You can use the tax code to save yourself money. Tax benefits are not solely for the rich. In fact, there are plenty of tax credits and deductions available for middle-class and low-income taxpayers.
Here are ten tax benefits you can utilize to lower your tax bill. Make sure you are not leaving any money on the table by overlooking these opportunities when filing your taxes.
Low-Income Tax Breaks
Some tax credits are designed for lower-to-middle income taxpayers. There are two kinds of tax credits: refundable credits, which allow taxpayers to receive refunds regardless of their tax liability (or the lack thereof); and nonrefundable credits, which allow taxpayers to reduce their tax liability up to zero dollars. Lower-income earners can potentially use both in their tax returns. Here are three of them:
1. American Opportunity Tax Credit
This educational tax benefit replaces and expands the Hope Credit, which enables matriculated college tuition payers to reduce their personal income taxes based on the amount of college expenses incurred. The American Opportunity Credit applies to the first four years of college educational expenses, including tuition, books, and other supplies. The credit is limited to $2,500 per eligible student, and a portion of the tax credit is refundable, if you have zero tax liability. So, if your income tax liability is $750, and you have $1,000 in refundable tax credits, you can get a $250 check from Uncle Sam. You can claim 100 percent of the first $2,000, and 25 percent of the next $2,000 you spend for each eligible student, which adds up to a maximum credit of $2,500.
To claim the full amount of this credit, you must have a modified adjusted gross income (MAGI) of $80,000 or less, or $160,000, if you’re married and filing jointly (MFJ). The credit starts phasing out as your income rises above these levels. If your MAGI is above $90,000, or $180,000 for MFJ, you do not qualify for this tax credit.
2. Savers Tax Credit
The savers tax credit was created to help lower-income families contribute to retirement plans. This credit essentially pays you to put money into a retirement account. You can write off the first $2,000 of contributions you make to a qualified retirement plan, which can be a 401K, a traditional or Roth IRA.
In order to claim this credit, you must not be a full-time student or be claimed as a dependent on someone else’s tax return. You must be 18 years of age, or older.
The adjusted gross income (AGI) limits for the savers tax credit are as follows:
- Single: $30,750 in 2016, and $31,000 in 2017
- Head of Household: $46,125 in 2016, and $46,500 in 2017
- MFJ: $61,500 in 2016, and $62,000 in 2017
The amount of your credit will be 10, 20 or 50 percent of your contribution, depending on your AGI. For instance, for tax year 2017, if MFJ, you can claim 50 percent of your contribution, as a tax credit, if your AGI is below $37,001. If your AGI is from $37,001 to $40,000, you are entitled to a 20 percent credit, and if your AGI is from $40,001 to $62,000, you will only get a credit of 10 percent of your contribution.
3. Earned Income Tax Credit
The earned income tax credit (EIC) was designed specifically to assist low-income working families. However, single taxpayers can also benefit from this credit.
The level of income and the number of children in your household determine the amount of the tax credit. For tax year 2016, the income limit ranges from $14,880 for single tax payers to $53,505 for MFJ taxpayers, with three or more children.
For 2016, the maximum EIC is:
- $6,269 for three or more qualifying children
- $5,572 for two qualifying children
- $3,373 for one qualifying child
- $506 for zero qualifying children
You must have earned income, either from wages or business income, in order to qualify for the EIC. A qualifying child must be younger than 19, unless he’s enrolled as a full-time student, in which case the age limit increases to 24.
Middle-Income Tax Benefits
Generally speaking, the government gives tax benefits to help lower-income taxpayers or to incentivize high earners to help the country’s economy. The middle-income folks are left with in an unfavorable tax situation. But, there are some tax incentives for middle-income. Here are a few of them:
4. Home Mortgage Interest Deduction
Perhaps the biggest tax break available to middle-income families is the mortgage interest deduction. The government allows you to deduct the interest payments you have made all year on a qualifying mortgage you obtained to purchase your own home. This deduction can be a huge tax saver if you take out a big loan to purchase your home.
The IRS publishes extensive information regarding qualifying loans, appropriate properties, and eligible taxpayers. Generally speaking, most standard home mortgage loans qualify, as long as it is taken out for your primary residence, in which you are owner.
5. Lifetime Learning Credit
The Lifetime Learning Credit is another educational tax credit. However, if you claim the American Opportunity Credit, you cannot claim the Lifetime Learning Credit. Unlike the American Opportunity Credit, this credit is nonrefundable – meaning the credit is limited to you tax liability amount. The Lifetime Learning Credit can be claimed for an unlimited number of tax years, hence the name “Lifetime,” where as the American Opportunity Credit has a four-year maximum.
The Lifetime Learning Credit allows you to claim up to $2,000 to help offset educational costs of a qualifying student. MAGI limits include: $130,000 for MFJ, and $65,000 for single, head of household or qualifying widower taxpayers. You cannot claim this credit if you are married and filing separately (MFS). You can take advantage of this credit any time, as long as it goes toward qualified educational expenses, which include tuition, student activity fees, and course-related books and supplies.
6. Child Tax Credit
This tax credit can be claimed on top of the EIC and Child and Dependent Care Credit. The child tax credit can go up to $1,000 per qualifying child living in your household.
To qualify, you must claim the child as a dependent on your taxes. The child must be a U.S. citizen and have lived with you for at least 6 months during the past year. Additionally, the child must not provide more than half of his/her own support.
You may qualify for this credit if your MAGI is less than the following amounts:
- Single: $75,000
- MFS, Head of Household, or Qualifying Widower: $55,000
- MFJ: $110,000
This is a nonrefundable tax credit. However, if the credit amount exceeds your tax liability, you might qualify for the refundable Additional Child Tax Credit. However, you may not be eligible for the Additional Child Tax Credit if you already receive the full amount of the Standard Child Tax Credit.
7. Retirement Savings Accounts
This tax benefit is typically available to middle-income earners. Low-income taxpayers often do not have enough money to contribute to retirement accounts, and the rich are ineligible for the tax deductions associated to certain retirement accounts, such as employer-provided 401Ks and self-directed Individual Retirement Accounts (IRAs).
So, this is how the 401K works: If you contribute $5,000 to your 401K plan, the amount of your taxable income drops by $5,000. So, if you are in the 25 percent tax bracket, this means you can save up to $1,250 in federal tax.
Traditional retirement accounts offer more than just an immediate tax benefit. The earnings grow tax-deferred as long as you keep the money in the account. You have to pay taxes on regular brokerage account transactions every year if dividends are paid and capital gains are incurred. But if you have a traditional 401K or IRA, you pay taxes only when you withdraw from the account.
Contributions to Roth Retirement Plans do not qualify for immediate tax deductions, but the earnings in such accounts grow tax-free. You will not have to pay taxes on money you withdraw from the account after you reach the age of 59.5.
High-Income Tax Incentives
High-income taxpayers have challenges and advantages when it comes to paying Uncle Sam. Having a high income disqualifies you from many tax breaks. However, there are a whole set of special tax breaks created specifically for affluent individuals. And because they pay a higher rate, their tax incentives end up saving them more money, dollar-wise, at the end of the day. Here are some of the more common tax breaks that may apply to you, if you are a high-income earner.
8. Capital Gains Tax
Because we have a progressive tax system, the rich tend to reap the most benefits from lower capital gains rate. Long-term capital gains and dividend income is from 15 to 20 percent, depending on your income level. In contrast, the ordinary income tax rate for high earners can be as high as 39.6 percent for 2016. This difference means great tax savings for rich people.
For example, if a person, who’s in the highest tax bracket, makes $1,000,000 in 2016 and is taxed as ordinary income, she will owe up to $396,000 in federal income tax. However, if this income is considered a capital gain, she would $238,000 in federal income tax (= $1,000,000 * 20% capital gains rate + 3.8% Net Investment tax rate, which applies to the wealthy). This equates to a tax savings of $158,000. Now, how many people do you know make more than $150,000 annually? This person saved more in taxes than a majority of Americans earn in one year.
9. High Income Mortgage Interest Deduction
High-income tax filers tend to have larger mortgage payments, which could mean more significant mortgage interest deductions. Banks will only give large mortgages to high-income folks. According to the Internal Revenue Code (IRC), taxpayers are allowed to deduct interest payments on home mortgage loans of up to one million dollars. So, if you have a one million dollar mortgage on your mansion, and the interest rate on the loan is 3.5%, then you can write-off $35,000 from your earned income. To top it all off, the wealthy can also deduct interest paid on home equity loans amounting up to $100,000.
10. Carried Interest
The carried interest provision only applies to high-income taxpayers. If you are a venture capitalist, hedge fund manager, or a partner of a private equity firm, then you are eligible for special tax treatment based on your occupation.
The carried interest provision is very similar to the capital gains tax benefit. Compensation to these Wall Street type professions is considered a distribution of investment fund profits, which is known as carried interest. Because this money is treated as investment profits, rather than wages, it is taxed at the long-term capital gains rate, rather than as ordinary income. This kind of tax treatment yields significant tax savings for such professionals.
For instance, if a hedge fund manager gets paid $1 million, and is taxed at the 39.6% bracket, plus a 3.8% Net Investment Income tax, he would being paying $434,000 in federal income tax. However, since his income is considered to be carried interest, his $1 million would be subject to only the 20% capital gains rate, plus the 3.8% Net Investment Income tax, which would yield a much smaller $238,000 tax bill.
As we can see, there are plenty of tax benefits you can take advantage of, ranging from educational tax credits to deductions on retirement contributions. You need to find the deductions or credits that are relevant to you. This list is just a starting point for your beginning tax education. Continue to learn and see how much you can save in your tax bill.