Making an error on your tax return can expose you to significant penalties. But figuring out what you need to pay in taxes can be incredibly confusing.
The U.S. tax code is 74,608 pages long and includes thousands of special deductions and credits. You can maximize your return by claiming as many of these as possible.
Keep reading to learn the difference between tax exemptions, deductions and credits.
Tax Exemptions
These reduce the amount of income you have to pay taxes on. For individuals and families, the exemptions we talk about are personal and dependent.
Personal exemptions are available to anyone who has to file taxes and isn’t being used as a dependent on someone else’s taxes. Dependent exemptions are used for anyone who is a legal dependent of the tax filer.
For 2017, the personal and dependent exemption was $4,050 per individual. This starts to phase out once you begin making more than $261,500.
As an example, if you made $45,000 with one dependent, you would be able to exempt $8,100 of your income from federal taxes.
Many state and local government bodies also offer tax exemptions. These mostly apply to charitable organizations and other groups that usually don’t pay taxes.
Tax Deductions
Deductions work similarly to exemptions. They reduce the amount of income you have to pay taxes on and are generally based on your expenses. Many different deductions are available.
Most people are familiar with the standard deduction. This is the amount anyone filing taxes can deduct all else being equal. For 2017, the standard deduction was $6,350.
Special deductions are available for people who are self-employed or who run a small business. These kinds of deductions focus on business expenses that can seep into individual life.
Other deductions work either above the line or below the line. Above the line, deductions can be used with a standard deduction. These include interest paid on student loans and income contributed to a traditional IRA or Health Savings Account (HSA).
Below the line deductions are where you get into itemizing deductions. You cannot use both the standard deduction and itemized deductions. Charitable giving is the most common type of below the line deduction.
Most Americans use the standard deduction rather than itemizing their deductions as it is usually higher.
Tax Credits
Tax credits are one of the best kind of tax reduction tools available. They actually reduce the amount you have to pay in taxes, dollar for dollar.
These generally require you to take an action Congress has decided is good for the country. The IRS provides a full listing of available tax credits on their website, but here’s an overview of the most commonly used.
Common tax credits are the Earned Income Tax Credit, Child, and Dependent Care Credit and Earned Income Tax Credit. Homeowners could also qualify for the Mortgage Interest Credit or Residential Energy Efficient Property Credit.
If you worked abroad at any point in the taxable year, you can qualify for a Foreign Tax Credit. This allows you to reduce taxes paid in the U.S. proportionate to taxes you paid abroad.
Getting Ready to File
When you’re preparing your taxes for the year, it’s very important to review all the deductions, tax exemptions and credits you qualify for. These can greatly reduce your tax burden.
Make sure you don’t miss out on any possible tax savings this year by using an expert filer. Request a free quote from VTax Tax Prep to get started!