Who says taxes are boring? Well, lots of people say that, but they must not be thinking of tax deductions, because taking advantage of deductions can shave hundreds, if not thousands of dollars off your tax bill.
Here's a look at six of the best tax deductions that you might be able to take advantage of come April. Note that with standard deductions having been significantly increased by recent tax reform, many people will not have sufficient deduction to make itemizing worthwhile. Still, run the numbers to see where you stand.
Image source: Getty Images.
No. 1: Charitable contributions
Being a generous sort can be a win-win proposition, when it comes to taxes. That's because the money (or other assets) that you donate to qualifying charities can be deducted. There are rules to know about, though, of course. For example, you'll need to keep receipts or acknowledgments from the charities for your donations, in case the IRS wants to see them. If you received anything for your donation, you'll have to subtract the value of that. For example, if you donated $100 to your local public radio station and received a mug valued at $10, you can only donate $90. You can donate the fair market value of items you donate to qualifying organizations, too -- such as a pile of sweaters or a sofa. And if you did some driving in service of a qualifying charity (for example, delivering meals to the elderly), you may be able to deduct mileage, too -- for 2018, the rate is $0.14 per mile driven for charity.
No. 2: Contributions to retirement accounts
Here's a biggie: You can deduct many thousands of dollars from your taxable income if you made big contributions to retirement accounts such as IRAs and 401(k)s. Each of those comes in a traditional or Roth variety. With a traditional IRA or 401(k), you contribute pre-tax money, reducing your taxable income for the year, and thereby reducing your taxes, too. A contribution of $5,000, for example, will shrink your taxable income by $5,000 and if you're in the 24% tax bracket, that can save you $1,200. (With a Roth IRA or 401(k), you contribute post-tax money that doesn't reduce your taxable income at all in the contribution year. So no tax deductions there, but Roth IRAs are still well worth considering, as their back-end tax breaks can be huge.)
In 2018, you can contribute up to $5,500 to one or more traditional or Roth IRA(s) -- in total. If you're 50 or older, the limit is $6,500. (In 2019 that rises to $6,000 and $7,000, respectively.) The limits for 401(k)s are much higher: For 2018, the limit is $18,500, or $24,500 for those 50 or older. In 2019, it's $19,000, or $25,000 for those 50 and older. (At a minimum, contribute enough to your 401(k) to grab all available matching dollars from your employer, as that's free money.)
Retirement accounts can be powerful, beyond the deductions they offer. The table below shows how much money you can accumulate over various periods, socking away various amounts:
|
Growing at 8% For... |
$5,000 Invested Annually |
$10,000 Invested Annually |
$15,000 Invested Annually |
|---|---|---|---|
|
10 years |
$78,227 |
$156,455 |
$234,682 |
|
15 years |
$146,621 |
$293,243 |
$439,864 |
|
20 years |
$247,115 |
$494,229 |
$741,344 |
|
25 years |
$394,772 |
$789,544 |
$1.2 million |
|
30 years |
$611,729 |
$1.2 million |
$1.8 million |
Data source: calculations by author.
No. 3: Home office
If you're self-employed and have a home office, you may be able to benefit from some deductions. There are rules, though, of course. For starters, the office in your home must be exclusively used for business. If it's in a room that you also use as a home gym, or where your kids do their homework, it doesn't qualify. The space must also be your principal place of business, or where you meet regularly with customers. (If you're a salaried employee, you might have been able to take a home-office deduction in the past, via the miscellaneous itemized deduction, but recent tax reforms have eliminated that deduction. Self-employed people can claim the deduction on their Schedule C form.)
To claim a home-office deduction, you'll need to figure out what percentage of your home your office takes up. Once you have that, you can deduct that percent of utilities such as electricity and heat, as well as mortgage interest, property taxes, home insurance, security expenses, homeowner association fees, home repairs, and maintenance expenses. You can also deduct the full cost of a dedicated phone line into the office if you have one, and the full cost of work done on that room, such as painting it. If you pay $10,000 for a new roof for your house and your home office takes up 10% of your house, you may be able to deduct $1,000.
Image source: Getty Images.
No. 4: Health Savings Account contributions
A Health Savings Account (HSA) works much like a traditional 401(k) retirement account, deduction-wise, as you fund it with pre-tax money, thereby lowering your tax bill. That money can be used tax-free for qualifying healthcare expenses, such as doctor visits, lab work, and eye exams. The money in the account can accumulate over many years, invested and growing. Once you turn 65, you can withdraw money from your HSA for any purpose, paying ordinary income tax rates on withdrawals. HSA contribution limit is $3,450 for individuals and $6,900 for families for 2018. Those numbers rise to $3,500 and $7,000, respectively, in 2019, and in both years, those 55 or older can chip in an additional $1,000. Note that any employer contributions to your HSA are not deductible.
You'll need to have a qualifying high-deductible health insurance plan to contribute to an HSA and you generally must not have any other health coverage, either. Learn the rules, because an HSA can deliver tax deductions plus potential retirement savings, as well.
No. 5: State and local taxes
You might remember that for the tax year 2017 and many previous years, you could 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. That has changed a bit starting with the 2018 tax year. Your total deduction for state and local taxes is now capped at $10,000. That might seem generous, but remember that many people pay much more than that just in property taxes, while other people live in states with steep state income tax rates.
Still, the deduction can permit you to shrink your taxable income by up to $10,000. You just need to determine whether your state and local income taxes or sales taxes were higher, and which one to deduct. The IRS offers an online sales tax calculator to help you come up with an acceptable estimate of what you can deduct. (If you use it, be sure to add in sales tax paid for any major purchases such as a car or refrigerator.) If you pay significant state income taxes, that's probably your better option. But if your state imposes no income tax, or you made an especially big purchase during the year, the sale-tax option might be more beneficial.
No. 6: Mortgage interest -- and more
Finally, there's the mortgage interest deduction. Most people can deduct most or all of the interest they pay on their mortgage each year, which can add up to a lot of money. Here are some rules you need to know:
- The recent tax law changes reduce the maximum home loan size for which you can deduct interest from $1 million to $750,000.
- The new law limits the deductibility of interest on home equity loans, too. You can now only deduct the interest if the loan was used to buy, build, or improve your home, and if it doesn't push your total outstanding mortgage debt above the $750,000 limit.
- The new rules apply to mortgages originated after 2017. If your mortgage was taken out earlier, the older limits apply.
These are just some of the many tax deductions available to us. If you spend 30 to 60 minutes looking up and reading some overviews of tax deductions, you may run across a few more deductions that you can take. Being smart about tax deductions can shrink your tax bill by thousands of dollars, if not tens of thousands.
