Lowering your tax bill is always a joy. For most taxpayers, it's fairly easy to trim down your tax liability without breaking the rules (and therefore inviting some truly nasty penalties down the road). The simplest way to manage this feat is to reduce your taxable income. That doesn't mean asking your boss for a pay cut – rather, the idea is to make part of your income exempt from taxation. This strategy really shines when it can drop you into a lower tax bracket, because not only will you pay less in taxes, but you'll also reduce your tax rate for part of your income.
How tax brackets work
You've probably seen those tax charts with the income ranges on one side and a series of percentages – 10%, 15%, 25%, etc. – on the other side. Many people jump to the conclusion that having an income in a particular range means all of their income is taxed at that bracket's rate. Actually, tax brackets are "marginal," rather than absolute. That means only the part of your income within each range is taxed at the corresponding tax rate.
Take a look at this 2017 tax bracket report to get an idea of what that means. If your filing status is single, and you made $50,000 in 2017, then the first $9,325 of your income would be taxed at a 10% rate (in other words, you'd owe $932.50 in taxes on that chunk of income). Your income between $9,325 and $37,950 would be taxed at a 15% rate, and the rest of your income for the year would be taxed at a 25% rate.
In this example, the income that the IRS hits the hardest is the bit above $37,950. But if you could turn all your income above $37,950 into nontaxable income, then the IRS would keep its hands off everything in the 25% tax bracket, and your top tax rate for the year would be 15% – a much nicer number. So if you wanted to drop into a lower tax bracket, your goal for 2017 would be to get at least $12,050 (that's $50,000 minus $37,950) of your income declared off-limits for tax purposes.
RELATED: Oft-overlooked tax deductions
50 tax deductions you didn't know about
50 tax deductions you didn't know about
1. Standard Tax Deduction
Even if you don't have a lot of itemized deductions to file, you still qualify for a standard deduction, which has increased to $12,600 for married couples filing jointly on income earned in 2016. That number is the same for surviving spouses. For single filers and married couples filing separately, the deduction is now $6,300. If you file as head of household, you can deduct $9,300.
If you obtained a mortgage insurance policy in 2007 or later, you might qualify for a deduction on the amount you've paid toward the premiums. As part of the Protecting Americans from Tax Hikes Act, qualified mortgage insurance will be treated as tax-deductible interest through the end of 2016.
3. Tuition and Fees Deduction
Regardless of whether you take the standard deduction or itemize, you can deduct up to $4,000 in qualifying higher education tuition and fees you paid for yourself, your spouse or a dependent in 2016. If you're married but filing separately, or if another person can claim an exemption for you as a dependent, you don't qualify for this deduction.
4. State and Local Sales Tax
Taxpayers have the option of deducting either the state and local income taxes or state and local general sales taxes they paid during the tax year, but not both. If you live in a state with no income tax, consider deducting state and local sales taxes you paid.
5. Cash Donations
You can deduct cash donations to IRS-approved charities for up to 50 percent of their adjusted gross income. You must have written records of donations to deduct cash gifts in any amount, and a copy of a bank record or statement from the organization will work.
6. Noncash Donations
If you itemize, you can claim the fair market value — the price for which you otherwise could have sold the items — of clothing and household items you donated. If you plan to donate your car, make sure you donate to a qualified charity, such as a 501(c)(3).
7. Donating Your Time and Talents
You can deduct certain expenses for charity work, such the cost of gas and oil if you use your car to get to and from the place you volunteer. If you don't want to calculate the value per mile you can deduct, a standard rate of 14 cents per mile is acceptable.
You can also deduct the cost of purchasing and maintaining uniforms you wear to a place you volunteer, or parking in a garage if that's required.
8. Student Loan Interest Deduction
You can deduct some or all of any qualified student loan interest you paid in 2016 — whichever is less: $2,500 or the amount you actually paid. You can’t claim the deduction if you're married and filing separately, or if you or your spouse is listed as a dependent on someone else's return.
9. Job Search Expenses
If you itemize, you can deduct expenses you incurred during a job search, but you must have searched for the same line of work as your current or most recent job. Expenses you can deduct include:
Transportation, which includes a deduction of 54 cents per mile, parking, tolls and cab fees
Preparing, printing and mailing out your resume
Fees related to job searches
Employment agency fees
10. Moving Expenses
If you meet the IRS distance and time tests after you relocate for a new job, you can take a moving-expense deduction. Qualified expenses include the cost of moving your belongings and traveling to your new home, and the standard rate is 19 cents per mile. You can also deduct the cost of lodging, but not meals, for yourself and other household members.
11. Military Reservist Travel Expenses
If you travel more than 100 miles from your home for service, you can subtract travel expenses from the income you report on your tax return. Qualifying expenses include transportation, meals and lodging, with some exceptions.
12. Medical and Dental Expenses
You can deduct medical and dental expenses for you, your spouse and your dependents after your total medical expenses exceed 10 percent of your adjusted gross income. If you or your spouse is 65 or older, you can deduct total medical expenses that exceed 7.5 percent of your AGI.
13. Tax Preparation Fees
Whether you did your own taxes or paid someone to do them, you can include the fees on your miscellaneous tax deductions list. Costs can include tax return preparation and electronic filing fees. In order to qualify, however, the preparation fees must total more than 2 percent of your AGI.
14. Mortgage Interest Deduction
Most taxpayers who itemize are eligible to deduct the interest they paid on their mortgages. You can deduct the interest you paid on loans of $1 million or less, but if you're married and filing separately, you can deduct only the interest on loans of up to $500,000.
House keys and mortgage loan agreement on desk, close-up (differential focus)
16. Home Renovation Deduction
Typically, home renovation costs are not deductible on your tax return. However, if you make improvements to your home for medical purposes — such as adding entrance-and-exit wheelchair ramps or lowering cabinets for better accessibility — you can deduct those renovations as medical expenses. If the renovations increase the value of your home, however, you can’t claim them as medical-related expenses.
17. State, Local and Foreign Taxes
You can claim certain taxes imposed on you as itemized deductions. Apart from state and local sales tax, you can also deduct:
Local and state personal property taxes
Foreign, local and state real estate taxes
Foreign, local and state income taxes
18. Business Use of Your Home
You can deduct certain expenses for using a part of your home for business. To qualify for this deduction, you must use part of your home for one of the following:
As the primary location for trade or business
As the primary location for meeting with patients or clients
As a storage facility for inventory or product samples for your business or trade
If you have a separate, unattached structure on your property, you must use it exclusively for your business or trade.
For rental use
As a daycare facility
19. Business Use of Your Car
If you use your car for your job or business, you might be able to deduct the costs. You can either use a standard mileage rate or the actual-expense method, which is what it actually costs to operate the car for its business-use portion.
20. Business Travel Expenses
You might be able to deduct certain unreimbursed business expenses you incur while traveling for work. Costs could include transportation, baggage fees, meals, lodging, laundry and business calls. Any expenses that are considered extravagant or lavish don't qualify for the business travel expenses deduction.
21. Educational Expenses
Under the American Opportunity Tax Credit, which was extended through 2017, you can deduct up to $2,500 per student for four years of post-secondary education.
22. Employee Business Expenses
If you itemize, some local transportation costs are deductible, as well as certain business entertainment and gift expenses. Make sure you keep records of your expenses if you take these deductions.
23. Appraisal Fees
You cannot deduct appraisal fees if they went toward the purchase of a home. You can deduct them as a miscellaneous itemized deduction, however, if the property was donated, but only if the fees totaled more than 2 percent of your AGI.
24. Fees to Collect Interest and Dividends
Any fees you paid to a broker, bank, trustee or similar agent to collect taxable bond interest or dividends on shares of stock — but not the actual stocks, bonds or securities — are deductible.
25. Hobby Expenses
You can deduct some ordinary expenses you incur from a hobby. Unlike a business, a hobby is an endeavor from which you do not expect to profit. If you suffer losses due to a hobby, you cannot deduct the loss from your income.
26. Investment Fees and Expenses
Certain fees you pay to manage your investments qualify as a miscellaneous deduction. Such costs include:
Fees for investment counseling
Custodial fees you paid for outside of the account
Software and online services you used to manage investments
Safety deposit rental fees
Transportation costs to and from an advisor's office
Attorney costs you used to collect taxable income
Costs to replace lost security certificates
27. IRA Losses
You can claim losses on traditional and Roth IRAs as a miscellaneous itemized deduction, but only in very rare cases. For Roth IRAs, all accounts must be closed, including those that earned a profit. Traditional IRAs don't need to be closed and are treated separately. You must show a loss from your tax base to qualify.
28. Repayment of Income
If you had to repay income that you included in ordinary income in an earlier year, you might be able to deduct the repaid amount. In most cases, you can claim a deduction only for repayment of income if your repayment qualifies as an expense or loss you had at your business, trade or in a transaction. The claim has to be for income totaling more than $3,000, and it's deductible only if you held the money under a claim that you included it in income from a previous year because you believed you had an unrestricted right to the money.
29. Legal Fees
If you itemize, you can deduct certain legal fees related to doing or keeping your job, collecting taxable alimony or any fees dealing with tax advice. Deductions, however, are subject to the 2-percent rule, which dictates that the fees must total at least 2 percent of you AGI.
30. Safety Deposit Box Rental Fees
You can deduct safety-deposit box fees paid for storing documents and items that are "reasonably related" to tax-related investments. The deductible fees, however, are subject to the 2 percent rule.
31. Gambling Losses
Gamblers might be able to recoup some of their losses at tax time. Winnings from gambling are taxable and must be reported. If you suffered gambling losses, you can deduct up to the amount of gambling income you reported. You can claim your losses as an “other miscellaneous deduction,” but be prepared to show proof of your losses.
32. Casualty, Disaster and Theft Losses
Losses related to your home, household items and vehicles that aren't covered by insurance are deductible.
33. Educator Expenses
K-12 educators can deduct up to $250 for unreimbursed expenses for books, supplies and computer equipment. To qualify, you must work at least 900 hours in a school year. Deductions can go up to $500 for married couples filing jointly if both parties are educators who incurred expenses.
34. Health Savings Account Contributions
Health Savings Accounts are tax-exempt accounts you use to pay or reimburse certain medical expenses. You can claim a tax deduction on contributions you or someone other than your employer made to your account.
If you paid alimony in 2016 as part of a divorce or separate maintenance decree, you can deduct how much you paid. Your payments qualify as alimony if:
You and your spouse or former spouse do not file jointly.
You paid with cash, check or money order.
Your payment went to your spouse or former spouse.
If you are legally separated and you don't live in the same household as your former spouse.
Your payment is not for child support.
36. Self-Employed Health Insurance
Health insurance is tax-deductible for self-employed taxpayers. If you were self-employed in 2016, you can deduct premiums you paid for medical and dental insurance, as well as for qualified, long-term care insurance.
If you withdrew your money early from a certificate of deposit, IRA or similar account or investment, the penalty you paid could qualify as a tax deduction, even if you don't itemize deductions on your 1040.
38. IRA Contributions
Although IRS rules don't allow deductions for Roth IRA contributions, you might be able to claim the amount you put toward a traditional IRA, as long as you or your spouse doesn't have an employer-based retirement account. You can take a deduction up to the full amount of allowable contributions, which is $5,500, or $6,500 if you are 50 or over.
39. Personal Exemptions and Dependents
For personal exemptions and dependents, you can deduct up to $4,050 for 2016, an increase of $50 from the 2015 limit of $4,000. There are, however, income limits on this deduction.
40. State Balance Due
If you owed additional taxes on a prior year's state return and paid them in 2016, you might be able to deduct the taxes you paid.
41. 401k Contributions
401k plans provide special tax status for retirement savings and immediate tax benefits. You can deduct the money you contribute to your 401k from the income you claim on your federal returns.
42. Dependent Care Flexible Spending Account
A Dependent Care Flexible Spending Account lets you set aside pretax money for expenses related to caring for a child, disabled spouse, parent or other mentally or physically handicapped dependent. You're allowed to contribute up to $5,000 toward an FSA every year, and the amount you contribute won't be taxed.
43. Union Dues
You can deduct union dues, initiation fees and other related expenses from taxable income. The deductions, which are considered unreimbursed employee expenses, are subject to the 2 percent rule.
44. Work Uniforms
If your employer requires you to wear clothes that aren't suitable for everyday wear, you can claim them as a deduction. Common items you can deduct include theater costumes, military uniforms and protective clothing.
45. Senior Tax Deduction
If you and your spouse were 65 or older by the end of 2016, you're eligible for a higher standard deduction.
46. Car Registration Fees
If you meet certain requirements, you might be able to include some or all of your vehicle registration fees in your 2016 tax deductions.
47. Jury Duty Pay
If you gave your jury pay to your employer because he continued to pay your salary while you served on the jury, you can deduct your jury pay from your taxable income.
48. Earned Income Tax Credit
The Earned Income Tax Credit is a commonly overlooked tax credit for low- to moderate-income individuals. Although it's not considered an IRS deduction, the EITC is a refundable tax credit meant to supplement income. The amount ranges from $510 to $6,318.
49. Bad Debt Deduction
If you lent money that you never got back, it is considered a bad debt, which might make you eligible for a tax rebate. Generally, to deduct a bad debt, you must have previously included the amount in your income or loaned out your cash. You must also show that you attempted to collect the debt and that there's no chance you'll be able to recoup it.
50. Home Sale
If you sold your home at a profit, you can exclude up to $250,000 — or $500,000 for married couples filing jointly — of gains from your income.
The IRS actually provides quite a few ways to transform taxable income into nontaxable income. They're called "deductions." Yes, that's what a deduction really is – a way to flag a piece of income as nontaxable. It's how the federal government rewards you for spending money in ways that it deems beneficial to society. The trick to maximizing your deductions is planning them out in advance so that you can be sure to reach your goal ($12,050 in this example).
Consider the following options:
Contributing to a retirement account. If your employer offers you a 401(k) account, then use it – the contributions will typically come out of pre-tax income, so they automagically lower your taxable income without any extra work required on your part. No 401(k) available? No problem. Practically any bank or brokerage firm will happily set up an individual retirement account (IRA) for you, often with low or no fees. Any contributions you make to an IRA are fully deductible (as long as your income falls below a certain threshold ). Note that if you're trying to reduce your taxable income now, you'll want a traditional IRA, not a Roth IRA, which is funded with after-tax money. For 2017, you can contribute up to $18,000 into a 401(k) or up to $5,500 into an IRA. If you're aged 50 or older, the maximums go up to $24,000 and $6,500, respectively.
Contributing to an HSA. If you have a high-deductible health insurance plan, then you may qualify to open an HSA, and any contributions you make to said HSA are deductible. For that matter, distributions from the HSA (when used to pay for medical expenses) are also tax-free. HSAs are definitely a taxpayer's friend. For 2017, the annual contribution limit for HSAs is $3,400 if you're on an individual health insurance plan or $6,750 if you're on a family plan.
Pay (the right kind of) interest. The interest you pay on certain kinds of debt is deductible. This includes mortgage interest, student loan interest, interest on debt used to purchase investments, and interest on business debt. There is one catch, though: You can only claim interest deductions if you itemize, rather than taking the standard deduction (excepting student loan interest -- you don't have to itemize to take that one). Retirement account and HSA contributions, on the other hand, can be deducted regardless of you itemize. If you have a lot of itemized deductions to claim, it's probably worth your while to do so.
Pay your taxes. The state and local taxes that you pay, including real estate taxes, qualify as an itemized deduction. This can help push you into the "itemizing makes sense" category if you're close but not quite there. Note that you can deduct either state income tax or state sales tax, but not both; usually, it makes more sense to deduct the state income tax, but if your state has low or no income tax, then deducting your sales tax is the way to go.
Donate to charity. Charitable contributions of up to 50% of your adjusted gross income are also deductible if you itemize. The contributions must go to a qualified charity, and both cash and property donations can be deducted (property is generally deducted at the fair market value). This is a great way to do well by doing good. If you're approaching the end of the year and you don't have quite enough itemized deductions to make itemizing worthwhile, then consider clearing out the attic and making a big donation.
If the year's already over and you didn't quite manage to drop into a lower tax bracket, then you have one last chance: IRA contributions made up until the deadline for the previous year's tax return can count as deductions for the previous year (usually April 15, unless that date falls on a weekend). This will only work if you're eligible to deduct IRA contributions and you haven't already maxed them out for the year, but if you meet those requirements it's a perfect last-minute save for your tax bill.
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