Paying taxes isn't fun, but the good news is that there are steps you can take to lose less money to the IRS -- namely, by capitalizing on the tax credits and deductions that are available to you. But before we dive into some of the most popular tax breaks out there, let's first review the difference between a tax credit and a deduction.
A tax credit is a dollar for dollar reduction of your tax liability, and it has the same value no matter what tax bracket you fall into. If you owe the IRS $2,000 and claim a $2,000 tax credit, that knocks that liability down to $0, regardless of how much money you earn.
A tax deduction, on the other hands, works by exempting a portion of your income from taxes. If you take a $2,000 tax deduction, you don't pay taxes on $2,000 of earnings. But the value of that deduction will hinge on the tax bracket you fall into. If you're in the 22% bracket, you'll save $440 with a $2,000 deduction. If you're in the 24% bracket, you'll save $480. The higher your earnings, the more valuable tax deductions will be for you.
Now that that's out of the way, let's talk about some of the most popular credits and deductions tax-filers tend to enjoy. Here are a few to put on your radar, even if you're not gearing up to file a tax return anytime soon.
1. The mortgage interest deduction
To claim the mortgage interest deduction, you'll need to itemize on your tax return. And that's something most filers don't do. But if you do happen to itemize, you'll have the option to deduct mortgage interest on a home loan of up to $750,000 ($1 million if you signed your mortgage before Dec. 15, 2017).
Now to be clear, it's just the interest portion of your home loan that's eligible for a deduction. Say you make a monthly mortgage payment of $2,000, of which $1,200 goes toward interest and $800 is applied to your loan's principal. In that case, you'd only claim a deduction against the $1,200. But in the early stages of a mortgage, this deduction can be particularly valuable, because at that point, more of your money is going toward interest and less so toward principal.
2. The SALT deduction
The state and local tax deduction, or SALT deduction , is worth up to $10,000, and you can claim it if you itemize on your tax return. The SALT deduction includes all state income taxes and property taxes you're liable for, but to be clear, you're limited to $10,000 across all categories. For example, if you pay $10,000 in state income tax and another $10,000 in property taxes, you'll still only get a $10,000 deduction.
3. Deductions for charitable contributions
Being charitable doesn't just make people feel good -- it can also be a huge money-saver. If you itemize on your tax return, you can claim a deduction for contributions to registered charities, and that includes the donation of goods as well as cash. For goods, you can deduct the fair market value of the items you give away (not their original value, which is apt to be much higher).
Furthermore, in 2020 specifically, you can deduct up to $300 in charitable contributions even if you don't itemize on your taxes as part of the CARES Act. And thanks to the latest coronavirus relief bill, in 2021, you can deduct up to $300 in charitable donations without itemizing if you're a single tax filer, or up to $600 if you're a married couple filing jointly.
4. The IRA deduction
Contributing to an IRA won't just set you up for the future -- it will also lower your taxes. Traditional IRA contributions can be taken as an above the line deduction, which means you can write them off even if you claim the standard deduction and don't itemize on your taxes. In both 2020 and 2021, IRA contributions max out at $6,000 for adults under 50, and $7,000 for those 50 and over.
5. The Child Tax Credit
The Child Tax Credit applies to children in your household under the age of 17, and in both 2020 and 2021, it's worth up to $2,000 per child. Better yet, up to $1,400 of that credit is refundable, so if it knocks your tax liability below $0, you'll get paid the difference.
To qualify for the Child Tax Credit in full, your income can't exceed $200,000 if you're single or $400,000 if you're married filing a joint tax return. From there, the credit phases out by $50 for each $1,000 you earn, but that still means most tax-filers will be eligible to claim it.
Know your tax breaks
The more tax credits and deductions you're able to score, the less money you'll lose to the IRS. Take the time to read up on tax breaks so you reap the most savings you're eligible for.