Often, people mistakenly use the terms “credits” and “deductions” interchangeably. However, at tax time, it’s important to understand the difference between the two, and ensure you’re utilizing them to your advantage. Generally, tax credits are the more beneficial of the two, though when used correctly, both can save you significantly when you file your taxes.
Tax deductions decrease your taxable income amount. If your annual earned income reported at tax time is 70,000, and you’re eligible to claim $15,000 in deductions, you’d only be taxed on $55,000 of your income. Tax deductions are an excellent way to reduce your tax liability and save money, so be sure you claim as many as you qualify for.
Credits are usually dollar-for-dollar deductions on the amount of taxes that you owe to the IRS. They don’t reduce your income, like deductions do, but instead decrease the amount you must pay once your liability is calculated. If your tax return requires you to pay the IRS $1,500, and you find that you’re eligible to claim a $1,500 tax credit, your tax debt is abolished. You won’t owe anything to the IRS. If you owed $2,000 and claimed the same $1,500 credit, you’d only be responsible for paying $500 (the difference after the credit is subtracted from your balance). There are even some tax credits, like the Earned Income Tax Credit, that are refundable, meaning the IRS may owe you money. Refundable credits allow you to collect the balance of the credit once your tax liability becomes zero.
When filing your tax return, it’s essential to claim all deductions and credit you are eligible to maximize your savings!
Though there are no refunds once you have children, they may be worth a credit – a tax credit, that is. Parents can benefit from the Child Tax Credit, a popular tax break that is worth $1,000 per child when you file. Your child must be claimed as a dependent on your tax return and are required to meet certain criteria to qualify for the Child Tax Credit. The child must:
- Be under 17 years old
- Have an assigned Social Security number prior to the due date of the year’s tax returns
- Be a biological child, adopted child, stepchild, or legally placed foster child
- Not provide more than 50% of their own financial support
- Be a U.S. citizen
- Have resided with you for at least half of the year
Like the Earned Income Tax Credit, The Child Tax Credit is subject to income limitations. If you exceed these thresholds, the credit amount is decreased. To claim the full $1,000 per child, your income needs to fall under the following amounts (according to filing status):
- Single and Head of Household: $75,000
- Married, filing Jointly: $110,000
- Married, filing separately: $55,000
For every $1,000 that your income exceeds these limits, the Child Tax Credit is reduced by $50. It is a non-refundable credit.
Taxpayers who earn at least $3,000 in income may qualify to claim the Additional Child Tax Credit, which can be worth as much as 15% of your taxable income over $3,000. Though the Child Tax Credit isn’t refundable, you may see some of it returned to you if you claim the Additional Child Tax Credit and your tax liability is completely fulfilled.
Being married gives you the option to choose your filing status, you can either file Married Filing Jointly or Married Filing Separately.
Why should I choose Married Filing Jointly?
Depending on your tax situation Married Filing Jointly may get you bigger refunds and smaller tax bills. Most married couples choose to file with the status of Married Filing Jointly. Although in some tax situations there may be an advantage to using the filing status of Married Filing Separately. Continue reading to find out more about Married Filing Separately and how it affects your tax status.
Married Filing Separately Explained
If you decide with your spouse to us the tax status of Married Filing Separately you both must file your own return, this includes individual income, deductions, exemptions and credits. When you do this, you are only responsible for your own tax liability. Any taxes, penalties or interest that results from your spouse’s return will not be your responsibility. (more…)
Have you had to pay for someone to take care of your dependents while you worked? If so, you may be able to claim a special tax credit to help offset some of the costs. This credit, the Child and Dependent Care Tax Credit, has certain requirements that taxpayers must meet. These include:
- You must have incurred the care expenses while you either worked or sought employment. Married taxpayers have to both be working or seeking employment, provided neither of you is disabled or a full-time student. If so, the requirement to work does not apply.
- The care must have been provided to a “Qualifying person”. A child under age 13, a spouse or dependent who lives with you but is disabled and incapable of caring for themselves, are qualifying persons. You’ll need the Social Security number of the person for whom care was provided in order to claim the credit.
- You have to have earned income throughout the tax year. Married taxpayers both have to earn income, and any form of dependent care reimbursement by your employer is subject to additional requirements in order to claim the credit.
- The Child and Dependent Care credit depends on your income, and can be about 20% and 35% of all the allowable expenses incurred, with a max of $3,000 in expenses for one dependent, and $6,000 for two or more dependents.
- The care provider will have to supply you with their taxpayer identification number, and you’ll have to fill out their name and contact information on the credit claim Form 2441, which you file with your tax return.
After getting divorced, you may notice a change in your taxes, along with everything else you are altering in your life. Tax time may mean a new filing status, as well as different eligibility for certain tax credits.
If you have always filed using the Head of Household tax status, you may not be eligible to continue to file that way after a divorce. Head of Household typically has a lower tax liability compared to the Single or Married, Filing Separately status that people generally use before they are divorced.
Your custody agreement plays a big part in determining if you are still eligible to file under Head of Household status. The privilege of filing Head of Household usually goes to the spouse who has custody more than 50% of the year. If each parent has a different child, conceived during the marriage, living with them for more than half the year, Head of Household status can be claimed by both spouses. This is the only way the status can be claimed by both parents. (more…)
Investing in your retirement is important. When it comes to saving for your future, you have a multitude of options. One option, the Individual Retirement Arrangement (IRA), factors in at tax time regarding contributions that you make. Since this is a popular retirement plan, you should be aware of the following seven facts in order to make the most of your IRA savings.
- To contribute to a traditional IRA, you’re required to be 70 ½ years old by the end of the tax year. Roth IRAs don’t have age restrictions.
- You’re required to earn taxable income to contribute to an IRA. If you file a joint return, only one of you are required to earn taxable income, and it can come from any source, such as self-employment income, wages, tips, commissions, alimony, and bonuses.
- You’re able to contribute at any point throughout the year to your IRA. If you want the contribution for the year in which you’re filing your return, you have to contribute by the date the return is due, without extensions. The most common deadline is April 15th, and any contributions made between January 1st and April 15th, double check to make sure that the contribution is applied to the right tax year.
- Many IRAs have limits to the amount of contributions that can be made. In most cases, you can contribute either the taxable compensation amount, or $5,500, depending on which amount is smaller. Contributors over 50 have an increased limitation of $6,500. Contributions over the limit are subject to additional taxes starting at 6%.
- Typically, you don’t have to pay taxes on the amount saved in a traditional IRA until distributions begin. Additionally, some distributions from a Roth IRA are tax-free.
- Contributions are only deductible if made to a traditional IRA. Use the worksheets on your Form 1040 or Form 1040A to determine your eligibility for deduction.
- The Saver’s Credit can lessen your taxes up to $2,000 if you file a joint return.
Tax mistakes are more common than you think, and despite people worrying about making mistakes, they do happen. If you make a mistake when filing, it may take longer for the IRS to process your return but it’s not the end of the world. If you opt for e-filing, you decrease your chances of making a mistake compared to when you file a paper return. If you are aware of the most common filing errors, you’re less likely to make the mistake yourself when filing your tax return. The eight biggest tax mistakes are:
- Social Security Number: often, Social Security numbers are left off returns, and in many cases, when they are entered, the incorrect number is given.
- Names: people misspell the names of one of the people on the return. Each person’s name has to match exactly what is written on their Social Security Cards.
- Filing Status: You should always choose the filing status which best fits your situation. When you e-file, the software will ensure you’re choosing the correct status.
- Accounting: Errors in calculations are pretty much a given when it comes to paper returns. Again, this is a major benefit for e-filing, as the software does the math for you, and ensures its accurate before you submit.
- Credits/Deductions: Be aware of calculations regarding the Earned Income Tax Credit and the Child and Dependent Care Credit, as these are the most commonly found to have errors in accounting.
- Bank Account: if you want to have your refund direct deposited, ensure you put the correct bank account number and routing number on your return. E-filing combined with direct deposit is one of the fastest ways to get your return.
- Signature: Many people forget to sign their tax return, which makes it unvali If it’s a joint return, all persons have to sign the form.
- PIN errors: those who have e-filed in the past use a Personal Identification Number to sign their tax return. This number is valid from year to year, so it’s important to remember it. If you forget, your AGI from the previous year can be used, but not the AGI from a corrected or amended return.
Do you regularly make donations to charitable organizations? It feels great to help out those in need, and you can even get a benefit at tax time in the form of a deduction. In some cases, you may be eligible to deduct your donation from your taxes. The following facts can help you determine if your donation is able to be deducted.
Organization: You must donate to a charity qualified by the IRS if you want to claim a deduction. Any charitable gifts made to individuals, political associations, and candidates are not tax-deductible.
Itemized: You have to itemize your deductions to claim a donation. File Schedule A, Itemized Deductions with your regular Form 1040.
Benefits: If you received any compensation or benefits for your donation, such as meals, event tickets, or other goods, your deduction amount may be limited. In these cases, you are only able to deduct the amount donated that exceeds the value of the benefit.
Value: Donation amounts for property are determined using the fair market value. Usually, you determine the value of donated property based off what you can actually get if you were to sell the item.
Noncash: If you donate gifts that aren’t cash, and the amount exceeds $500, you will be required to file Form 8283, Noncash Charitable Contributions with your regular return.
Records: Ensure that you keep all documentation to support the amount of the donation you gave. Each donation may have a different type of proof, so save receipts and documentation. If you donate cash, you need a written record.
Cash: If you donate more than $250 worth of goods or cash, the charity will need to provide a written statement, documenting the amount and description of items donated. If any benefits were received, they should also be listed on the document.
Generally, it is easier to just choose the standard deduction when filing your tax return, however it may not be the best method for saving you money. In some cases, opting to itemize your deductions can actually lower the amount of taxes you owe. The best option is to determine the amount you will save with each deduction method, and opt for the choice that reduces the amount of tax you owe. Follow these tips to make an educated choice about which deduction method to use when filing:
First, calculate your itemized deductions by adding up all the expenses you accumulated throughout the year which are eligible for deduction. These can include home mortgage interest, property taxes, medical expenses, unreimbursed employee expenses, income and sales taxes, and donations made to charity.
Next, see how the total amount of itemized deductions compares to the standard deduction. For 2016, the standard deduction is based on your filing status like so: Single, Married Filing Separately, $6,300, Married filing Jointly, and qualifying widow(er), $12,600 and Head of Household, $9,300. If you are blind or over the age of 65, the standard deduction may increase. It may decrease if you are claimed as a dependent by another taxpayer.
In some cases, the standard deduction doesn’t apply, and therefore you are ineligible to claim it. If your spouse choses to itemize on their separate return, you must also itemize. Generally, this lowers your taxes anyway, but it’s important to be aware of when you can and can’t use the standard deduction.
Always ensure you have the correct forms for the deduction method you chose. If you want to itemize, you’ll need to file a Schedule A, Itemized Deductions along with your Form 1040. Standard deductions are able to be claimed directly on your tax form.
College is an important part of your life, hopefully solidifying your path for the future. However, it comes at a price, and often students need all the help they can get. Thankfully, there are a two different tax credits that can alleviate some of the burden on your wallet as a student.
American Opportunity Tax Credit:
The American Opportunity Tax Credit (AOTC) applies to any student enrolled in their first four years of undergraduate study at an eligible college or vocational school. The student must be studying to earn a degree or a recognized certificate, and be enrolled at least half time for an entire academic period. This credit can be claimed up to $2,500 per eligible student, and is refundable up to $1,000. AOTC expenses can be tuition fees, books, supplies and other incidentals.
Lifetime Learning Credit:
Students who are enrolled in any level of higher education, including graduate and vocational classes. Unlike the AOTC, this credit is not refundable, but uses the same expenses to reduce the amount of your taxes by up to $2,000.
You can claim these credits if you, your spouse, or your dependent are an eligible student. To claim a student credit, file Form 8863 with your tax return. As a student, you will receive a Form 1098-T, Tuition Statement, which will report all the required information to claim the credits correctly.
You can’t claim both credits for the same expenses, and you also can’t be a dependent of anyone else to claim the credit yourself. There are income limitations that affect both credits as well.