A guide to tax credits and deductions
The U.S. tax system is incredibly complicated. Not only are you supposed to report your own taxes, but you are supposed to choose your tax credits and deductions carefully. Otherwise, you may end up needing to look for some of the best tax debt help companies to bail you out of an unfortunate situation. If you want to save money on your taxes, it is in your best interest to learn how to report your taxes properly, as well as how to utilize tax credits and deductions you may qualify for. In this article, we will explain exactly what tax credits and deductions are and show you some of the most popular tax breaks you have available to you.
What are tax credits?
A tax credit is, essentially, a reduction in your tax bill. What this means is that you get to apply for tax credits after you fully calculate your taxes. For example, if your full tax bill for the year amounts to $50,000, applying a tax credit of $5,000 will have you pay $45,000 in taxes ($50,000 minus $5,000). Simple as that. Furthermore, there are two types of tax credits: Refundable and non-refundable. Refundable tax credits are best, as they have the potential to not only reduce your tax lien but provide you with a tax refund as well.
Here’s an example: Let’s say that you owe $500 in taxes, but you qualify for a $1000 refundable tax credit due to tax breaks for single parents, let’s say. In that case, you will receive a check from the IRS for $500! However, most tax credits are not refundable. Furthermore, the situations in which you actually get a refund are few and far between.
Even so, the fact that tax credits are applied at the end of the tax calculations makes them extremely powerful when it comes to saving money. It is usually in your best interest to apply for as many tax credits as you can qualify for, as they are basically free money. Of course, you need to be very careful when doing so, as failure to report your credits properly can lead to various IRS penalties.
What are tax deductions?
Tax deductions, unlike tax credits, do not influence your tax bill directly. They lower your taxable income instead. This, of course, reduces your overall tax bill. Tax deductions are usually not as “powerful” as tax credits unless these deductions actually lower your AGI (Adjusted Gross Income) into a lower bracket. To explain how this works, let’s take a look at the U.S. tax income brackets.
There are seven federal income tax brackets for 2023: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The bracket you fall into depends on your AGI, as well as your filing status. To make matters simple, let’s presume that you are a single filer. In that case, your income and tax brackets would look like this:
- Less than $11,000 – 10% tax
- More than $11,000 but below $44,725 – 12% tax
- More than $44,725 but below $95,375 – 22% tax
- More than $95,375 but below $182,100 – 24% tax
- More than $182,100 but below $231,250 – 32% tax
- More than $231,250 but below $578,125 – 35% tax
- More than $578,125 – 37% tax
As you can see, the largest difference in taxation is when your income goes over $44,725, where taxes jump from 12% to 22%. If you take advantage of popular tax deductions to lower your AGI into the previous bracket, you may be able to save more money. While tax deductions may not be as powerful as tax credits, there is absolutely no reason why you can’t apply for both. There is no limit to how many tax deductions and credits you can qualify for, after all.
How to claim tax credits and deductions
The procedure for claiming a tax credit depends on the credit itself. Generally, if you qualify for a certain credit, all you need to do is submit the appropriate forms alongside any necessary documentation, and that is it. Claiming popular tax deductions can only be done if you choose to itemize your deductions. Otherwise, you will need to take the standard deduction. Sometimes, the best way to boost your tax refund amount is to take the standard deduction. However, if you qualify for multiple tax deductions, then it might be a good idea to itemize.
With this in mind, let’s take a look at what credits and deductions might be available to you.
Most popular tax credits and deductions
While there are literally hundreds, if not thousands, of tax credits and deductions, some are more popular than others. Currently, the most popular tax credits and deductions in the U.S. include:
- Standard tax deduction
- Earned income tax credit
- American opportunity tax credit
- Lifetime learning credit
- Charitable donations deduction
- Mortgage interest deduction
- Adoption credit
- Home office deduction
- Residential energy credit
Furthermore, if you are behind on your taxes, you may be able to benefit from the IRS debt forgiveness program. This program is usually reserved for low-income families, but anyone can get some kind of settlement with the IRS. That said, it is usually advisable to enlist help from a professional tax consultant before you start corresponding with the IRS. Since the tax system is as complicated as it is, chances are that you do not have sufficient knowledge to make the most out of your tax situation. With that in mind, let’s take a look at these popular tax deductions and credits in a bit more detail.
Standard tax deduction
Most people who do not want to bother too much with their taxes take the standard tax deduction. This deduction presents the taxpayers with an option to reduce their AGI by a flat, no-questions-asked amount. There is only one thing that determines the amount of standard tax deduction, and that is your filing status. Here’s what you can expect from this deduction in 2023:
- Single filers – $13,850 deduction
- Married joint filers – $27,700 deduction
- Married separate filers – $13,850 deduction
- Head of household – $20,800 deduction
Furthermore, if you happen to be blind and over the age of 65, the standard tax deduction increases.
As you can see, the standard tax deduction is quite “powerful” in its own right, and it is a great way to cut your tax bills. Therefore, it is usually a good choice for people that are uncertain about which deductions they qualify for. Furthermore, itemizing tax deductions is a time-intensive affair, requiring you to submit more forms, and you will need to prove that you qualify for your itemized deductions.
That being said, itemizing your deductions has the potential to save you a lot of money if the circumstances are right. The best thing you can do is consult a tax professional to create an analysis of your tax situation or use tax software for the analysis.
Earned income tax credit (EITC)
Earned income tax credit, also referred to as simply earned income credit, is one of the most popular tax credits due to the fact that it is fully refundable. To qualify for this credit, you will need to have a low to moderate AGI, and the credit itself depends on the number of children in the household. Here’s a quick breakdown:
- Taxpayers with 0 children and an income of $17,640 or less ($24,210 for married joint filers) can get a maximum EITC of $600.
- Taxpayers with 1 child and an income of $46,560 or less ($53,120 for married joint filers) can get a maximum EITC of $3,995.
- Taxpayers with 2 children and an income of $52,918 or less ($59,478 for married joint filers) can get a maximum EITC of $6,604.
- Taxpayers with 3 or more children and an income of $56,838 or less ($63,398 for married joint filers) can get a maximum EITC of $$7,430.
Furthermore, if you want to protect your income from taxes by utilizing EITC, you also need to have at least $1 in earned income aside from your unemployment benefits or pensions. You also can’t have more than $11,000 of investment income.
It is also possible to qualify for IETC if you are in a marriage but living separately. The requirement is that you are also not filing a joint tax return and that the children live with you for more than half the year while not living with your spouse during the last six months. If you want to claim EITC without any children, you need to be between 25 and 65 years of age.
American opportunity tax credit (AOTC)
The AOTC allows you to get a tax refund for any qualified expenses for books, school fees, equipment, and tuition, up to $2,000. Furthermore, AOTC will also refund you 25% of the expenses after $2,000, up to $4,000 total credit. Basically, the first $2,000 you spend on qualified expenses will be fully refunded, while you will get up to $500 for the next $2,000 in expenses.
To qualify for AOTC, you will need to:
- Be a student (of course)
- Pursue a degree or any other education credential that is recognized by the IRS
- Not claim either the former Hope credit or AOTC for more than four tax years
- Be enrolled in at least one academic period (full or half-time)
- Not have a felony drug conviction
To claim AOTC, you will need to submit Form 8863 when filing your tax return. You will also need Form 1098-T Tuition Statement from your school to determine your qualified education expenses. Do note that living expenses and transportation do not count as qualified education expenses.
Lifetime learning credit (LLC)
Another education-based tax credit, the lifetime learning credit, allows you to claim 20% of the first $10,000 that you pay for any fees and tuition. The maximum credit amount is $2,000. Similar to AOTC, you can’t apply lifetime learning credit toward transportation or living expenses. You can, however, claim the credit to cover the expenses for any supplies and books you may need for your coursework. Aside from AOTC and LLC, there are additional tax breaks for higher education that you may want to explore, which may further lower the cost of your education. However, be careful when applying for these tax breaks, as some of them might be mutually exclusive.
Charitable donations deduction
If you contribute to charity on a regular basis, you may qualify for a charitable donations deduction. This particular deduction allows you to deduct up to 60% of your AGI but is usually limited to either 20%, 30%, or 50%, depending on the organization you are contributing to. Furthermore, any deductions that you make that exceed this limit may be deducted from your tax return in the next five years. This is called a “carryover”, and it lasts either until five years pass or until your contributions run out.
Mortgage interest deduction
The mortgage interest deduction allows taxpayers to reduce their taxable income based on the amount of money they’ve paid in mortgage interest throughout the tax year. Only the first $750,000 ($375,000 if you are filing separately) of your mortgage debt is calculated for this deduction, however, unless you bought the house before December 16, 2017, in which case the first $1 million ($500,000 for separate filers) is calculated.
The way in which mortgage interest deduction works is quite simple. You can deduct the entire interest from your tax report if your mortgage is not over $750,000. If it is, you will still get a deduction of the interest based on the first $750,000 of your mortgage debt.
The adoption credit will cover the first $14,890 of the adoption costs. The credit itself will decrease according to certain income levels and will phase out completely once your AGI surpasses $263,410. The credit itself, while quite popular, is also quite complicated. If you want to know more about the adoption credit, the best thing to do is take a look at IRS Topic No. 607. Alternatively, you may also hire a tax consultant and have them do the calculations for you.
Home office deduction
If you happen to use your home (or part of your home) for business purposes, you may be able to take advantage of a home office deduction. This particular deduction will allow you to write off some of your real estate taxes, repairs, maintenance, and utilities according to the percentage of your home that you allocate to your business.
Residential energy credit
Residential energy credit is quite popular these days due to the rising popularity of solar panels. This particular credit will allow you to get a refund on up to 30% of the solar energy systems installation costs!
These were the most popular tax credits and deductions for 2023. However, there are many more deductions and credits that you may be able to qualify for and reduce your tax bill even further. You can find all of them right here at the Consumer Opinion Guide! We can also help you find the best tax advocates in your area, provide you with tax tips and tricks, and much more!