For many taxpayers, tax preparation is both a curse and a blessing.
It's a curse because it's cumbersome to take a walk through our past year's worth of finances and what could be a sea of receipts. It's can also be extremely complicated without the right software and/or professional assistance. The U.S. tax code consists of more than 10 million words these days, and that doesn't count the novel's worth of pages of litigation that helps explain certain tax laws.
At the same time, it's often rewarding because four in five taxpayers are due a refund from the federal government each year. In 2016, this average refund check topped $2,700. That sizable amount could be the beginnings of an emergency fund, investable money for a retirement account, or enough to pay down some debt.
But are American taxpayers really getting their money's worth come tax time? According to professional tax-preparation software business TurboTax, maybe not.
In the most recent tax year, more than 45 million taxpayers itemized their deductions on their Form 1040s, resulting in about $1.2 trillion worth of tax deductions. At the same time, the taxpayers who chose to claim the standard deduction wound up accounting for about $747 billion in deductions. Since the number of taxpayers who chose the standard deduction vastly outnumbers the taxpayers who itemized, essentially taking the easy way out, it's possible that millions of Americans may have cheated themselves out of some juicy tax deductions and/or credits.
Here are four commonly overlooked tax credits and deductions that could be costing you money.
1. Earned Income Tax Credit
The Earned Income Tax Credit (EITC) could easily be the most overlooked credit for lower-income individuals and families -- and it's a potentially large discount to miss, since tax credits reduce your tax liability dollar for dollar, unlike deductions that reduce your tax liability by a percentage of a dollar. According to the Internal Revenue Service, around 25% of taxpayers who are eligible fail to claim the EITC, either because the rules are too complicated or they're simply unaware they qualify.
Because it's so frequently missed, the EITC is also a prime target of criminals looking to defraud the IRS. As a result, the IRS will be paying special attention to EITC-qualifying returns in 2017, which could delay refunds for some taxpayers.
The EITC is designed to reward hard-working, lower-income individuals and families with a healthy tax break. For 2016, the EITC refundable tax credit ranged between $506 and $6,269. But it can also apply to middle-class workers who may have lost their job, had their hours cut, or took a pay cut to keep their job.
What might be particularly confusing for eligible EITC recipients is that you'll need to file a tax return to get the refund. Lower-income individuals and families with zero taxable income might see little point in filing a tax return. However, they could still net a refund if they qualify for the EITC, even with $0 in taxable income. The EITC can be a game-changer and shouldn't be overlooked come tax time.
2. Student loan interest paid by your parents
A deduction that's easy for taxpayers to overlook is student loan interest that's paid for by a students' parents. Many years ago, the IRS rules were clear: The only person eligible to take a student loan interest deduction was the person whom the debt directly belonged to, and who made the payments. This meant if parents made a payment on their child's behalf, no one received a deduction.
However, the rules have changed. The IRS does allow a student who can't be claimed as a dependent, and who is making less than $75,000 in modified adjusted gross income, to deduct up to $2,500 in student loan interest. The IRS simply assumes that a parent paying back a loan is money being channeled from the parent to the child, and then subsequently to the loan. Therefore, it only makes sense for the child to be able to take the interest deduction as long as he or she can't be claimed as a dependent.
3. Out-of-pocket charitable contributions
Charitable contributions are another area where valuable tax deductions may be overlooked. Charitable payroll deductions, and those we've made by writing a check, are pretty easy to keep track of. But how many of you have volunteered your time to a qualified nonprofit organization, or donated to a qualified nonprofit in cash directly out of your pocket? If this sounds like you, then simple charitable actions like this could be tax deductible.
For example, purchasing supplies, food, or even stamps for a qualifying charitable organization may qualify you for a deduction. In 2016, utilizing your car for charity could also have netted you a $0.14-per-mile deduction. The one exception you'll want to be aware of is that your time and services as a worker, should you choose to volunteer your services to a nonprofit organization, aren't deductible. Thus, if you help construct affordable housing for a nonprofit organization, the tools and lumber you buy out of your pocket are deductible, but your work hours are not.
4. Child and Dependent Care Tax Credit
Finally, the Child and Dependent Care Tax Credit is another source of missed opportunity for some taxpayers. The credit, which is specifically designed for working people who have to pay for child care, can total up to $6,000. Best of all, there are no income limits associated with this credit. Although the credit declines as income increases, even wealthier families will receive some sort of tax credit if they have qualifying child care expenses.
As noted by TurboTax, what often gets missed with the Child and Dependent Care Tax Credit is the difference in qualifying child-care expenses between a tax-favored reimbursement account at a person's place of employment, and the $6,000 maximum for the Credit. Reimbursement accounts at work have a limit of $5,000 in qualifying child-care expenses, but not a cent more. Should you have more than $5,000 in qualifying child-care expenses, you can claim up to the extra $1,000 via the Child and Dependent Care Tax Credit. Some families are missing this extra $1,000 credit.
Tax deductions and credits are everywhere -- we just need to know where to look and have the right tax software or professionals at the ready so we don't miss out on the money we're due.