Most taxpayers can use a standard deduction when filing their taxes, but you can possibly save more money if you’re eligible for a variety of itemized deductions or credits.
While deductions and credits can save you money when you file, they’re not necessarily created equal; a tax deduction lowers your taxable income, while a credit reduces the taxes you owe.
If you’re not sure whether you should file with itemized deductions or take the standard deduction, consult with a tax professional. This article should not be considered tax advice. (Read the IRS guidelines for more information about the difference between standard and itemized deductions.)
To understand the difference between a deduction and a credit, think of it this way: In the 25% tax bracket, each dollar of a deduction is worth a quarter, but each dollar of a credit is worth a dollar.
Regardless of their differences, overlooked tax deductions and credits can cost you money. See if any of these apply to your 2014 income tax return.
1. State Sales Taxes
The sales tax deduction is usually most beneficial to those who live in states that do not impose a state income tax.1 You must choose between deducting state income taxes or sales taxes, and you should choose whichever provides the largest deduction.
However, sometimes even those who pay state income taxes will save more with the sales tax choice, especially in New Hampshire or Tennessee, where wage income is not taxed. The IRS provides a calculator that shows how much residents of each state can deduct, based on income, number of exemptions, and state and local sales tax rates.
If 2015 was the year you purchased a vehicle, boat, or airplane, you can add the sales tax you paid on that high dollar item to the amount shown in the IRS table for your state.
2. Points for Refinancing
Quick refresher on points: Also known as discount points, these are the fees you pay directly to the lender at closing in exchange for a reduced interest rate.
When you buy a house, you get to deduct the points paid to get your mortgage. Rules for refinancing, however, are different; when you refinance, you have to prorate the points and deduct them over the life of that loan. You get to deduct any points (that haven’t been deducted already) in the year you pay off a refinancing loan—whether you sell the house or refinance again.
3. Job Search Expenses
If you were looking for a position in the same line of work as your current or most recent job —job-hunting expenses incurred while looking for your first job don’t qualify—you can deduct job search costs as miscellaneous expenses. Qualifying expenses can be written off even if you don’t find a new job. Some expenses you can deduct are resume preparation and mailing, costs for placing ads, and travel for out-of-town job-hunting trips.
Note that expenses can be deducted only if you itemize and to the extent that your total miscellaneous expenses exceed 2% of your adjusted gross income.
4. Legal Fees Related to Alimony
Although legal fees in a divorce are generally nondeductible, any lawyer fees that you incur while settling alimony are tax deductible.
You must itemize to get the deduction, and only those expenses that exceed 2% of your adjusted gross income are deductible. Make sure to ask your attorney to provide an itemized statement of fees so you can determine how much may qualify for a deduction.
5. Child Care Credit
You may qualify for a tax credit worth 20% to 35% of what you pay for child care while you work. Plus, if your employer offers a child care reimbursement account—which allows you to pay for the child care with pre-tax dollars—that may result in even greater bottom-line savings. For example, if you qualify for a 20% credit but are in the 25% tax bracket, the reimbursement plan would result in more money saved.
Expenses paid through an employer’s reimbursement plan can’t also be used for the tax credit. However, you may be eligible for both. (Read the IRS guidelines on the child care credit.)
For example, although only $5,000 in expenses can be paid through a tax-favored reimbursement account, up to $6,000 can qualify for the credit (for the care of two or more children; $3,000 for one child). So if you use the maximum of $5,000 through your reimbursement plan at work but spend even more than that for work-related child care (for two or more children), you may be able to claim the credit on as much as $1,000 of additional expenses.
6. American Opportunity Credit
This tax credit is good for the first four years of college. It is based on 100% of the first $2,000 spent on qualifying college expenses, and 25% of the next $2,000 for a maximum annual credit of $2,500 per student.
The credit is phased out for taxpayers with incomes above certain levels: modified adjusted gross income of $90,000 for individuals and $180,000 for married couples filing a joint return. (Read the IRS.gov guidelines on the American Opportunity Credit).
7. Credit for Lifetime Learners
The Lifetime Learning credit can be claimed for any number of years.
It is worth up to $2,000 a year, based on 20% of up to $10,000 you spend for post-high school courses that lead to new or improved job skills. Courses taken at a vocational school or community college can count.
The credit is phased out as income rises from $55,000 to $65,000 on an individual return and from $110,000 to $130,000 for couples filing jointly. You can’t claim a lifetime learning credit if your MAGI is $65,000 or more, or $130,000 or more if filing jointly. (Read the IRS.gov guidelines on the Lifetime Learning Credit.)
8. Credits for Residential Renewable Energy Equipment Home Improvements
There’s no longer a tax credit for installing storm windows and insulation. However, there is still a credit for installing qualified residential renewable energy equipment on your primary residence, such as geothermal heat pumps, wind turbines, and solar hot water heaters. Your credit could be 30% of the total cost (including labor) of such systems installed through 2016,according to guidelines introduced by the recent Consolidated Appropriations Act.
9. Reinvested Dividends
This isn’t a tax deduction or credit, but it can result in significant savings if you have mutual fund dividends automatically reinvested and used to buy additional shares.
Reinvested dividends should be added to your tax basis, which will reduce the taxable capital gain (or increase the loss) when you redeem the shares.
Forgetting to include reinvested dividends in your basis results in paying taxes twice on dividends—once in the year when they were paid out and reinvested, and later when they’re included in the proceeds of the sale. Note that Betterment automatically reinvests dividends and tracks basis for customers.
10. Local Exemptions for Municipal Bonds
If you held municipal bond ETFs or mutual funds, a portion of the dividends paid by municipal bond funds may be exempt from state and local tax. The applicable rules for exemption vary by state—consult a tax advisor.
1 The seven states that do not have state income tax in 2016 are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
The content on this post is not intended to provide tax, legal, accounting, financial, or professional advice, and readers are advised to seek out qualified professionals that provide advice on these issues for specific client circumstances. In addition, the publisher/blogger cannot guarantee that the information on this website/post has not been outdated or otherwise rendered incorrect by subsequent new research, legislation, or other changes in law or binding guidance. The publisher/blogger shall not have any liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website/post.
More from Betterment:
What Should I Know About Taxes on My Investment Accounts?
An informed and educated investor can make better decisions if they know the unique tax attributes of each type of investment account.
Reducing Your Biggest Retirement Expense: Where You Live
You’ll probably want to retire somewhere different than where you live right now. Let’s make that part of your retirement plan.
Optimizing Performance in Lower Risk Betterment Portfolios
In this methodology, we provide insight into how we optimize the performance of the lower risk bonds in Betterment's portfolios.
Explore your first goal
This is a great place to start—an emergency fund for life's unplanned hiccups. A safety net is a conservative portfolio.
Whether it's a long way off or just around the corner, we'll help you save for the retirement you deserve.
If you want to invest and build wealth over time, then this is the goal for you. This is an excellent goal type for unknown future needs or money you plan to pass to future generations.