"We don't pay taxes. Only the little people pay taxes."
-- Leona Helmsley
Hotel tycoon (and convicted tax evader) Leona Helmsley might have thought that she didn't have to pay taxes, but she was wrong. Anyone in America with income is likely to owe income taxes. Still, while you probably can't avoid paying taxes (legally!), there are lots of permissible ways to reduce what you owe through the use of tax deductions.
A tax deduction reduces your income and thereby lets you avoid paying taxes on the amount of the deduction. If you're in the 25% tax bracket and can take a $1,000 deduction, you'll save $250.
With this in mind, here are 12 tax deductions that apply to many Americans.
"Above-the-line" deductions are subtracted from your income before you arrive at your "adjusted gross income" (AGI). Most deductions require you to itemize your deductions in order to take them, and if you don't have sufficient deductions, you'll just skip it and take the standard deduction. But above-the-line deductions don't require you to itemize. Here are the above-the-line deductions average Americans should know about:
- IRA contributions: Contributions to a traditional IRA can be deducted from your income. The maximum allowable deduction for both 2016 and 2017 is $5,500 -- plus an additional $1,000 for those aged 50 or older. You have until April 18, 2017 to make IRA contributions for the 2016 tax year.
- Health Savings Account (HSA) contributions: A Health Savings Account is a terrific way to pay for qualifying healthcare expenses in a tax-free manner. The money in your HSA can accumulate over years, too, invested and growing, and once you turn 65, you can withdraw money from it for any purpose, paying ordinary income tax rates on withdrawals. HSA contribution limits for individuals are $3,350 for 2016 and $3,400 for 2017. For families they're $6,750 for both years. Those 55 or older can chip in an additional $1,000. This deduction is also an above-the-line one, and contributions for the 2016 tax year can be made until April 18, 2017.
- Moving expenses: Those who move during the year for a new job may be able to deduct expenses they incur such as the cost of hiring a moving company, storage, and transportation. Not all moves and expenses will qualify. If you're moving for non-job-related reasons or you're not moving a qualifying distance, you'll be out of luck.
- Student-loan interest: Those with sufficiently low earnings can deduct up to $2,500 in student-loan interest they pay via this above-the-line deduction. How much you can deduct starts shrinking (all the way to zero) once you exceed AGI of $65,000 for single filers and $130,000 for married-filing-jointly filers. (Those are the limits for 2016.)
- Teacher expenses: If you're a teacher who has spent money out of your own pocket for your classroom, you may be able to take a deduction of up to $250.
- Self-employment deductions: Self-employed taxpayers may deduct the self-employment tax they pay (which can amount to 15.3% of their earnings, for Social Security and Medicare), as well as contributions to a SEP IRA or other retirement account. They may also be able to deduct health insurance premiums.
Below-the-line (itemized) deductions
Below-the-line deductions are ones you may or may not be able to take advantage of, depending on whether your deductions exceed the standard deduction. (The standard deduction is one any taxpayer can take instead of itemizing deductions.) Many of these can only be taken to the extent they exceed a certain percentage of your AGI. (Thus, they benefit from above-the-line deductions that shrink your AGI.) Here are key below-the-line deductions to know about:
- Mortgage interest: If you're paying off a mortgage, you may be able to deduct the mortgage interest you pay, as well as any "points" you paid when securing the loan. Interest from a home equity loan or home equity line of credit is also deductible. This is all subject to some rules and limits, of course, so read up before claiming this.
- State and local taxes: You can deduct the state and local income tax you paid during the tax year or the state and local sales tax you paid -- but not both. (Tallying your sales tax paid, though, can be a chore, so the IRS offers an online sales tax calculator to help you come up with an acceptable estimate. If you go this route, be sure to add in sales tax paid for any major purchases such as a car or refrigerator.)
- Charitable contributions: You can deduct contributions you make to charity, but there are a bunch of rules to follow. For example, donations must be made to qualifying organizations, which tend to include churches and other types of non-profit organizations. Donations can be made in the form of cash (which includes checks and credit card payments) or items such as household goods and even cars. When you're donating items, they should be in good condition and you can generally deduct their fair market value. With cash donations, you'll need either a receipt or a cancelled check with the date and amount -- if the donation is for less than $250. Donations of $250 or more will require a written record of the donation from the organization. (These days, many charities will send out an end-of-the-year summary of your giving, to assist with your taxes.) There are other rules, too.
- Medical and dental expenses: There's also a deduction for medical and dental expenses. You can only deduct the portion of qualifying expenses that exceed 10% of your AGI. So if your AGI is $75,000 and you have $7,500 or less in qualifying medical expenses, you'll get no tax relief. If you have $9,000 in qualifying medical expenses, though, you can take a $1,500 deduction. That 10% threshold used to be 7.5% and those 65 or older get to use the 7.5% rate through the 2016 tax year. After that, it's 10% for them, too. The 10% hurdle can seem high, but if you spend a lot on medical expenses -- which is especially likely if you have a high-deductible health insurance plan -- this deduction may still be worthwhile.
- Miscellaneous deductions: Your friends at the IRS even offer you a catch-all "miscellaneous deductions" category. Expenses in this category include unreimbursed employee expenses, tax preparation fees, union dues, gambling losses, and job-search costs. For some of these, you can only deduct the portion of qualifying expenses that exceeds 2% of your AGI.
- Investment losses: If your investing transactions during the tax year leave you with a capital loss, you can offset capital gains with that loss. Better still, if you have more losses than gains, you can deduct the remaining loss, up to $3,000, from your income. If there is still some loss left, that can be carried forward to the next tax year.
These deductions may be able to help you shave thousands of dollars off your tax bill. And there are even more deductions available, so consider spending a little time seeing whether you can save even more.