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How to Pay Less Tax Using Deductions and Credits

Find out which tax deductions and credits can really save you money.

By
Laura Adams, MBA,
March 15, 2011
Episode #212
 

This is the first post in a three-part series we’re calling Tax Boot Camp—because Uncle Sam wants you, but he also wants your money!

How to Pay Less Tax Using Deductions and Credits

Taxes are a part of life, but no one (at least no one I know) wants to pay more than their legal share. So you Boot Camp recruits can call me Sergeant Adams for the next few weeks. I won’t scream for pushups or tell you that you can’t handle the truth, but I will expect you to pay close attention. Taxes certainly aren’t the most stimulating personal finance topic out there, but if you don’t go AWOL on this Boot Camp series, you’ll learn how to pay less tax, save more money, avoid getting into trouble with the IRS, and get last-minute filing tips that’ll keep you calm and cool. 

What Do You Need to Know About Tax Deductions?

In this first episode of the series, I’m going to cover what you really need to know about tax deductions and tax credits. Why should you care about them? Well, because they can cut your tax bill or even increase your tax refund! A true tax warrior fights to claim every single deduction and credit that they qualify for so they never pay more tax than they absolutely have to. So let’s start with deductions.

A tax deduction is an amount that the IRS allows you to subtract from your taxable income. When you reduce your taxable income, you lower your tax liability. For example, if your taxable income is $40,000 and you’re eligible to claim $10,000 in allowable tax deductions, then you only have to pay tax on $30,000—not $40,000. That makes a huge difference!

Should You Take the Standard Deduction?

The trick with claiming tax deductions is that to be eligible for some of them, you have to “itemize” your deductions. Itemizing isn’t nearly as complicated as it may sound. Here’s the deal: There are two ways you can file your tax return—by itemizing deductions or by taking a standard deduction. Itemizing simply means that you list each deduction on a form called Schedule A and submit it with your tax return.

The standard deduction is a fixed amount of deductions based on your tax filing status, and it can change from year to year. You get to choose the option that gives you the lowest tax bill and saves you the most money! For instance, if you’re a single taxpayer, your standard deduction for 2010 is $5,700. If you can come up with more than $5,700 in total allowable deductions to itemize, you’ll save more money by itemizing than you would by claiming the standard deduction.

Why Do Some People Overpay Taxes?

It’s important to remember that lots of people overpay taxes every year because they’re just too lazy to keep up with their deductions. I’ll admit that taking the standard deduction is easy because you don’t have to gather any records or do any calculations on Schedule A. But since you listen to Money Girl, you know that taking the easy route doesn’t necessarily save you money! Always figure your taxes both ways and pick the method that lowers your tax bill the most.

What Are the Itemized Tax Deductions?

Many people overpay taxes every year because they’re just too lazy to keep up with their deductions.

The best way to learn about all the potential deductions to itemize is to look at Schedule A. For 2010, the itemized deductions include the following:

  • Medical and dental expenses

  • Taxes you paid for state income taxes, sales taxes, real estate taxes, and certain motor vehicles

  • Charitable gifts to qualified organizations

  • Casualty and theft losses

  • Job expenses that are not reimbursed by your employer

  • Tax preparation fees

  • Safe deposit box fees

  • Interest you paid for investments and for a home mortgage, including points and mortgage insurance premiums

As a side note, I’ve been getting lots of questions lately about claiming the home mortgage interest deduction, so I created a short video with information and frequently asked questions to help you understand who’s eligible to claim it. When you sign up at SmartMovesToGrowRich.com you can watch this video and get e-mail updates from me.

Be aware that some of the deductions are limited based on your income. For example, you can only deduct the amount of your medical and dental expenses that exceed 7.5% of your adjusted gross income. Schedule A walks you through all the rules that apply for each itemized deduction.

Tax Deductions You Can Take Without Itemizing

But what if you don’t have enough deductions to make itemizing pay off? Don’t worry, there are deductions you can take when you claim the standard deduction, too! They’re listed on Form 1040 in the section labeled Adjusted Gross Income. They include the following for 2010:

Okay, this isn’t a complete list, but it should be enough information to help you know if you can save money using tax deductions whether you itemize or claim the standard deduction. You’ll find links to much more information at the bottom of this post.

What You Need to Know About Tax Credits

Now, let’s switch gears and talk about another way to legally reduce your taxes—tax credits. I love tax credits because they’re even more effective at slashing taxes than deductions. Here’s why a tax credit can be more valuable than a deduction: A tax deduction reduces the income on which your tax is calculated. But a tax credit cuts your actual tax bill dollar for dollar. For instance, if you owe $1,000 in taxes, getting a $600 tax credit means you save that full amount and only owe $400.

What Tax Credits Can You Claim?

The following are credits that you may be eligible to claim for 2010:

I hope this first installment of Tax Boot Camp has taught you something you didn’t know about tax deductions and credits. Again, this isn’t a complete list. If you have questions about your tax situation or feel too overwhelmed to file your own return, be sure to hire a qualified tax preparer or accountant. They can save you more money than they cost when they help you maximize tax benefits that you’re eligible for.

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Download FREE chapters of Money Girl’s Smart Moves to Grow Rich

If you like the tips you get in the Money Girl podcast, I think you’ll like my book, Money Girl’s Smart Moves to Grow Rich. I devote a whole chapter to taxes so you can be sure you know what you should. The book tells you what you need to know about money without bogging you down with what you don’t. It’s available at your favorite book store in print or as an e-book for your Kindle, Nook, iPad, PC, Mac, or smart phone. You can even download two free book chapters at SmartMovesToGrowRich.com!

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More Resources:

Form 1040, U.S. Individual Income Tax Return

Schedule A, Itemized Deductions

Publication 502, Medical and Dental Expenses

Publication 936, Home Mortgage Interest Deduction

Publication 936, Charitable Contributions

Publication 529, Miscellaneous Deductions

Publication 590, Individual Retirement Arrangements (IRAs)

Publication 969, Health Savings Accounts and Other Tax Favored Health Plans

Publication 521, Moving Expenses

Publication 970, Tax Benefits for Education

Publication 535, Business Expenses

Publication 4819, First-Time Homebuyer Credit

Image courtesy of Shutterstock

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