It’s hard to believe that we only have a couple months left in 2016, and tax-filing season will begin soon. In this post we’re going to look at 5 big categories of tax credits and deductions you should consider when filing your 2016 tax return next April.
One point to keep in mind before we continue is the difference between a tax credit and a tax deduction. A tax credit directly reduces the amount of taxes that you owe. A tax deduction reduces the amount of your income that can be taxed. Let’s say, for example, you’re in a 15% tax bracket, and you have a $1,000 tax deduction. This deduction would lower your taxable income by $1,000 and save you $150 in taxes. A $1,000 credit would directly save you $1,000 in taxes owed regardless of your tax bracket.
Tax Deductions for Homeowners
Buying a home can qualify you for additional tax deductions that you weren’t eligible for as a renter. It can also make your tax return a bit more complicated because you have to itemize vs. taking the standard deduction in order to qualify for most homeowner’s deductions. This means that amount you pay in mortgage interest combined with other deductions such charitable donations and certain medical expenses has to exceed the standard deduction for 2016 of $6,300 for taxpayers filing as single or $12,600 for married filing jointly.
You can also typically deduct the full amount of interest you paid on your mortgage loan for your main home or second home if the loan is under $1 million. You should receive Form 1098 from your mortgage lending company by January 2017. This form will provide you with the amount of interest you paid, and you should hang on to it for record keeping purposes.
If you purchased a home after 2006 and are required to pay private mortgage insurance, you may be able to deduct your premiums. For example, if you bought a home and weren’t able to pay at least 20% down, the mortgage lender may consider you a riskier borrower. They could require you to pay a private mortgage insurance policy to insure the money they loaned to you.
The amount you’re required to pay in premiums will be reported on Form 1098 by your mortgage lender. You may then be able to deduct this amount on your tax return. You won’t be eligible for this deduction if your adjusted gross income for 2016 is over $109,000. Also, this deduction is set to end in 2016 unless Congress takes steps to renew it.
Tax Credits for Education Expenses
There are two types of tax credits for education expenses: The American opportunity tax credit and the lifetime learning credit. You are only allowed to apply one of these credits in your annual tax filing
American Opportunity Credit: This tax credit of up to $2,500 per eligible student applies to qualified education expenses paid for the first 4 years of higher education. You can claim this credit for yourself, your spouse or a dependent child. You or your dependent must be enrolled at least half time in a program that will lead to either an associates or bachelor degree.
There are income limits. You won’t qualify for the credit if your modified adjusted gross income (MAGI) is more than $90,000 for single filers and $180,000 if you’re married filing jointly.
This means if you have 2 kids enrolled in a 4-year university program, and you and your spouse have an MAGI of less than $160,000 (the amount at which the credit begins to phase out) you could reduce the taxes you owe by $5,000 ($2,500 X 2).
Lifetime Learning Credit: This tax credit allows you to deduct 20% of the first $10,000 you paid in qualified education expenses up to $2,000. You don’t have to be earning a degree to qualify for this credit. You can deduct expenses you paid for postsecondary programs such as job training courses even if you aren’t working towards a degree.
There are also income limits on your modified adjusted gross income. If you earn more than $65,000 for single filers and $130,000 for married filing jointly, you won’t qualify for the credit.
Tax Credit for Childcare
Uncle Sam knows that childcare is expensive, which is why you may qualify for a tax credit. You may qualify to deduct up to 35% of qualified childcare expenses. The maximum you can deduct is $3,000 for one qualified dependent or double that amount for 2 or more dependents. While a qualifying dependent includes a child age 12 or younger, it also includes disabled dependents. This could be an elderly parent or a disabled spouse.
There are several “tests” you must meet in order to qualify for the credit. For example, you must work or be looking for work in order to claim credit for the care you paid. While there is no income limit to qualify for the credit, higher earners may only be able to deduct 20% of childcare expenses up to the maximum of $3,000 paid for one qualifying dependent or double that for 2 or mores dependents.
Tax Deductions for Medical Expenses
Healthcare costs rise every year and medical expenses can have a huge impact on your financial health. You can deduct certain medical expenses if they exceed 10% of your adjusted gross income (AGI) or 7.5% if you or your spouse is age 65 or older.
For example, if your AGI was $50,000 in 2016, you could deduct qualified medical expenses you paid over $5,000. This means if you paid $7,000 in qualified medical expenses, you could claim a $2,000 tax deduction. Keep in mind that the IRS allows you to include dental, vision and preventive care costs.
You have to itemize your tax return in order to deduct medical expenses, and you’ll need to keep records of the expenses you paid.
Tax Deduction for Retirement Contributions
If you would like to lower your tax bill for 2016, you can consider opening an Individual Retirement Account (IRA). A Traditional IRA allows you to save for retirement while also receiving a tax break now.
The contribution limit for 2016 is $5,500 or $6,500 if you are 50 or older. You can then deduct your contribution amount on your tax return, which reduces the amount of your taxable income. However, keep in mind that if you or your spouse is covered by a retirement plan at work then the amount you can deduct on your tax return might be reduced
For example, let’s say Mary, who is a single filer for tax purposes, earns $45,000 a year, and does not have a retirement account at work. She decides to open an IRA to save for her retirement, and she contributes $2,000 in 2016. She can claim a $2,000 deduction on her 2016 tax return, which will reduce her taxable income by $2,000.
This was a brief overview of 5 categories of tax deductions and credits that might help you lower your tax bill for 2016. Note that you will need to itemize deductions (rather than taking the standard 2016 deduction) to claim a number of the above deductions. It’s important to consider them now so that you can keep good records. After all, April 2017 will be here before we know it!