12 Tax Deductions and Credits You Shouldn't Overlook
Morningstar
10 min read
Editor's note: A version of this article was initially published on Feb. 2, 2018. It is part of the 2020 Tax and IRA Guide.
April 15 is fast approaching; it's a good time to familiarize yourself with tax deductions and credits. Though many phase out at higher income levels, take a look to see if you are eligible for any of them. It's also possible that applying deductions could reduce your modified adjusted gross income to a point where you might qualify for a tax benefit you otherwise wouldn't.
To better understand how these tax benefits work, it's important understand the difference between deductions and credits. Tax deductions reduce taxable income, and their value thus depends on the taxpayer's marginal tax rate, which rises with income. (Investors in higher tax brackets get a larger benefit from deductions.) Factoring in the tax deduction reduces your taxable income and ultimately reduces the amount of taxes you end up paying.
Tax credits, meanwhile, reduce your tax liability dollar for dollar and do not depend on tax rates. Many tax credits are nonrefundable, which means that they can reduce your tax liability by the amount of the credit, all the way down to zero. But if your credit is bigger than your tax bill, you will forgo these further credits (you can't get a refund from them), and you can't carry them forward. With refundable tax credits, on the other hand, after your tax liability is reduced to zero you will pocket the surplus credit in the form of a tax refund.
For Individuals/Workers
Earned Income Tax Credit Type: Refundable Credit IRS Form: 2019 Schedule EIC The earned income tax credit is available to workers of low to moderate income, with children or without. The more children you have, the higher the adjusted gross income thresholds. (Note: You can't claim the EITC if you are married filing separately.)
Saver's Credit Type: Nonrefundable Credit IRS Form: 8880 You might be eligible for the saver's credit if you contributed to a tax-sheltered retirement account in 2019, such as an IRA, 401(k), 403(b), or 457(b). Aftertax contributions such as a Roth IRA or aftertax 401(k) also count. The Tax Cuts and Jobs Act temporarily allows the beneficiary of an ABLE account to claim the saver's credit. Rollover contributions are not eligible for the credit. You can claim the credit if you're over age 18, not a full-time student, and can't be claimed as a dependent on anyone else's tax return.
The amount of the credit is 50%, 20%, or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (reported on your Form 1040 or 1040A).
IRA Contribution Type: Deduction, Above the Line IRS Form: 1040 Schedule 1 Did you know you have until April 15 to fund an IRA for the 2019 tax year? The contribution limit is $6,000, plus $1,000 in catch-up contributions if you're 50 or older. To contribute to an IRA, you must have at least as much earned income as the contribution.
If you are covered by a retirement plan at work such as a 401(k), and you are married filing jointly and your modified adjusted gross income is less than $64,000 ($103,000 for married filing jointly), you can take a full deduction for the contribution amount; for incomes between $64,000 and $74,000 ($103,000 and $123,000 if married filing jointly) you are entitled to a partial deduction for your contribution.
If you are a single filer who is not covered by a retirement plan at work, or if neither you nor your spouse are covered by a retirement plan at work, there are no income limits for deductions on IRA contributions. If you are married filing jointly and your spouse is covered by a retirement plan but you are not, you can take a full deduction if your modified adjusted gross income is below $193,000 and a partial deduction if your modified adjusted gross income is between $193,000 and $203,000.
Health Savings Account Contribution Type: Deduction, Above the Line IRS Form: 1040 Schedule 1, 8889 If you are enrolled in a high deductible health insurance plan, your contributions to a health savings account are deductible (provided your contribution to the plan is not in pretax dollars, of course). The maximum amounts you can save in HSA accounts are $3,550 (individual coverage) and $7,100 (family coverage).
Premium Tax Credit Type: Refundable Credit IRS Form: 8962 If you get your health insurance through the Marketplace and are not eligible for or cannot get affordable coverage through an employer-sponsored health insurance plan, you may be eligible for the premium tax credit. To qualify, you must meet many eligibility requirements. You cannot claim the credit if you are married filing separately, or if you can be claimed as a dependent by another person. Also, your income must be with a certain range.
This is a complex tax credit. The size of your premium tax credit is based on a sliding scale. If you have a lower income you will get a larger credit to help cover the cost of your insurance. When you enroll in Marketplace insurance, you can choose to have the Marketplace compute an estimated credit that is paid to your insurance company to lower what you pay for your monthly premiums (advance payments of the premium tax credit). Or you can choose to get all of the benefit of the credit when you file your tax return for the year.
If you choose to have advance payments of the premium tax credit made on your behalf, you will reconcile the amount paid in advance with the actual credit you compute when you file your tax return. More information can be found on the IRS site.
For Students/Graduates
Student Loan Interest Deduction Type: Deduction, Above the Line IRS Form: 1040 Schedule 1 You can deduct the lesser of $2,500 or the amount of interest paid on a qualifying loan during 2019. The deduction is reduced when your modified adjusted gross income surpasses $70,000 ($140,000 if married filing jointly) and phases out completely when your modified adjusted gross income surpasses $85,000 ($170,000 if married filing jointly).
Lifetime Learning Credit Type: Nonrefundable Credit IRS Form: 8863 If you are enrolled in school at least part time, you may be able to claim a Lifetime Learning Credit of up to $2,000 for qualified education expenses paid for all eligible students.
Qualified expenses are tuition and fees required for enrollment or attendance (including amounts required to be paid to the institution for course-related books, supplies, and equipment).
This credit is available for a unlimited number of tax years, but it cannot be filed in the same year that the American Opportunity Credit is filed.
- source: Morningstar Analysts
American Opportunity Credit Type: Partially Refundable Credit IRS Form: 8863 The American Opportunity Tax Credit is a credit for qualified education expenses paid for an eligible student for the first four years of higher education. The student must be pursuing an undergraduate degree or other recognized education credential. You can get a maximum annual credit of $2,500 per eligible student. If the credit brings the amount of tax you owe to zero, you can receive 40% of any remaining amount of the credit (up to $1,000) as a refund.
Each eligible student can only claim this tax credit four times (for each of the four years of postsecondary education). It cannot be taken in the same year that the Lifetime Learning Credit is taken.
The American Opportunity Tax Credit includes expenses for course-related books, supplies, and equipment, but room and board is not a qualified expense.
For Families/Households
Child Tax Credit Type: Partially Refundable Credit IRS Form: 8812 The Tax Cuts and Jobs Act has increased the child tax credit to $2,000 per dependent child. Qualifying children must have a Social Security number and be younger than 17. (Qualification requirements can be found on the IRS site.)
The new tax law also substantially increases the adjusted gross income limit; the credit begins to phase out at an AGI of $400,000 for married filing jointly and $200,000 for other taxpayers. Filers with AGI above $440,000 for married filing jointly and $240,000 for other taxpayers are phased out completely.
The Tax Cuts and Jobs Act rolled the additional tax credit into the child tax credit, resulting in one credit (instead of two); as a result, if the credit brings the amount of tax you owe to zero, you can receive up to $1,400 of the credit as a refund.
Credit for Other Dependents The Tax Cuts and Jobs Act also provides a new tax credit of up to $500 for each qualifying dependent who doesn't qualify for the child tax credit. (Qualification requirements can be found on the IRS site.)
To make it easier, the IRS has an interactive tool you can use to determine your children/dependents' eligibility.
Child and Dependent Care Expense Credit Type: Nonrefundable Credit IRS Form: 2441 The IRS offers a credit for the costs of care for a qualifying child while you are working (or seeking employment). The dollar limit on the amount of the expenses you can use to figure the credit is $3,000 for one dependent or $6,000 for two or more qualifying dependents. Infant/toddler day care, preschool, summer day camp, or after-school care for children younger than 13 are all qualified expenses. (Tuition and fees associated with kindergarten or elementary school do not qualify.)
Depending on your adjusted gross income, the amount of your credit is between 20% and 35% of your allowable expenses, up to $3,000 for one qualifying child or $6,000 for two or more qualifying children. The percentage you use depends on the amount of your adjusted gross income. The maximum credit you can receive for one qualifying child is $1,050 (down to $600). For two children, the credit ranges from $2,100 (down to $1,200). For more on the child and dependent care expense credit, see "Ways to Make Child Care More Affordable."
For Homeowners
Home Mortgage Interest Deduction Type: Deduction IRS Form: 1040 Schedule A The Tax Cuts and Jobs Act lowered the interest deduction on qualified mortgage loans to $750,000 beginning in tax year 2018 (for properties purchased after Dec. 16, 2017). (The deduction is limited to $375,000 if married filing separately.)
If the mortgage was taken out before Dec. 16, 2017, taxpayers can deduct the interest paid on first and second mortgages up to $1 million in mortgage debt ($500,000 if married filing separately).
No matter when you initially took out the loan, you can no longer deduct the interest from a loan secured by your home (such as a home equity loan or home equity line of credit) if the loan wasn't used to buy, build, or substantially improve your home.
