The easiest way to reduce your tax bill is to reduce your taxable income. But you don’t have to turn down your next raise or ask your boss for a pay cut. Instead, utilize tax deductions.
You can choose to use the standard deduction amount that the IRS establishes annually for each taxpayer based on filing status. Or, if you have expenses that will produce a larger tax break, you can itemize deductions. You do so by keeping track of your expenses, meeting some income thresholds and deductibility limits and filing the long Form 1040 and accompanying Schedule A.
Schedule A generally allows you to subtract from your income the amounts you spent in a given tax year on medical care, other taxes, certain interest payments, charitable gifts, casualty losses and several miscellaneous expenses.
Schedule A is divided into seven deduction sections. Using the form as our guide, here’s what you can claim.
- Medical and dental expenses
- Taxes you paid
- Interest you paid
- Gifts to charity
- Casualty and theft losses
- Job expenses
- Other miscellaneous deductions
Medical and dental expenses
The first group of deductions is for medical expenses, but you really need to rack up some big bills for this to kick in. You can deduct only the medical and dental expenses that exceed 7.5 percent of your adjusted gross income, or AGI. With an AGI of $40,000 your medical deduction threshold is $3,000. That means if you have less than that in medical costs, they are of no tax value. And if you have $5,000 total medical expenses, you can deduct only $2,000, the amount that exceeds 7.5 percent of your income.
You might be able to reach the limit by claiming some tax-deductible medical costs that are often overlooked. Examples include mileage to the hospital, the costs of special medical equipment or home renovations for medical purposes — even a portion of long-term care premiums. The costs of medical care for your spouse and dependents also count here, too.
Taxes you paid
If you live in a state that collects state or local income taxes, the amount you pay can be deducted against your taxable federal income. This includes taxes withheld from your paycheck (and shown on your W-2), as well as payments made directly to your state or local tax collector (such as estimated taxes).
Mandatory contributions you made to the California, New Jersey or New York Nonoccupational Disability Benefit Fund, Rhode Island Temporary Disability Benefit Fund or Washington State Supplemental Workmen’s Compensation Fund also can be deducted here.
Taxpayers who live in a state that does not collect income taxes, but does levy sales tax — they are Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming — also get a chance to deduct those payments on Schedule A. Local sales taxes count, too, which could benefit residents of Alaska, where there is no statewide income or sales tax, but where some municipalities do collect sales taxes.
If you pay both state income and sales taxes, you must choose which amount to deduct. For some taxpayers, for example, those in Illinois which has a relatively low 3 percent flat income tax rate, the sales tax deduction might be more beneficial.
Other taxes apply, too. Property owners can deduct real estate taxes they paid during the tax year. If they are paid by your mortgage company with escrowed funds collected as part of your mortgage payments, remember that you can only deduct the actual amount of taxes paid in the tax year, not the full amount of escrow payments you sent in to your lender.
Some states, counties and cities also assess personal property taxes, most commonly on vehicles. Car taxes, as well as other personal property tax bills, can be claimed on Schedule A.
You also are allowed to deduct what the IRS calls “any deductible tax” not specifically listed on the form. A common entry here is a deduction for foreign taxes paid in connection with investments funds.
Interest you paid
Interest paid on personal loans won’t help you at tax time, but for most homeowners, interest on home loans — for both a primary residence and a second home — is deductible.
Home mortgage interest is usually reported on the Form 1098 you get from your lender by the end of January. If you bought your home during the tax year and paid points for the loan, those points also will be listed on the 1098 and that amount can be deducted on Schedule A. If the points aren’t noted on your 1098 form, double check your settlement statement.
Interest paid on a home equity loan or line of credit also is generally deductible, as is interest paid on money borrowed to buy investment property.
And some homeowners might qualify to deduct their private mortgage insurance premiums. This policy is required by lenders in cases where a homebuyer is unable to make a substantial down payment. This deduction option, however, is limited to taxpayers who meet certain requirements (date the loan was acquired, loan amount), so carefully read the Schedule A instructions or follow your tax software’s directions in claiming this tax break.
Gifts to charity
The tax code allows you to deduct donations to qualified charities. This includes contributions to religious groups, nonprofit organizations, veterans’ associations, not-for-profit schools and public park and recreational facilities.
The organization can provide you with its tax-deduction eligibility. You also can check IRS Publication 78, which is searchable online.
However, recently contribution rules have been toughened. You must keep a record of the contribution, such as a bank or credit card statement or canceled check. An official receipt from the charity also will suffice and is, in fact, required when the gift is $250 or more. The substantiation documents do not need to be filed with your return, but you will need them if the IRS has questions about the deductions.
As for donated household goods, the IRS now requires that the items be in good or better shape. If the agency later determines they were in bad condition, your tax claim could be denied.
You also can deduct the gift of a vehicle to a qualified organization. There are specific rules, however, as to how much you can deduct based on the value of the vehicle and how the charity uses the gift. IRS Publication 4303 (pdf), A Donor’s Guide to Car Donations, provides details on figuring the deductibility of these gifts.
You also can deduct your travel costs to do charitable work, as well as out-of-pocket expenses related to a charitable endeavor, such as costs incurred for postage for a group’s mailing.
And while there is no income threshold on donations, the IRS does set some limits here. Annual cash contributions in most cases cannot exceed 50 percent of your AGI. Annual gifts of property — such as stocks, bonds and artwork — cannot exceed 30 percent of your AGI. If you give more than those limits, you can carry over the amount that you’re unable to deduct to future tax years.
Casualty and theft losses
If you are the victim of casualty or theft, you can get some tax help in covering your losses on Schedule A.
Casualty loss deductions aren’t limited to catastrophic damages, such as those suffered in a fire, flood, hurricane, tornado or earthquake. Losses from theft and vandalism are eligible, as are any damages from a car wreck (as long as it wasn’t the result of driver negligence).
You cannot, however, deduct the full amount of your loss. You must complete Form 4684 (pdf) to determine how much you can claim.
Job expenses and certain miscellaneous deductions
The next section of Schedule A lets you take into account money you spent in connection with your job search, as well as a variety of miscellaneous expenses. This overall amount, however, must exceed 2 percent of your AGI. For a taxpayer making $40,000, that would mean these costs must go over $800 before they can be deducted.
Some of the items you can count to exceed the deduction threshold are professional memberships and journal subscriptions, uniforms you buy and the cost of keeping them clean, as well as expenses of looking for another job in the same field. You can also deduct the cost of tax-preparation software programs and any fee you paid for electronic filing or charges paid a professional tax preparer to complete your return.
One other consideration here is that you might have to file and attach Form 2106 (pdf), Employee Business Expenses, especially if you claim any travel, transportation, meal or entertainment expenses.
The “miscellaneous expenses” that can be deducted in this section include investment management costs. These refer to custodial and trust administration fees, accounting charges, safe deposit box rentals if you keep investment-related material in it, subscriptions to financial publications and fees reported on the Form 1099-DIV issued in connection with the investment.
Other miscellaneous deductions
This is a “catch-all” section for expenses that are not limited by your income. One of the most common deductions here is gambling losses.
Keep in mind, however, that while your gambling losses aren’t restricted by a percentage of your AGI, they are limited by your good luck. You can only deduct losses of up to how much you won. That is, if you won $1,000 and had losses of $1,700, you can only deduct $1,000.
Other miscellaneous deductions that can be claimed here are casualty and theft losses from income-producing property, amortizable bond premiums on some bonds, certain unrecovered investment losses in a pension, impairment-related work expenses of a disabled person and some other obscure expenses. IRS Publication 529 (pdf), Miscellaneous Deductions, has details on these specific deductions.
Once you’ve completed these seven Schedule A sections, tally your total itemized deductions. If the amount is greater than your standard deduction amount, you’ll be able to reduce your tax bill or possibly get a larger refund.