Doing taxes probably isn't your idea of a good time. Deductions and credits are here to change your mind.
We'll start with some definitions.
Tax deductions indirectly lower your tax bill by lowering your taxable income. You add up eligible costs you've paid throughout the tax year and subtract that number from your income.
Tax credits are even better. Because it's a dollar-for-dollar discount. Meaning a $1,000 tax credit lowers your tax bill by $1,000.
Related: Tax Terms You Need to Know
It's a two-parter:
The standard deduction is what the IRS lets you subtract from your taxable income, no questions asked. For single filers, the 2020 standard deduction is typically $12,400. Double that if you’re married and filing jointly. But it could be higher or lower based on your age, whether you’re blind or if someone claims you as a dependent. The IRS’s Interactive Tax Assistant can give you a final answer.
Itemized deductions require you to do some HW. As in, make a list of everything you paid for during the tax year that could qualify. You’ll find yourself asking ‘is this deductible?’ a lot. It could be a 'yes' to medical expenses that add up to a certain percentage of your income, mortgage interest, property taxes, certain biz costs, and charitable donations.
That tax break is currently reserved for the self-employed. So if you're still a full-time employee, no luck. But if you've turned to freelance/contract work or picked up a side gig, then maybe. It depends on if your home workspace is dedicated to biz only (meaning your kitchen-table-office-combo doesn't count...sorry). And if it's the primary place where you work.
Be a 'whichever saves more money' person. Taking the standard deduction is nice and easy. But itemizing could help you avoid leaving money on the table. Look back at your receipts and do the math.
A fun exception to the rule: "above-the-line deductions." Aka deductions you can claim without itemizing. Think: traditional IRA contributions, HSA contributions, up to $300 in charitable donations (made by December 31, 2020), and up to $2,500 in student-loan interest. (If you have federal loans, don't forget to deduct interest you paid before those debts were put on pause).
Keep in mind that income limits often apply when it comes to tax breaks. Read: if you make above a certain amount, how much of a break you qualify for may be lowered – or, in tax-speak, "phased out." Earning more than the uppermost limit means no break for you.
A new one to see if you qualify for this year: the Recovery Rebate Credit. When the gov was handing out first- and second-round stimulus payments, they looked at your income on the last tax return you filed to determine if you were eligible. If you previously earned too much, but your income fell in 2020, you may be able to claim the payment as a tax credit on your return this year.
And here are some popular credit classics:
The American Opportunity Tax Credit helps offset the high cost of higher education. It’s worth up to $2,500 a year for each eligible student in your household. And 40% of it (up to $1,000) is refundable.
The Saver's Credit is Uncle Sam’s way of rewarding you for planning ahead. It gets you 10-50% of your qualified retirement contribution, worth up to $1,000 for single filers and $2,000 for joint filers. Not-so-fun fact: income limits apply.
You might also qualify for state and local tax credits. By doing things like installing an energy-efficient water heater and installing solar panels. Green recognize green.
Credits and deductions are the MVPs of tax season – giving you the discounts you deserve, and keeping more money in your wallet.
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Liz Smith, Stacy Rapacon, and Elyse Steinhaus