Did you know that the average American shells out an average of $525,037 in taxes throughout the course of his or her life? It’s a pretty steep amount, and almost 65% of the amount includes a tax on earnings, according to financial technology company Self Financial, which analyzed data from the Bureau of Labor Statistics.
Nobody likes paying taxes, so you might as well look for the silver linings — tax deductions and tax credits. Think of them as a little break in the amount you’ll shell out over your lifetime.
Let’s walk through an overview of tax deductions and tax credits and a few common tax deductions and credits you may want to consider for the upcoming year.
What is a Tax Deduction?
A tax deduction refers to a deduction that lowers your tax liability by lowering your taxable income. You can get both a standard deduction and an itemized deduction. Let’s go over the details of both.
The standard deduction is a fixed dollar amount that reduces your taxes on your income, which varies according to your filing status. Most taxpayers claim the standard deduction. Standard deduction amounts are as follows:
- Single or married filing separately individuals: $12,400
- Married filing jointly or qualifying widows or widowers: $24,800
- Head of household: $18,650
Your standard deduction goes up if you’re blind or 65 or older. It increases by $1,650 if you’re single or filing head of household and by $1,300 if you’re married or a qualifying widow(er). It eliminates the need to itemize deductions and means you don’t have to keep records in the event that you are audited by the IRS.
Itemized deductions also reduce your adjusted gross income but they work differently than the standard deduction. You add up the applicable deductions and subtract that number from your taxable income. You’ll get to know Form 1040 when you file taxes.
When do you itemize instead of taking the standard deduction? Great question. In some situations, filing and itemizing your tax deductions makes sense if you:
- Have itemized deductions that go over the standard deduction amount
- Had big medical and dental expenses that you paid out of pocket
- Paid mortgage interest and real estate taxes on your home
- Had uninsured losses, like a fire in your home
- Made large charitable contributions
- Experienced gambling losses
- Have other allowable deductions
What is a Tax Credit?
Tax credits are different from deductions: They reduce the amount of tax you owe directly. In other words, they reduce your tax liability by the exact dollar the tax credit is valued at. Let’s say you receive a tax credit valued at $2,000. It would lower your tax bill by $2,000. Tax deductions, on the other hand, reduce how much of your income gets taxed.
Common Deductions and Tax Credits
Let’s take a look at some common deductions and tax credits that you may tap into based on your personal situation.
401(k) Contributions Deduction
Your 401(k) contributions directly reduce your taxable income at the time you make them as long as you utilize pre-tax dollars. You pay less on your income taxes by directly reducing your taxable income.
Taxpayers can receive a tax credit for all qualifying adoption expenses, which is indexed for inflation. In 2021, the maximum adoption credit is $14,440 per child.
American Opportunity Tax Credit
The American Opportunity Tax Credit is a credit that aims to reduce the cost of attending college. You can take advantage of it during the first four years of your child’s time in college and use it toward a maximum annual credit of $2,500 per eligible student.
Charitable Donations Deduction
You may deduct charitable contributions of money or property made to qualified organizations. You must itemize your deductions.
Child and Dependent Care Tax Credit
Did you pay expenses for the care of a qualifying individual so you and/or your spouse could go to work? If so, you may be able to claim the child and dependent care credit.
Child Tax Credit
The normal child tax credit — usually $2,000 per qualifying dependent — was built up to $3,600 in 2021 as part of the American Rescue Plan, the coronavirus relief package that took effect in March.
Earned Income Tax Credit
The Earned Income Tax Credit (EITC) helps low- to moderate-income workers and families achieve a tax break. You must show proof of earned income and meet the requirements. You can use the credit to reduce the taxes you owe.
Gambling Loss Deduction
You can deduct your gambling losses as long as you report all the money you win as taxable income on your return and as long as you itemize your deductions.
Health Savings Account Contribution Deduction
You can claim a tax deduction for contributions you or someone other than your employer makes to your HSA even if you don’t itemize your deductions. The interest or other earnings on the assets in your account are tax free and distributions may be tax free if you pay qualified medical expenses.
Home Office Deduction
Self-employed taxpayers, independent contractors and those working in the gig economy can claim a home office deduction.
IRA Contributions Deduction
You can deduct your traditional IRA, though you may face limits if you (or your spouse, if you are married) are covered by a retirement plan at work and you don’t meet the income requirements. If you don’t have a workplace retirement plan, you can make the full deduction. Your spouse, if you are married, may also not be covered by a retirement plan at work.
Student Loan Interest Deduction
The student loan interest deduction allows you to deduct up to $2,500 of the interest paid if you paid on a loan for higher education.
Lifetime Learning Credit
The Lifetime Learning Credit refers to a credit that allows you to get credit for qualified tuition and related expenses as long as your child is enrolled in an eligible educational institution. The credit is worth up to $2,000 per tax return, or 20% of the first $10,000 of qualified education expenses.
Medical Expenses Deduction
The IRS allows you to deduct unreimbursed expenses for preventative care, treatment, surgeries and dental and vision care as qualifying medical expenses. In addition, you can deduct visits to psychologists and psychiatrists. You can also deduct unreimbursed payments for prescription medications and appliances such as glasses, contacts, dentures and hearing aids.
Residential Energy Credit
You can qualify you for a credit of up to 30% of your total cost by installing renewable energy equipment in your home. The percentage you can claim depends on when you installed the equipment. You take the amount directly off your tax payment instead of as a deduction.
The retirement savings contribution credit, also called the saver’s credit, is a tax credit worth up to $1,000 ($2,000 if married filing jointly) that you can contribute to if you are a mid- to low-income taxpayer who contributes to a retirement plan.
Self-Employment Expenses Deduction
Look into the following potential deductions: health insurance, continuing education, retirement savings, travel and your vehicle, self-employment taxes, business insurance premiums, office supplies and more.
Don’t Miss Out on Tax Credits and Deductions
When you do your taxes yourself, you might miss out on specific tax deductions and credits available to you.
Taxpayers who claimed the standard deduction on their returns receive billions in tax deductions, but many missed out on some every year.
According to the IRS, one of the most common missteps comes from not claiming the Earned Income Tax Credit, according to the IRS, which could offer a major boost for individuals with low or moderate incomes.
When you don’t think you’re eligible for a specific tax deduction or credit, dig into the minute details so you know for sure. Otherwise, get a savvy accountant on your side to make sure you take advantage of every opportunity.
Curious about tax tricks? Keep up with UNest’s blog for more information.