Tax Deductions, Credits, and Strategies
Every dollar saved on taxes can be invested and grown to help meet your retirement goals. Sometimes saving on your taxes is just a matter of knowing that a specific deduction or credit exists. For instance, did you know you can receive up to a $7,500 tax credit on a new car this year (see Plug-in Electric Drive Vehicle Credit below)? This article explores the various deductions and tax credits you may be eligible to take.
Tax Deductions – Reduce adjusted gross income
- Standard Deduction for 2021/2022
- $12,550/$12,950 Single
- $25,100/$25,900 Married Filing Joint
- $18,800/$19,400 Head of Household
- Itemized Deductions
- Real estate and other state and local taxes paid (subject to a $10,000 cap)
- Mortgage interest (subject to a $750,000 loan cap for homes acquired after December 16, 2017)
- Charitable contributions
- Medical expenses (eligible expenses must exceed 7.5% of adjusted gross income)
- Gambling losses (the amount deducted for gambling losses is limited to the total gambling winnings you report)
- Retirement plan contributions
- Health Savings Account contributions
- Capital loss deduction (-$3,000 per year)
- Student loan interest (up to $2,500)
- Self-employed health insurance premiums
Credits – Reduce taxes dollar for dollar
- American Opportunity Tax Credit – Taxpayers are eligible to receive a maximum annual credit of $2,500 for expenses paid for an eligible student during the first four years of higher education.
- Lifetime Learning Credit – Taxpayers may receive up to a $2,000 credit for qualified education expenses (including courses taken to acquire or improve job skills). There is no limit on the number of years you can claim the credit.
- Child Tax Credit – the new child tax credit amount is between $2,000 and $3,000 per child, and $3,600 for children who are five years or younger. Half of the credit was also authorized to be paid in advance of your tax return. A Child Tax Credit Calculator can be found here.
- Child and Dependent Care Credit – If you and your spouse work full-time and pay for eligible child/dependent care expenses, the American Rescue Plan increased qualified expenses to $8,000 for one child and $16,000 for two or more children. The maximum credit percentage is 50%, so taxpayers are eligible to receive up to a $4,000 credit for one child (and $8,000 for multiple kids).
- Residential Energy-Efficient Property Credit – According to the IRS, taxpayers may claim a credit for (1) 10% of the cost of qualified energy efficiency improvements and (2) the amount of the residential energy property expenditures paid or incurred by the taxpayer during the taxable year (subject to the overall credit limit of $500). A few examples of qualified improvements are energy efficient heating and air conditioning systems, water heaters, exterior windows, doors, skylights, roofs, and insulation.
- Foreign Tax Credit – If your foreign taxes paid are less than $300 ($600 if married), and all of your taxes paid are reported on a 1099, you may receive a full credit for your taxes paid without filing Form 1116. If your foreign taxes paid are more than the amounts listed above, you are required to file Form 1116 to determine your eligibility.
- Premium Tax Credit – Taxpayers who have health insurance coverage through the Health Insurance Marketplace and are not able to get affordable coverage through an eligible employer-sponsored plan or a government program may be eligible to receive a credit for premiums paid. In the past, the Premium Tax Credit was limited to taxpayers who were under 400% of the Federal poverty line; however, the American Rescue Plan vastly expanded the credit to household incomes above 400% of the poverty line by lowering the upper premium contribution limit to 8.5% of household income.
- Plug-in Electric Drive Vehicle Credit – Taxpayers who acquired new electric/plug-in vehicles after Dec. 31, 2009 are eligible to receive up to a $7,500 credit. The credit begins to phase out once the manufacturer sells 200,000 vehicles in the U.S. As of 12/31/21, Toyota’s 2021 RAV4 and Ford’s 2021 Mustang Mach-E Premium AWD are a few of the vehicles that are eligible for the full $7,500 credit. The full list is available here.
The tax deductions and credits above are valuable items to keep in mind throughout the year. For instance, if you were already going to buy a plug-in vehicle, it may make sense to explore the cars that are eligible for the plug-in electric drive vehicle credit. To go one step further, taxpayers can use deductions and credits to proactively save on taxes over time. Here are a few strategies to consider:
- Prepay Itemized Deductions – If you want to get the most out of your itemized deductions, you can prepay expenses (such as property taxes) and batch all your charitable contributions in one year.
- Capital Loss Harvesting – When stocks drop, taxpayers experience a “paper loss.” To realize the loss (and use it to offset future capital gains), you must sell the stock. Many financial advisors and CPAs recommend capital loss harvesting wherein the taxpayer sells stocks when the market drops and buys back similar stocks. This way, the taxpayer has similar market exposure but was able to take advantage of the loss to offset future gains.
- Capital Gain Harvesting – For one reason or another, income tends to fluctuate. Maybe you retired early, took a sabbatical, or you were laid off. These are great opportunities to maximize the 0% long-term capital gains tax bracket and reset your tax basis at a higher level (thus reducing future taxable income), completely tax-free.
- Roth Conversions – Converting tax-deferred income to a Roth IRA can be one of the best strategies to control your taxes. Roth conversions accelerate taxes paid in the current year while reducing taxes paid over your lifetime. Taxpayers who utilize Roth conversions are essentially trading higher taxes later for lower taxes now.
- Retirement Plan Contributions – There are many different types of retirement plan contributions (e.g. 401(k)s, Roth-401(k)s, IRAs, SEP IRAs, Solo 401(k)s, etc.). Maximizing tax-deferred accounts (including health savings accounts) can be a great way to shelter income from high tax rates.
Taxpayers deserve to know the deductions, credits, and strategies available to them so they can make educated decisions and reduce their annual tax bills. Consider working with a qualified CPA or financial advisor to make sure you are taking advantage of all the tax incentives and strategies available to you.
IRS – Credits and Deductions for Individuals
Kiplinger – Child Care Credit Expanded for 2021
Kiplinger – Child Tax Credit Calculator
Forbes – How Much is the Standard Deduction for 2021 and 2022?
The Motley Fool – 5 Last-Minute Moves to Save on Taxes