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Tax season can feel overwhelming, but understanding the tax breaks available to you can make a significant difference in what you owe—or even result in a nice refund.
Whether you're a parent or student or simply trying to reduce your taxable income, knowing how to claim the correct deductions and credits is essential. In this guide, we'll walk you through some of the most common tax breaks available for individuals and how they can help reduce your tax bill.
Before diving into specific tax breaks, it's essential to understand the difference between tax deductions and tax credits.
A tax deduction reduces the amount of your income that's subject to tax. For example, if you earned $50,000 and qualified for a $2,500 deduction, your taxable income would drop to $47,500, meaning you pay taxes on that reduced amount. In contrast, a tax credit directly reduces the amount of tax you owe. So if your tax bill is $5,000 and you qualify for a $1,000 tax credit, you only owe $4,000.
Knowing this distinction can help you take full advantage of tax breaks that can reduce your tax liability.
The key takeaway is that tax credits are generally more valuable than deductions. While deductions lower your taxable income, credits offer a dollar-for-dollar reduction in your taxes owed. If you qualify for both, maximizing your tax credits first is an intelligent strategy.
Now that we've covered the basics let's explore some of the most popular tax credits for which you may be eligible.
Tax credits are precious because they reduce the amount you owe the IRS and, in some cases, can even result in a refund. Below are some of the most common tax credits available to individuals.
If you have children, the Child Tax Credit is one of the most valuable tax breaks available. For the 2023 tax year, parents can claim up to $2,000 per qualifying child under the age of 17. Part of this credit is refundable, meaning you can receive up to $1,400 per child as a refund, even if you owe little or no federal income tax. Keep in mind that there are income thresholds and the credit phases out for higher earners.
Parents who pay for daycare or other dependent care expenses may qualify for the Child and Dependent Care Credit. This credit can cover up to 35% of qualifying child care expenses, with a maximum credit of $3,000 for one child and $6,000 for two or more children. Eligibility depends on your income, but even families with moderate incomes can benefit.
For students or their parents, the American Opportunity Tax Credit (AOTC) can provide relief for college tuition and related expenses. You can claim up to $2,500 per eligible student, and up to 40% of the credit is refundable. This credit covers educational expenses such as tuition, course materials, and specific fees during the first four years of post-secondary education.
Suppose you're taking courses to improve your job skills or pursue lifelong learning. In that case, the Lifetime Learning Credit offers up to $2,000 per year for tuition and educational expenses. Unlike the AOTC, this credit isn't limited to the first four years of college, so it's a great option for graduate students or adult learners.
Need help navigating your tax breaks? Contact us today for expert advice on maximizing your deductions and credits this tax season.
While these tax credits can reduce your tax liability, deductions also play a significant role in lowering your taxable income.
Tax deductions reduce your taxable income, which in turn lowers your overall tax bill. Below are some standard deductions that may apply to your situation.
If you're paying off student loans, you can deduct up to $2,500 of the interest paid on your loans. This deduction is available even if you don't itemize, meaning it's considered an "above-the-line" deduction that directly reduces your Adjusted Gross Income (AGI).
Adopting a child can be expensive, but the Adoption Credit can help offset those costs. For 2023, you can claim up to $14,890 per child in qualified adoption expenses, including legal fees and travel expenses. Be aware that this credit begins to phase out for taxpayers with higher incomes.
The Earned Income Tax Credit (EITC) is aimed at helping low to moderate-income workers. Depending on your income, filing status, and number of children, the EITC can provide significant relief, with credits ranging from $560 to $6,935 for the 2023 tax year. Even if you don't owe taxes, the EITC can result in a refund if you qualify.
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Let's now explore the difference between taking the standard deduction versus itemizing deductions.
When filing your tax return, you have the option of claiming the standard deduction or itemizing your deductions. Understanding the benefits of each can help you decide which option is best for you.
The standard deduction is a flat amount that reduces your taxable income. For the 2023 tax year, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly. Most taxpayers find that claiming the standard deduction is more straightforward and results in a higher reduction of taxable income compared to itemizing.
Itemized deductions are a way to reduce your taxable income by listing specific expenses such as mortgage interest, property taxes, and charitable donations. If your qualifying expenses exceed the standard deduction amount, itemizing can result in a more significant tax break. However, it requires more documentation and time to calculate.
Let's look at some examples of expenses that are typically deductible when itemizing.
Itemizing your deductions can be worth the effort if you have significant expenses. Here are a few examples of commonly deductible expenses.
Suppose you make alimony payments to a former spouse as part of a divorce agreement finalized before 2019. In that case, you can deduct those payments from your taxable income. Additionally, contributions to a traditional IRA are tax-deductible, lowering your taxable income for the year you contribute.
If you made donations to qualified charitable organizations, those contributions may be deductible. Mortgage interest on your primary residence is also deductible, up to certain limits, providing a significant tax break for homeowners.
Medical expenses can add up quickly, and if your unreimbursed medical costs exceed 7.5% of your AGI, you may be able to deduct them. These expenses can include everything from doctor visits and surgeries to prescription medications.
Now, let's discuss how to correctly claim these deductions and what you need to know about tax deduction procedures.
When it comes to claiming tax deductions, it's essential to understand the difference between above-the-line and below-the-line deductions.
Above-the-line deductions, also known as adjustments to income, are subtracted from your gross income to determine your AGI. These include deductions for student loan interest, IRA contributions, and specific business expenses.
Below-the-line deductions are applied after your AGI has been calculated, further reducing your taxable income. These include itemized deductions like mortgage interest, charitable contributions, and medical expenses.
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Next, let's look at how you can claim these deductions and credits on your tax return.
Filing your taxes and claiming deductions or credits can feel complicated. Still, with the right tools and knowledge, it becomes manageable.
Whether you use tax software or file manually, the process of claiming deductions and credits is straightforward. Most tax software platforms guide you step-by-step through the process of entering your deductions and credits. If you're filing manually, you'll need to complete IRS forms like Schedule A for itemized deductions or Form 8863 for education credits.
It's crucial to keep records of all the expenses you plan to deduct or claim for tax credits. This includes receipts for charitable donations, childcare expenses, tuition payments, and any other eligible costs. Having proper documentation is essential if the IRS ever requests proof of your claims.
It was a lot of information to grasp, let’s go over them briefly.
Understanding and utilizing tax breaks can significantly reduce your tax liability and even increase your refund. Whether you're claiming the standard deduction or itemizing, knowing which tax breaks apply to your situation can help you keep more of your hard-earned money. Remember to review your eligibility for deductions and credits each year, as tax laws and limits can change.
By exploring your options and ensuring you have the right documentation, you'll be well on your way to maximizing your tax benefits and minimizing your own.
Want to learn more about optimizing your tax strategy? Schedule a consultation with us today to get personalized advice tailored to your financial situation.
