Reducing Your Tax Burden: Obscure Tax Benefits
The Internal Revenue Code does not contain a comprehensive list of items that you can claim as deductions or tax credits and the IRS does not publish such a list. The items below are by no means exhaustive, but we chose them based on the fact that some taxpayers may be completely unaware of them while many taxpayers could take advantage of them in some manner.
Before we dive in, let’s briefly explore the difference between a tax deduction and tax credit.
A deduction lowers your taxable income and consequently how much you owe in taxes (your tax liability). The taxpayer subtracts the amount of the tax deduction from his or her income, thus lowering the taxable income (or total income that is subject to taxation).
A tax credit is a dollar-for-dollar reduction in your actual tax bill. A tax credit is applied after the taxpayer’s tax liability is assessed to directly lower the amount of taxes he or she will pay. A few credits are refundable, which means if you owe $250 in taxes but qualify for a $1,000 credit, you’ll get a check for the difference of $750. (Most tax credits, however, aren’t refundable.)
Two of the most well-known tax credits are the Child Tax Credit—the “$2,000 child tax credit”—and the Earned Income Tax Credit (EITC), which helps low- to moderate-income workers and families reduce the taxes it owes – and maybe increase the amount of the refund.
A credit is much better than a deduction because it reduces your tax bill dollar for dollar.
How to claim tax deductions
Generally, there are two ways to claim tax deductions: Take the standard deduction or itemize deductions. You can’t do both.
The standard deduction basically is a flat-dollar, no-questions-asked reduction in your adjusted gross income (AGI). The amount you qualify for depends on your filing status.
The standard deduction is a specific dollar amount that reduces your taxable income. In 2020 the standard deduction is $12,400 for single filers and married filing separately, $24,800 for married filing jointly and $18,650 for head of household.
In 2021 the standard deduction is $12,550 for singles filers and married filing separately, $25,100 for joint filers and $18,800 for head of household.
The election made between taking the standard deduction or itemizing deductions depends on each taxpayer’s circumstances and can be easily resolved by your tax professional.
You can claim a deduction for medical expenses not covered by insurance so long as the IRS characterizes them as “covered medical expenses” for the tax year you are claiming, and the total amount of covered medical expenses is at least 7.5 percent of your adjusted gross income (AGI).
Commonly covered medical expenses for 2020 can be found here. To give you a general idea some qualified expenses include necessary medical and dental procedures, herbal supplements prescribed by a doctor to alleviate a medical condition, hormone therapy and sex reassignment surgery for someone afflicted with gender identity disorder, batteries for hearing aids, fertility treatments may also be deductible
Social Security Taxes You Pay
This doesn't work for employees. You can't deduct the 7.65% of pay that's siphoned off for Social Security and Medicare. But if you're self-employed and have to pay the full 15.3% tax yourself (instead of splitting it 50-50 with an employer), you do get to write off half of what you pay. Plus, you don't have to itemize to take advantage of this deduction.
This isn't a deduction, but most mutual fund dividends are automatically reinvested to buy more shares. This has the effect of increasing the investors’ tax basis in the fund which, reduces the taxable capital gain (or increases the tax-saving loss) when the shares are redeemed. If the reinvested dividends are not included in your basis, it results in double taxation of the dividends—once in the year when they were paid out and immediately reinvested and later when they're included in the proceeds of the sale.
Funds are required to must report the basis to investors and to the IRS for shares redeemed during the year. If you are unsure as to your basis in the fund, simply ask.
Credit for Dependents
In addition to the $2,000 child tax credit, which has been putting money back in parents' pockets for decades, there's a separate $500 credit for dependents who don't qualify for the child tax credit. Consequently, your can claim a credit for older children, even if they're in college, and for older relatives that you're caring for at home. The credit is phased out if your AGI is more than $200,000 ($400,000 for married couples filing jointly).
The taxpayer may qualify for a credit between 20% and 35% of childcare expenses paid for children 13 and younger capped at $3,000 per qualifying individual or $6,000 for two or more qualifying individuals. Childcare expenses include before and -after-care. However, it cannot be paid to a spouse or parent of the qualifying individual, your child under the age of nineteen, or your dependent claimed on your return.
If your employer has a childcare reimbursement program, that is probably going to be the best option since it avoids federal income taxes. However, it is capped at $5,000 per year. So, if you have $6,000 or more in expenditures (the cap is $6,000 for two or more individuals), $1,000 may qualify for the credit which will reduce your tax liability by $200 to $350 for that tax year.
Practically speaking, this is not a deduction for the casual gambler. In order to itemize these deductions, you must report gambling winnings as “other income.” The gambling losses cannot exceed your winnings—in other words, they cannot reduce income from other sources. You must also maintain a record of your gambling winnings and losses that includes the date and type of wagering, name and location of gambling establishments, names of people with you when you gamble, and amounts you won or lost.
State Tax Paid Last Spring
The state taxes paid last year can be deducted from this year’s federal tax return, along with state income taxes withheld from your paychecks or paid via quarterly estimated payments during the year up to $10,000 per year.
State Sales Taxes
This is a particularly important deduction if you live in Florida, which does not collect state income taxes. However, the taxpayer may not claim both the deduction for state income taxes and state and local sales taxes they paid. The taxpayer must opt for one or the other.
If you do not keep all of your receipts, DO NOT WORRY. The IRS has a calculator that shows how much residents of various states can deduct, based on their income and state and local sales tax rates. If you purchased a vehicle, boat or airplane, the calculator will also include the tax you paid on that big-ticket item when it spits out your total sales tax deduction amount.
Tax Breaks for College Costs
Taxpayers who are students or claim students that are enrolled at least half-time in a program leading to a degree, certificate or other recognized educational credential may qualify for a credit of up to $2,500 per student. The taxpayer’s modified AGI must be less than $90,000 for single and head of household filers, or less than $180,000 for joint filers. Expenses such as tuition, fees and books purchased at the campus bookstore counts toward the credit while the costs for books from an off-campus bookstore and board do not qualify
Tax Credit for Continuing Education
Taxpayers and their dependent children in graduate school, taking classes toward a degree, or continuing education classes to help with job skills, may qualify for the lifetime learning credit, which can be worth up to $2,000 per return. To qualify, single and head of household filers must have an AGI of less than $68,000, and married taxpayers filing jointly must have a modified AGI of less than $136,000. Additionally, the education institution must be eligible to participate in the U.S. Department of Education student aid program
Contact your tax professionals if you have any questions about credits or deductions.