Key Takeaways
- The Standard Deduction is a dollar amount that you can deduct from your income without itemizing.
- Itemized deductions are actual expenditures that are deductible. Taxpayers usually itemize deductions when they amount to more than the Standard Deduction.
- Qualified contributions to an individual retirement account (IRA) can be deducted from your income, and the earnings grow tax-free year to year.
- Qualified contributions to health coverage savings plans and dependent care savings accounts can be deducted from your income, and the qualifying withdrawals are tax-free.
Planning your deduction method
When completing your tax return, you have a choice between taking the Standard Deduction or itemizing your tax deductions 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.
TurboTax Tip:
You may qualify for the Child Tax Credit of up to $2,000 per qualifying child (tax year 2024) if you have dependent children under 17 who meet the eligibility requirements.
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 2021 for dependent children under 17 who qualify.
For tax year 2021, 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 sent 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.
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