Your tax refund is based on how much tax you pay in excess of the tax you owe. Basic tax planning strategies aimed at reducing the amount of your taxable income may increase the gap and thus your refund. In some cases, these strategies benefit you in other ways, offsetting future costs for health care or providing for retirement. Though some aspects of tax law can be complicated, even a beginner can focus on taxable income reduction.
For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.
Planning your deduction method
When completing your tax return, you have a choice between standard or itemized tax deduction methods to determine taxable income. The standard deduction is a dollar amount set by the government that you can claim without accounting for the expenses that typically make up a taxpayer's allowed deductions. Itemized deductions are actual expenditure you make for deductible expenses. Your actual deductible expenditures in a tax year may amount to more than the standard deduction amount. If that's the case, you'll likely pay less tax or get a larger refund using the itemized deduction method. However, the itemized method requires support in the form of receipts and other documents to demonstrate these amounts were actually spent. Consider a filing system to save receipts. Even if you choose to claim the standard deduction, having receipts on file will help you make an informed choice at tax time.
Retirement savings strategies
"Savings plans such as qualified individual retirement arrangements save you tax in the current year, investment earnings grow tax-free year to year, and provide income for retirement, when you may be taxed in a lower bracket," says James Windsor, certified public accountant from Ann Arbor, Mich. Many taxpayers turn to retirement plans for both the tax reductions now and income later. With a tax rate of 25 percent, for example, contributing $15,000 to a retirement plan may save you $3,750 on your current tax return. Investment earnings on money in your account are not taxed until withdrawal. Maximizing your annual contributions to retirement accounts may be an effective cornerstone for your basic tax planning strategy.
Other tax-sheltered savings
While the size of allowable contributions to retirement plans is attractive to many taxpayers, there are other savings plans that also defer tax and, in some cases, help you avoid tax altogether.
- 529 education savings plans—Though these plans are funded by after-tax dollars, qualifying withdrawals are tax-free. You can choose prepaid tuition plans or education savings plans.
- Health coverage savings plans—These include health savings accounts, medical savings accounts and flexible spending arrangements. Plans are funded by you, your employer or a combination, though in each case, both contributions and withdrawals for qualifying expenses are tax-free.
- Dependent care savings accounts—These are flexible spending arrangements similar to health FSAs but focused on helping pay for childcare expenses while you’re working and held in a separate fund. Contributions and qualifying withdrawals are tax-free.
Withdrawals from any of these plans that are not made for qualifying expenses may be taxable at your rate at the time of withdrawal.
Using tax credits
Another way to reduce the tax you owe is to use tax credits that apply to your situation. Refundable tax credits not only reduce your tax but can be used to create a surplus, resulting in a refund.
- Low-income earners may qualify for the earned income tax credit. Eligibility depends on your earnings, filing status and number of dependent children.
- The child and dependent care credit applies when you must pay for care for children or disabled dependents so that you can work or look for work.
- You may qualify for the child tax credit of up to $2,000 in 2020 for dependent children under 17 who qualify.
For your 2021 tax return that you will prepare in 2022, the Child Tax Credit is expanded by the American Rescue Plan raising the per-child credit to $3,600 or $3,000 depending on the age of your child. The credit is also fully refundable for 2021. To get money into the hands of families faster, the IRS will be sending out advance payments of the 2021 Child Tax Credit beginning in July of 2021. For updates and more information, please visit our 2021 Child Tax Credit blog post.
- Modest income earners below certain income levels may qualify for the retirement savings contributions credit, which is over and above other tax savings earned from contributions to IRAs or other retirement plans.
- The American Opportunity tax credit can offset some costs of post-secondary education during the first four years of college or university. The maximum credit is $2,500 per qualifying student, and 40 percent of the credit is refundable.
Remember, with TurboTax, we'll ask you simple questions about your life and help you fill out all the right tax forms. With TurboTax you can be confident your taxes are done right, from simple to complex tax returns, no matter what your situation.