There are many different ways to save money as a taxpayer. Recognizing which credits and deductions you are eligible to claim may be the most important.
Tax deductions and credits can make a huge difference on your tax return and leave you with much more money to use, save, or invest. Tax deductions work by reducing your taxable income, while credits function by essentially paying off a portion of the taxes you owe.
Of course, the tax system itself is incredibly complicated. It’s easy to end up overpaying on your tax return if you don’t know how to take advantage of every opportunity for a deduction. That’s why it’s important to get help. Having a tax professional by your side can really help maximize your refund or minimize your taxes owed.
How Do I Maximize My Deductions and Credits for 2020?
It takes planning to set yourself up to take full advantage of available deductions and credits. It’s never too early to prepare by making these tax considerations a part of your bookkeeping. The more you plan now with your records, the easier it will be when tax season comes around.
Keep a running count of your itemized deductions throughout the year. When you make a business expense or spend something that could count as a deduction, make a record of it then and there. You also need to keep track of all of your receipts. This is helpful for your record-keeping, but it will also be essential in case of an audit.
Perhaps the most important step toward optimizing your tax deductions, however, is putting in the work to understand the credits and deductions themselves. Study to develop an understanding of which credits and deductions you’re eligible for, or hire a professional to help.
Here are some specific ways you can work to maximize your deductions this year:
1. Contribute to Your 401(k) and HSA
One of the smartest things you can do for your finances is to save for your retirement. You get to both optimize your deductions and increase your savings. The IRS sets a limit on the retirement savings contributions you can deduct from your taxes each year, so do your best to contribute the maximum amount.
IRA deduction limits set by the IRS vary based on your income range and whether you have a 401(k) through an employer. If you do have a retirement plan with an employer, make sure you are taking the maximum allowed amount out of your income if you can afford it.
Roth IRAs are funded with your income after taxes have already been paid, so those contributions are not eligible as a tax deduction.
Saving for medical expenses with an HSA is another opportunity to deduct a portion of your income. Contributions to your HSA are fully deductible and tax-free if used for qualified medical expenses. You can deduct up to $3,500 for individuals and $7,000 for families, and contributors 55 or older can deduct another $1,000 in contributions.
2. Donate to Charities
Many people also find many benefits for their taxes by recording charitable contributions they make throughout the year as tax deductions. Essentially you’re redistributing your tax income to specific nonprofits you want to support.
Charitable contributions are a great way to lower your adjusted gross income, but it only works if you’re itemizing your deductions. These contributions will have little to no effect on your tax return if you claim the standard deduction.
The charitable contribution limit for most cases is 50% of your adjusted gross income, so you’ll want to compare that to the standard deduction, which is $12,400 for a single, unmarried taxpayer in 2020. This deduction may only be worthwhile if you make significant payments to charities.
3. Defer Your Income
Everything around taxes depends on the calendar. If you’re going to have an expense deducted, it has to happen within the tax year you’re filing for. In much the same way, the year’s tax return is only concerned with the income that you received within that particular calendar year.
This may seem obvious, but it also creates an opportunity. If your income varies a lot from year to year, it may help defer some of your income from one year to the next.
Technically you only pay taxes when you physically receive the payment. As a business owner, you can have payments at the end of the year delayed until after December 31, making that income count for the following year’s tax return instead.
You’re still going to be responsible for paying taxes on that income later, but this technique lets you shuffle some of your income around to ease your tax burden. A single deferred payment can make a big difference if you’re on the edge of a tax bracket.
4. Charge Business Expenses Early
Like income, business expenses are claimed in the year in which they are paid for. Just as you can tweak your taxable income by deferring received income, you can also try to schedule your business expenses to optimize your deductions.
Claiming tax-deductible business expenses is incredibly important for optimizing your tax return if you own a business. Sometimes you may get more benefit out of these deductions if you make those expenses coincide with spikes in your income.
If you squeeze in last-minute expenses before December 31, all of those end-of-the-year expenses will count toward that same year’s tax return. It doesn’t matter if the actual expense or if the good or service purchased doesn’t arrive until after the close of the year.
5. Sell Losing Investments
If you make an investment that doesn’t pay off, you may use that investment to decrease your AGI. When you sell an investment at a loss, it can effectively count as negative income, reducing your taxable income.
Deducting stock losses from your tax bill can make a significant difference in the amount you end up paying on your taxes. You can claim up to $3,000 in capital losses like this each year, and losses in excess of that amount will carry over until they run out.
You can also use capital losses recorded this way to count against future capital gains. Otherwise, you can continue claiming $3,000 each year on your tax returns until you’ve captured your entire lost investment.
6. Work with a Professional
You can’t be an expert on every tax deduction and credit available out there. There are countless deductions and credits between the federal and state tax legislation ranging from basic and obvious to complicated and obscure.
Working with a tax professional will help you better understand the deductions and credits you’re already aware of. It will also undoubtedly help you discover many more deductions and credits to include that you didn’t know about.
Filing and optimizing your tax return can be a complicated process that requires a lot of time, effort, and expertise. Don’t be afraid to seek assistance and invest in a better result for your tax season.