Tax preparation software — or a good tax preparer — can help you navigate the maze of tax breaks, but it helps to understand the picture as you go through the year, ideally collecting invoices along the way. So let’s discuss deductions:
Deductions don’t pack quite the same punch as credits, but they offer far more opportunities to save — and they add up. Above-the-line deductions not only reduce your adjusted gross income — which impacts everything from your tax bracket to qualifying for key credits — they’re available even if you take the standard deduction.
Some of the notables include, but aren’t limited to:
- Retirement-plan contributions. In addition to the any pre-tax contributions you make to a 401(k), you can deduct your IRA contributions; the limit is $5,500 ($6,500 if you’re over 50). If you’re self-employed, you can deduct up to $52,000 (or 25% of compensation) in SEP contributions for 2014. “That’s a huge tax benefit,” says Shelter.
- Student loan interest. You can deduct up to $2,500 in interest, though benefits begin to phase out for modified adjusted gross income over $120,000 for joint filers ($60,000 for single).
- Health savings account. This is a big one as more people move to high-deductible plans. Families with qualified plans can deduct up to $6,500 ($3,300 for single) for contributions made to HSAs. The money can be rolled over to other years and used for a range of qualified expenses.
- Moving expenses and job search. If you moved more than 50 miles for a job within a year of starting a new job, you can deduct expenses related to the move, including mileage, lodging moving services and supplies.
Itemized versus standard deductions
Once you’ve taken care of the above deductions, you can turn your attention to the second category of deductions. Here you have the option of itemizing these below-the-line deductions or claiming what’s known as the standard deduction.
Among taxpayers who do itemize, however, the numbers are pretty substantial. In 2011, the most recent data, taxpayers who itemized had a total of $25,000 in itemized deductions, according to CCH.
How do you know which route makes the most sense? Start by looking at your largest itemized deductions — for most people that’s mortgage interest, property taxes and state taxes. If they come close to the standard deduction, odds are that it makes sense to itemize after you account for all the other breaks, notes Lisa Greene-Lewis, a CPA at TurboTax.
Here are key itemized deductions:
- Mortgage interest. You can deduct interest on your primary residence and a second home, if it’s used primarily for personal use. The deduction is only good for up to $1 million in combined loan balances. You can also deduct interest on home equity loans and lines of credit with limits up to $100,000.
- Mortgage points. If you buy a new home, you can deduct any points you pay to secure the mortgage in a single year. If you refinance, notes Greene-Lewis, you need to spread those points over the life of the loan — though you get to deduct them all at once if you refinance again.
- Taxes. Odd as it seems, you can deduct certain taxes, including property tax on your primary residence, and state and local income taxes. What about sales tax? That deduction — which lets tax payers deduct state and local sales tax in lieu of income tax — expired at the end of 2013.
- Self-employment expenses. This is a category unto its own. Suffice it to say, if you are self-employed, the odds are pretty good that you will benefit from itemizing your deduction.
- Charitable giving. In 2011, taxpayers with adjusted gross income between $50,000 and $100,000 deducted $2,881 in charitable contributions. The key thing is to document your gifts; TurboTax offers an app that calculates fair market value of goods and tracks donations on the spot. Do you do a lot of volunteering? “You can deduct any mileage or out-of-pocket expenses,” says Mueller. “But you can’t write off the value of your time.”
– Tom Wheelwright
Rich Dad Advisor
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