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Tax deductions and tax credits can be huge money-savers — if you know what they are, how they work and how to pursue them. Here’s a cheat sheet.
What is a tax deduction?
A tax deduction lowers your taxable income and thus reduces your tax liability. You subtract the amount of the tax deduction from your income, making your taxable income lower. The lower your taxable income, the lower your tax bill.
What is a tax credit, then?
A tax credit is a dollar-for-dollar reduction in your actual tax bill. A few credits are refundable, which means if you owe $250 in taxes but qualify for a $1,000 credit, you’ll get a check for the difference of $750. (Most tax credits, however, aren’t refundable.)
As the simplified example in the table shows, a tax credit can make a much bigger dent in your tax bill than a tax deduction.
How to claim tax deductions
Generally, there are two ways to claim tax deductions: Take the standard deduction or itemize deductions. You can’t do both.
The standard deduction
The standard deduction basically is a flat-dollar, no-questions-asked reduction in your AGI. The amount you qualify for depends on your filing status.
People over age 65 or who are blind get a bigger standard deduction.
Itemizing lets you cut your taxable income by taking any of the hundreds of available tax deductions you qualify for. The more you can deduct, the less you’ll pay in taxes.
Should you itemize or take the standard deduction?
Here’s what the choice boils down to:
- If your standard deduction is less than the sum of your itemized deductions, you probably should itemize and save money. Beware, however, that itemizing usually takes more time, requires more forms and you’ll need to have proof that you’re entitled to the deductions.
- If your standard deduction is more than the sum of your itemized deductions, it might be worth it to take the standard deduction (and the process is faster).
Note: The standard deduction went up significantly in 2018, so you might find that it’s the better option for you now even if you’ve itemized in the past.
Your tax software or tax advisor can run your return both ways to see which method produces a lower tax bill.
20 popular tax deductions and tax credits for individuals
There are hundreds of deductions and credits out there. Here’s a drop-down list of some common ones, as well as links to our other content that will help you learn more.
Deduct up to $2,500 from your taxable income if you paid interest on your student loans. (How it works.)
This lets you claim all of the first $2,000 you spent on tuition, books, equipment and school fees — but not living expenses or transportation — plus 25% of the next $2,000, for a total of $2,500. (How it works.)
You can claim 20% of the first $10,000 you paid toward tuition and fees, for a maximum of $2,000. Like the American Opportunity Tax Credit, the Lifetime Learning Credit doesn’t count living expenses or transportation as eligible expenses. You can claim books or supplies needed for coursework. (How it works.)
Generally, it’s 20% to 35% of up to $3,000 of day care and similar costs for a child under 13, an incapacitated spouse or parent, or another dependent so you can work — and up to $6,000 of expenses for two or more dependents. (How it works.)
This could get you up to $2,000 per child and $500 for a non-child dependent. (How it works.)
For the 2019 tax year, this item covers up to $14,080 in adoption costs per child. For 2020, it covers up to $14,300. (How it works.)
This credit can get you between $529 and $6,557 in 2019 depending on how many kids you have, your marital status and how much you make. In 2020, the range is $538 to $6,660. It’s something to explore if your AGI is less than about $57,000. (How it works.)
If you itemize, you may be able to subtract the value of your charitable gifts — whether they’re in cash or property, such as clothes or a car — from your taxable income. (How it works.)
In general, you can deduct qualified, unreimbursed medical expenses that are more than 7.5% of your adjusted gross income for the tax year. (How it works.)
The mortgage interest tax deduction is touted as a way to make homeownership more affordable. It cuts the federal income tax that qualifying homeowners pay by reducing their taxable income by the amount of mortgage interest they pay. (How it works.)
Gambling losses and expenses are deductible only to the extent of gambling winnings. So, spending $100 on lottery tickets isn’t deductible — unless you win, and report, at least $100, too. You can’t deduct more than the amount you win. (How it works.)
You may be able to deduct contributions to a traditional IRA, though how much you can deduct depends on whether you or your spouse is covered by a retirement plan at work and how much you make. (How it works.)
The IRS doesn’t tax what you divert directly from your paycheck into a 401(k). For 2019, you can funnel up to $19,000 per year into such an account. If you’re 50 or older, you can contribute up to $25,000. In 2020, those limits are $19,500 and $26,000, respectively. These retirement accounts are usually sponsored by employers, although self-employed people can open their own 401(k)s. (How it works.)
This runs 10% to 50% of up to $2,000 in contributions to an IRA, 401(k), 403(b) or certain other retirement plans ($4,000 if filing jointly). The percentage depends on your filing status and income. (How it works.)
Contributions to HSAs are tax-deductible, and the withdrawals are tax-free, too, as long as you use them for qualified medical expenses. For 2019, if you have self-only high-deductible health coverage, you can contribute up to $3,500; in 2020, it’s $3,550. If you have family high-deductible coverage, you can contribute up to $6,900 in 2019 and $7,100 in 2020.
There are many valuable tax deductions for freelancers, contractors and other self-employed people. (How it works.)
If you use part of your home regularly and exclusively for business-related activity, the IRS lets you write off associated rent, utilities, real estate taxes, repairs, maintenance and other related expenses. (How it works.)
If you’re a school teacher or other eligible educator, you can deduct up to $250 spent on classroom supplies.
This one can get you up to 30% of the installation cost of solar energy systems, including solar water heaters and solar panels. (Read more.)