This article was last updated on January 12
As the year draws to a close it’s always a good idea to review your tax situation and in light of that, we have put together a collection of fifteen tax deductions worth considering to lower your overall tax bill. But act soon, because if you wait until next year to evaluate your current tax status, it may be too late to qualify for some of these widely available tax credits and deductions.
1. Energy Saving Home Improvement Tax Credits
Certain home improvements qualify as energy saving improvements and as a result can land you a reasonable deduction based on the cost of the home improvement. There is a cap of $1,500 on this deduction over the course of two years. Energy saving home improvements are defined as biomass fuel stoves, qualifying skylights, windows and outside doors, and high-efficiency furnaces, water heaters and central air conditioners. New home owners can claim this credit in addition to the recently expired home buyers credit
2. Charitable Giving
This is one of the most well known tax deductions and is this simple rule that results in billions of dollars of charitable giving each year. You must however maintain adequate records for all cash contributions if claiming the deduction. This means retaining receipts from the charity, a canceled check or an official bank statement containing the name of the charity, the date, and the amount.
The one source of confusion comes from those who believe that 100% of charitable giving is deducted when in fact the percentage of deduction is based on your tax rate. This is why charitable giving is certainly a tax advantage but it is still recommended that giving be done for more “charitable purposes” rather than financial reasons.
3. Investment and Tax Expenses
If you’re a retail investor, you probably subscribe to investment publications, incur broker commissions, IRA fees that you pay directly, and even the Wall Street Journal that you purchase off the newsstand count as allowable deductions.
Tax software, tax attorney fees, fees you pay to settle tax implications from a divorce, and any other fee relating to taxes and investments is deductible. Many taxpayers don’t keep adequate records throughout the year in order to remember all of the allowable expenses. If you’re one of those, consider keeping detailed records next year.
4. Refinancing Points
Any points you pay to refinance your home is deductible on a monthly basis over the life of the new loan. For example, if you refinance for 30 years, you can deduct 1/30th of the points each year for 30 years or $33 per year for every $1,000 of points you paid. This doesn’t seem like much but every little bit counts as it adds up over time.
5. Health Insurance Premiums
Any money you pay for health insurance premiums is deductible. These premiums are combined with any out of pocket medical expenses you incur but before you can deduct any of these expenses they must equal 10% of your adjusted gross income.
6. Educator Expenses
Are you a K-12 teacher? If you are, you can deduct up to $250 for any expenses you directly incurred for your classroom. Books, Computer equipment or any other expense you incur is deductible.
7. Child Care Credit
If you have a child care reimbursement account set up through your employer, you are contributing money in tot that account on a pre-tax basis to pay for those expenses of up to $5,000. There is also a child care credit that can be claimed, which goes dollar for dollar against your tax bill for up to $6,000. If you have that $5,000 deducted from your paycheck but pay out more than that each year, you probably have another $1,000 credit coming to you. You can’t claim both credits but you can claim the $1,000 difference between the two.
8. State Taxes Paid Last Spring
If you owed the government money when you paid last year’s tax return in the Spring of this year, don’t forget to deduct that amount on this year’s taxes along with state income taxes withheld from your paycheck.
If you have your taxes completed by a tax preparer, ask them to verify that these deductions were evaluated on your return. If you use tax preparation software, check your return to verify that these deductions were applied if you qualify. Tax preparation software has evolved considerably over the past decade and because of that, you can feel confident that these deductions were evaluated and applied if you qualified.
9. American Opportunity Tax Credit
The American opportunity credit replaced the Hope Credit, making it available to a broader range of taxpayers, including many with higher incomes and those who owe no tax. It also adds required course materials to the list of qualifying expenses and allows the credit to be claimed for four post-secondary education years instead of two. Many of those eligible will qualify for the maximum annual credit of $2,500 per student.
The full credit is available to individuals whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing a joint return. The credit is phased out for taxpayers with incomes above these levels. These income limits are higher than under the existing Hope and Lifetime Learning Credits.
10. Max out your 401K/IRA Accounts
To reduce your taxable income for the current year, consider making extra or additional contributions to your retirement accounts up to the IRS allowed limits. If you have the extra cash, this is probably the smartest way to reduce your taxable income and also save for your future. For Roth IRA and Traditional IRA accounts you do have until April 15 of the following year to open an IRA and make a deductible contribution for the prior year. If
11. Review Your Income and Deductions to Accelerate or Slow Payments
The most fundamental year-end tax saver is to adjust the timing of income and deductions. If you anticipate income tax rates to increase in increase (e.g if Bush tax cuts expire), it may be beneficial to accelerate income into the current year and defer deductions into subsequent years in order to save the taxes on income and have the deferred deductions save you taxes in the current year when the rates are higher. In using this strategy, it should be noted that different itemized deductions are subject to different phase-out limits for regular tax purposes as it relates to the AMT (Alternative Minimum Tax).
12. Pay Deductible Expenses before December 31
Paying your state income tax estimate before Dec. 31 accelerates your federal deduction. You can also pay property taxes early, make an extra mortgage payment (the interest portion is deductible), pay your tax preparer for your year-end planning meetings or opt to have dental work or elective (deductible) surgery before the end of the year. Using a credit card is the same as using cash—the deduction is taken in the year the charge is incurred (rather than the year you pay off the credit card balance). CAVEATS: If you are in the AMT you should consider making the final estimated tax payment of state and local income tax in the subsequent year to get the exemption in the current year. Also refer to Points 2 and 3. Should tax rates increase for 2011 and your tax bracket is affected you may want to defer expenses from the current tax year to next year in order to save overall tax dollars
13. Consider Gifts to Children
If you intend to make gifts to children (or other relatives), do it well before Dec. 31 so that the checks clear. Gifts up to $13,000 per person need not be reported and are not subject to additional taxes by the recipient.
14. Consider a “529” education plan
A 529 Plan allows you to put away money (with tax-free growth) for a child’s college education and get some benefit on your state income tax return and not give up control over the money. This is not the same as an outright gift but you’ll still get some tax advantages and provide for the future education of a loved one.
15. Offset Capital Gains
Review your investment portfolio to determine whether you should sell some “losers” before year-end in order to offset capital gains you’ve already realized. Capital losses are first netted with capital gains, and then are deductible against ordinary income (limited to $3,000 a year). You should consider recognizing gains that might not be taxed because there is a loss that can offset it. In that way, you can immediately buy back the stock since there is no 30-day waiting period for stocks sold at a gain (known as the wash rule). If you expect capital gains rates to increase in 2011 (which will happen if Bush Tax cuts are not extended) you may consider taking the gain in this year in order to save on the potential income tax increase in the rate.
16. Get Organized (Bonus)
While this is not directly a tax deduction, it can make tax time much easier. Start organizing your tax data (receipts, medical reimbursements, share sales/ purchase etc) and files now, to avoid the last-minute rush before April 15th. It is much easier to get replacements when you have the time instead of finding out at the last minute that you’re missing some item that prevents you from finishing your tax return and having to pay penalties.