a few tax credits you might qualify for in the upcoming years. Some of these credits are refundable, which means that you can receive a refund as a result of taking them. Unfortunately, some of the other credits are non-refundable.
Earned Income Credit
Earned income credit is probably the favorite of all the credits because it's one of the refundable credits. Many taxpayers look forward to income tax season because of the return they can get due to EIC. For 2020, taxpayers can receive up to $6,660 in earned income credit. The credit applies according to each taxpayer's adjusted gross income and the number of children he or she has. A person with no children can qualify for a maximum amount of $529 of EIC if they have an AGI of less than $21,370. A person with three children can qualify for up to $6,557 if that person has an AGI of less than $55,952. People who are married filing separate returns do not qualify for earned income credit.
American Opportunity Tax Credit
You could qualify for the American Opportunity Tax Credit if you are a student within your educational venture's first four years. The credit allows you to claim up to $2,500 each year you are involved in learning endeavors. You must be actively pursuing a degree, and you must be enrolled in school at least halftime. To qualify, you must also not have a felony conviction at the end of the tax year.
Lifetime Learning Credit
The lifetime learning credit is a nonrefundable credit of up to $2,000. It's a credit for people who are enrolled in a higher education institute. There is no limit to the number of years that you can take this credit. However, you may not claim this credit and the American opportunity credit during the same tax year. It might be wise to see which benefit will serve you in a greater capacity and then use that one to your advantage.
Alternative Motor Vehicle Tax credit
You may be eligible to claim the alternative motor vehicle tax credit if you have a qualifying vehicle. The government offers this tax credit to encourage citizens to invest in alternative vehicles such as smart vehicles and electric cars. This particular credit is a non-refundable credit, which means that using it will not result in a refund under any circumstances. The most that this credit will do is reduce a taxpayer's obligation to $0. It still might be a great way for you to cut down on some of the money you will have to pay toward taxes this year.
There are many more credits that you might be able to claim on your taxes. You can talk to an experienced tax advisor if you want to learn more about your benefit.
Federal Versus State Taxes
Some people live in states that also impose taxes on residents' income. These persons must also file a state tax return in addition to their federal return. They must pay the state's governmental entity if they owe taxes at the end of the year. Fortunately, just as there are federal tax deductions, some state deductions also exist. The SALT deduction is an example of something that can help you with your income taxes. Taxpayers can sometimes deduct their state and local income taxes on their federal returns.
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Now you know why tax deductions are such a wonderful benefit. You can always learn more about them, however. You can do so by contacting us and allowing us to connect you with a tax advocate. We keep close ties with a variety of financial professionals, including tax specialists.
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