At a very high level, the IRS allows taxpayers to choose between a standard deduction or an itemized deduction.
What does that mean exactly?
The standard deduction amount varies depending on your household status (single, married, etc) but basically, you reduce your taxable income by a predetermined amount.
For example, if you’re married and filing jointly your standard deduction is $24,000.
Most taxpayers default to the standard deduction when they file their federal return.
Some taxpayers can actually bring their tax bill down by itemizing their deductions.
That means they elect out of the standard deduction and instead add up all tax-deductible expenses they’ve incurred throughout the year.
Generally, it’s worth doing the math to make sure you’re choosing the better of the two options.
It may be that you had fewer itemizable deductions than you predetermined standard deduction (or vice versa).
According to the IRS, more than 45 million taxpayers itemized deductions in 2016.
That translates to $1.2 trillion dollars’ (to be clear, this is how many zeros that includes: $1,200,000,000,000) worth of tax deductions. In the same year, standard deductions only accounted for $747 billion.
While taking the standard deduction is much easier, putting in the work might be worth the savings. You’ll only know which option is better once you do the math (unless you qualify for vitrually no tax deductions).
Keep in mind that with tax changes effective this year, the standard deduction has increased. Don’t assume you’ll be better off with the itemized deduction because you were last year.
You can use this quick IRS tool to find out how much your standard deduction will be.
If you’re going to gather and add up your itemized deductions, you’re going to want to make sure you don’t forget any of this.
Here are 10 powerful deductions you don’t want to miss out on
Disclosure: This is general advice, and you should seek help from your own professional as situations can vary. Please note this post contains affiliate links.
1. State sales taxes
If you live in a state that does not impose income tax, be sure to look into this write-off.
Basically, you need to either deduct state and local income taxes OR state and local sales taxes.
For most taxpayers living in income-tax states, the income tax deduction is generally higher.
In other words, if you purchased a big ticket item like a car or boat, you can add that state sales tax to your deduction.
The IRS has a neat calculator to help you figure out the deduction (since it varies by your state and income level).
While the new tax code (revised for 2018) places a $10,000 cap on state and local tax deductions, you still don’t want to miss out on this one.
2. Reinvested dividends
Do you have mutual fund dividends that are automatically reinvested in extra shares?
Be sure to ALWAYS increase your tax basis (tax talk for what your investment costs) in the stock or mutual fund.
By doing so, you reduce your taxable capital gain (tax talk for the increase in the value of your investment which is taxable).
To put it into perspective, let’s say you bought $100 worth of shares that pay $10 a year. One year later, that $100 is now worth $200 AND you’ve received a $10 dividend reinvested into shares. That’s $210 worth of shares.
If you sold that immediately without adjusting your tax basis, you would be taxed on the full increase of $110 [$210-$100].
BUT, if you increase your tax basis to include the dividends reinvested in shares, you’ll only be taxed on $100 [$210-$100-$10].
In other words, don’t forget to substract reinvested dividends from the amount you make when you sell your shares.
While this isn’t technically a deduction, it’s a money saving opportunity a lot of taxpayers miss out on.
3. Unexpected charitable contributions
Most taxpayers are well aware that they can deduct charitable donations.
But often times smaller donations tend to slip through the cracks.
For example, if you’re baking cookies for a charity event, all your ingredients are tax deductible.
You’d be surprised how much the little things can add up to.
Another good example of deductible charitable donations is your mileage if you drive your car for charity (you can deduct 14 cents per mile).
It’s worth mentioning that the IRS has increased the charitable donation limit from 50% to 60% of adjusted gross income.
4. Student loan interest paid by mom & dad
You can deduct up to $2,500 in interest paid on qualifying student loans for college or vocational school.
What most taxpayers don’t know is that if you or your parents are legally obligated to repay the loan, you can deduct that interest even if your parents paid for it.
The IRS considers the payment from your parents as child support which is then used to repay student loans.
In the past, if parents covered the student loan repayments of their children, no one was able to claim that tax break.
5. Moving expenses
Deducting moving expenses to relocate to a new job is not news.
But a lot of taxpayers don’t realize they can claim the cost of moving more than 50 miles for work even if they opt for the standard deduction.
The caveat here is that starting 2018, the IRS restricted eligibility for this deduction to military personnel.
6. Child & Dependent Care Tax Credit
You can claim up to $6,000 in child care expenses with this credit which is pretty spectacular.
Why is that better than the other deductions we’ve mentioned so far?
Well, this is a tax credit, NOT a tax deduction.
The difference being that a tax credit is applied against the taxes you owe and not your taxable income.
Let’s put that into perspective.
Say your income is $60,000. A $6,000 tax deduction, would result in $54,000 of taxable income. At a 25% tax rate, that means you’re tax payable is $13,500.
If, on the other hand, you have a $6,000 tax credit (assuming your income is still $60,000), your taxable income is $60,000. That sounds worse but at a 25% tax rate, it translates to only $9,000 in taxes payable ($15,000 LESS the $6,000 tax credit).
Long story short, tax credits are gold compared to tax deductions. They save you far more money.
It’s easy to forget the child and dependent care credit if you pay those bills through a work reimbursement account but not this time around!
Don’t forget to add this bad boy to your tax return.
7. Earned Income Tax Credit
If you’re working but not earning a whole lot, you can claim the Earned Income Tax Credit (EITC).
According to the IRS, 25% of eligible taxpayers don’t claim it and they’re essentially leaving money on the table.
Know whether you qualify for the credit and claim it if you do!
Like the Child and Dependent tax credit above, this is also a credit (not a deduction) so you don’t want to miss out on this one.
8. Last year’s state tax
If you owed taxes when you filed your 2017 state return, remember to add that amount to your 2018 state tax itemized deduction.
Be sure to also include state income taxes withheld by your employer or paid quarterly (if self-employed).
9. Refinancing mortgage points
If you’ve refinanced your mortgage, be sure to deduct the points paid for your mortgage over the life of the loan.
In other words, you can deduct 1/20th of the points each year if you’ve refinanced a 20-year mortgage. That’s $50 a year for each $1,000 of points paid per year.
While this may not seem like much, why not take the money?
This is different from your initial mortgage. When you first buy a home, you can usually deduct all of the points paid to obtain your mortgage at once.
10. Jury pay turned over to your employer
Paid jury duty is always taxable.
However, if your employer paid you while doing your civic duty and requested that you turn over jury fees to the company, you can deduct the jury amount.
Essentially, since that money is only passing through your hand, you end up in a zero position.
Therefore, the IRS allows you to deduct jury pay you turned over to your employer.
Bottom line is…
In the United States, there are over 5,800 pages of tax law. That’s right; it’s really really long.
But what most taxpayers don’t know is that only about 30 pages are devoted to raising taxes.
The remaining 5,770 pages are meant to help you reduce taxes.
That means 99.5% of tax law is written to save you money.
Most of us cringe at the thought of doing out taxes and honestly, it can be intimidating at first.
But filing your taxes is much easier than you realize.
Personally, I don’t think there is ever any harm in understanding and taking some ownership over your taxes. Not to mention, the more you know the fewer deductions you’ll miss out on.
And yes, this is coming from a CPA who already understands and is comfortable with taxes…
But I’ve helped countless clients take ownership of their taxes and they’ve all been glad they no longer avoid taxes like the plague.
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If you’re interested in learning more about your taxes and other powerful deductions, check out:
Do you claim any other powerful deductions?