This tax season, taxpayers across all income levels looking to reduce their tax burden may overlook opportunities that they or their advisors are unaware of.
“You should take every deduction to which you’re entitled because overlooked tax deductions are wasted opportunities to save money,” GOBankingRates says.
Kiplinger is even more to the point: “Cut your tax bill to the bone by claiming all the tax write-offs you deserve.”
Maria Alexeychuk, a certified public accountant for Hammer Financial Group who specializes in holistic financial services, says that in her experience, clients tend to overlook two ways to save on their tax bill: tuition and fees deduction for those who cannot take education credits, and miles for charitable and medical purposes.
Tax specialists at GOBankingRates and Kiplinger have compiled extensive lists of ways taxpayers can save money this year. We have picked out 15 of these:
1. Estate tax on income in respect of a decedent
“If one has inherited an IRA, that person may be able to deduct any estate tax paid by the IRA owner from the taxes due on the withdrawals you take from the inherited account,” Alexeychuk said.
Kiplinger notes that the taxpayer can save a lot of money if the IRA comes from an estate that is big enough to be subject to the federal estate tax, getting an income-tax deduction for the amount of estate tax paid on the IRA assets received.
Say someone inherited a $100,000 IRA, and that the money was included in the benefactor’s estate added $40,000 to the estate-tax bill. The recipient gets to deduct that $40,000 on his or her tax return as the money is withdrawn from the IRA. If the beneficiary withdraws $50,000 in one year, for example, he or she gets to claim a $20,000 itemized deduction on Schedule A. In the 28% bracket ($91,150 to $190,150), that would save $5,600.
2. Investment fees and expenses
Taxpayers can take a miscellaneous deduction for certain fees they paid to manage their investments. GOBankingRates lists these:
- Fees for investment counseling
- Custodial fees you paid outside of the account
- Software and online services you used to manage investments
- Safety deposit rental fees
- Transportation costs to and from an investment or financial advisor’s office
- Attorney costs you used to collect taxable income
- Costs to replace lost security certificates
3. Reinvested dividends
“When recording a stock sale on Schedule D, taxpayers sometimes forget to include the reinvested dividends in the cost of that stock,” Alexeychuk said.
If the taxpayer, like most investors, has mutual fund dividends automatically reinvested to buy extra shares, Kiplinger says it is important to remember that each new purchase increases the tax basis in the fund, which, in turn, reduces the taxable capital gain (or increases the tax-saving loss) when shares are redeemed.
Forgetting to include reinvested dividends in basis results in double taxation of the dividends: once in the year when they were paid out and immediately reinvested and later when they are included in the proceeds of the sale — a costly mistake.
If the taxpayer is unsure what her basis is, the fund can help. Funds often report to investors the tax basis of shares redeemed during the year. In fact, Kiplinger points out, funds must report the basis to investors and to the IRS for the sale of shares purchased in 2012 and later years.
4. Volunteer work donations
Many charitably inclined Americans volunteer their services to nonprofit organizations in addition to, or in lieu of, donating assets.
GOBankingRates notes that taxpayers can deduct certain expenses for charity work, such as the cost of gas and oil for driving to and from the place one volunteers. It is not necessary to calculate the value per mile to deduct; a standard rate of 14 cents per mile is acceptable.
Volunteers can also deduct the cost of purchasing and maintaining uniforms they wear to a place where they volunteer or parking in a garage if that is required.
5. State sales taxes
Congressional action in 2015 made state sales tax deductions permanent. Kiplinger says this is important for those who live in a state that does not impose a state income tax.
Itemizers have a choice between deducting the state income taxes or state sales taxes they paid. Those with the option of choosing either one should opt for whichever saves more money. In a state with no income tax, the sales tax write-off is clearly the way to go.
But even filers who pay state income taxes can come out ahead with the sales tax choice. Kiplinger points out that the IRS has tables showing how much residents of various states can deduct, based on their income and state and local sales tax rates. Not only that, purchasers of a vehicle, boat or airplane may add the sales tax they paid on that big-ticket item to the amount shown in the IRS table for their state.
6. Amortizing bond premiums
“Bond premiums can be amortized over the life of the bond,” Alexeychuk said. “The annual amortized amount should be deducted from the bond interest income. This helps reduce a taxpayer’s income.”
According to Kiplinger, the federal government will effectively help pay the premium on a taxable bond purchased for more than its face value—as the buyer might have to capture a yield higher than current market rates deliver. That is only fair, as the IRS will get to tax the extra interest that the higher yield produces.
The bondholder has two choices about how to handle the premium.
Amortize it over the life of the bond by taking each year’s share of the premium and subtracting it from the amount of taxable interest from the bond reported on the tax return. Each year, the bondholder reduces his tax basis for the bond by the amount of that year’s amortization.
The alternative is to ignore the premium until the bond is sold or redeemed. At that time, the full premium will be included in the bondholder’s tax basis so it will reduce the taxable gain or increase the taxable loss dollar for dollar.
Kiplinger says the amortization strategy could be more valuable, since the interest the bondholder does not report will avoid being taxed in her top tax bracket for the year — as high as 43.4% — while the capital gain the bondholder reduces by waiting until selling or redeeming the bond would be taxed only at 0%, 15% or 20%.
7. Home improvements
Taxpayers have one more chance this April to claim a tax credit for installing energy-efficient windows or making similar energy-saving home improvements. They can claim up to $500 in total tax credits for eligible improvements, based on 10% of the purchase cost (but not installation) of certain insulation, windows, doors and skylights. Kiplinger notes that the credit is subject to a lifetime cap, and cannot be claimed by anyone who has already claimed the maximum.
The good news is that no such limit exists for those who install qualified residential alternative energy equipment, such as solar hot water heaters, geothermal heat pumps and wind turbines in 2016. This credit can be 30% of the total cost (including labor) of such systems.
In addition, GOBankingRates reports that although home renovation costs are not deductible, home improvements for medical purposes — such as adding exit-and-entrance wheelchair ramps or lowering cabinets for better accessibility — can be deducted as medical expenses. But if renovations are made to increase the value of the home, they cannot be claimed as medical-related expenses.
8. State tax paid last spring
Kiplinger encourages taxpayers not to overlook taxes they paid when filing their 2015 state income tax return in the spring of 2016. They should include their state tax deduction on their 2016 federal return, along with state income taxes withheld from paychecks or paid via quarterly estimated payments during the year.
9. Child care credit
Taxpayers can qualify for a tax credit worth between 20% and 35% of what they pay for child care while they work, Kiplinger says. But if the employer offers a child care reimbursement account — which allows the employee to pay for the child care with pretax dollars — that is likely even better.
For those who qualify for a 20% credit but are in the 25% tax bracket ($37,950 to $91,900), for example, the reimbursement plan is preferable. Not only does money run through a reimbursement account avoid federal income taxes, but it also is protected from the 7.65% Social Security tax.
Double dipping is not allowed, Kiplinger warns. Expenses paid through a plan cannot also be used to generate the tax credit. However, even though only $5,000 in expenses can be paid through a tax-favored reimbursement account, up to $6,000 for the care of two or more children can qualify for the credit. Those who run the maximum through a plan at work but spend even more for work-related child care can claim the credit on as much as $1,000 of additional expenses. That would cut your tax bill by at least $200.
10. College credit for those long out of college
College credits are not limited to just the first four years of college. According to Kiplinger, taxpayers can claim the lifetime learning credit for any number of years and can use it to offset the cost of higher education for themselves or their spouses, not just for their children.
The credit is worth up to $2,000 a year, based on 20% of up to $10,000 spent for post-high-school courses that lead to new or improved job skills. Classes taken at a vocational school or community college, even by retirees, can count.
The right to claim this credit phases out as income rises from $55,000 to $65,000 on an individual return and from $110,000 to $130,000 for couples filing jointly.
11. Hobby expenses
Most folks have a hobby of some sort. GOBankingRates notes that taxpayers can deduct some ordinary expenses they incur from a hobby. But unlike a business, a hobby is an endeavor from which they do not expect to profit. Losses from a hobby cannot be deducted from income.
The IRS offers several tips concerning hobbies. First, determine whether it is a business, which one engages in to make a profit, or a hobby, which people often engage in for recreation or sport, such as coin collecting, horsemanship and craft making.
The hobbyist can usually deduct both ordinary expenses — ones that are common and accepted for the activity — and necessary expenses — ones that are appropriate for the activity. However, the hobbyist can deduct expenses only up to the amount of hobby income. If expenses exceed income, the resulting loss cannot be deducted from other income.
Deductions must be itemized on Schedule A in order to claim hobby expenses.
12. Waiver of penalty for the newly retired
Although not a deduction, with this waiver the taxpayer can duck a penalty. Those who do not pay what they owe during the year through withholding or estimated tax payments, or who owe more than $1,000 at the time they file, can be hit with a penalty for underpayment of taxes. The current rate is 3%.
Kiplinger notes that a little-known exception to this penalty can protect taxpayers 62 and older in the year they retire and the following year. The taxpayer can request a waiver of the penalty — using Form 2210 — if he or she has a reasonable cause, such as not having realized the necessity of shifting to estimated tax payments after a lifetime of meeting the obligation via withholding from paychecks.
13. State income tax refund — Shh!
Most taxpayers can ignore the line on the tax form for reporting a state income tax refund. They did not itemize deductions on their previous federal return, so the state refund is tax free.
But even if they did itemize, part of the refund may be tax free, according to Kiplinger. It is taxable only to the extent that the deduction of state income taxes the previous year actually saved money. If the taxpayer would have itemized (rather than taking the standard deduction) even without the state tax deduction, then 100% of the refund is taxable — since 100% of the write-off reduced their taxable income. However, if part of the state tax write-off pushed the taxpayer over the standard deduction threshold, then part of the refund is tax free.
“Don’t report any more than you have to,” Kiplinger says.
14. Deduction of Medicare premiums for the self-employed
Women and men who continue to run their own businesses after qualifying for Medicare can deduct the premiums they pay for Medicare Part B and Medicare Part D, plus the cost of supplemental Medicare policies or the cost of a Medicare Advantage plan.
Kiplinger notes that this deduction is available whether or not the taxpayer itemizes,and is not subject to the 7.5% of AGI test that applies to itemized medical expenses for those 65 and older.
However, the business owner cannot claim this deduction if he or she is eligible to be covered under an employer-subsidized health plan offered by either an employer (if the person has both a job and a business) or the spouse’s employer if that job offers family medical coverage.
15. Repayment of income
Taxpayers who had to repay income that they included in ordinary income in an earlier year might be able to deduct the repaid amount. In most cases, according to GOBankingRates, they can claim a deduction only for repayment of income if their repayment qualifies as an expense or loss they had at their business, trade or in a transaction.
The claim has to be for income totaling more than $3,000, and it is deductible only if they held the money under a claim that they included in income from a previous year because they believed they had an unrestricted right to the money.
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