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All Contents © 2017The Kiplinger Washington Editors
If you believe that tax breaks are for millionaires and companies with offshore subsidiaries, you’re probably paying too much to the IRS.
In recent years, lawmakers have enacted dozens of tax incentives targeted at middle-class families. Taking full advantage of these tax breaks is particularly important for dual-income couples because there’s a good chance they’ll get hit by the marriage penalty—when two individuals pay more in taxes as a married couple than they would pay if they were both single. And they work together: Lowering your adjusted gross income (AGI) with one strategy could make you eligible for other tax breaks.
The tax code offers a slew of incentives for starting a family, saving for retirement and educating yourself and your kids.
Take a look at these nine options and make sure you're not missing out.
By Sandra Block, Senior Associate Editor
David Muhlbaum, Online Editor
| February 2017
Anyone with earned income (meaning income from work rather than investments) can contribute to a traditional IRA, but not everyone who contributes can claim a tax deduction. That's a no-no for the rich if they're covered by a retirement plan at work.
Here's how the deduction rules operate for traditional IRAs: First, there's a limit on how much you can contribute each year—$5,500 ($6,500 if you'll be at least 50 years old by the end of the year) or 100% of your earned income, whichever is less. If you're not enrolled in a 401(k) or some other workplace retirement plan, you can deduct your IRA deposits no matter how high your income. But if you're enrolled in such a plan, the right to the IRA deduction is phased out as 2016 income rises between $61,000 and $71,000 on a single return or between $98,000 and $118,000 if you're married and file jointly with your spouse. (For 2017, the deduction phases out for income between $62,000 and $72,000 for singles and between $99,000 and $119,000 for couples.) The limits only apply if one spouse participates in an employer plan. If neither does, there are no income limits for taking a deduction.
Spouses with little or no earned income can also make an IRA contribution of up to $5,500 ($6,500 if 50 or older) as long as the other spouse has sufficient earned income to cover both contributions. For 2016, the contribution is tax-deductible as long as income doesn't exceed $184,000 on a joint return. You can take a partial tax deduction if your combined income is between $184,000 and $194,000. (For 2017, the contribution is tax-deductible as long as income doesn't exceed $186,000 on a joint return; you can take a partial tax deduction if your combined income is between $186,000 and $196,000.)
SEE ALSO: The Most Tax-Friendly States for Retirees
If you are single and have 2016 adjusted gross income of $30,750 or less, or you are married and have AGI of $61,500 or less, you can make out even better on a retirement contribution through the Saver's Tax Credit. (The income limits rise to $31,000 for singles and $62,000 for couples in 2017.)
The credit is a potential bonanza for part-time workers who fall within the income limits. You can claim a tax credit worth 10% to 50% of the amount you put in, up to a maximum credit of $1,000 ($2,000 for joint filers). Contributions to a workplace plan, such as a 401(k) or 403(b), as well as contributions to a traditional, Roth or SEP IRA, are eligible for this credit.
The lower your income, the higher the percentage you get back via the credit. Some key exceptions: Taxpayers under age 18, full-time students and those claimed as dependents on their parents' returns are not eligible, regardless of their income.
And here's the beauty of a credit compared with a deduction: While deductions reduce the amount of your income that can be taxed, credits reduce the amount of tax you owe—dollar for dollar. You’ll need IRS Form 8880.
SEE ALSO: The Most-Overlooked Tax Deductions
The government provides an incentive for people to work: the Earned Income Tax Credit.
For 2016 tax filing, the maximum EITC ranges from $506 to $6,269, depending on your income and how many children you have. (For your 2017 return, the range will be $510 to $6,318.) This program, originally conceived in the 1970s, has been expanded several times, and some states (and even municipalities) have created their own versions.
Part of what makes it popular: When the federal EITC exceeds the amount of taxes owed, it results in a tax refund—a check back to you. In essence, you're no longer a taxpayer. But, you have to act to claim the credit by filing—a step many don't take.
The income limits on this program are fairly low. If you have no kids, for example, your 2016 earned income and adjusted gross income (AGI) must each be less than $14,880 if you're single and $20,430 if you're married filing jointly. (For 2017, those income limits rise to $15,010 for singles and $20,600 for couples.) If you have three or more kids and are married, though, your 2016 earned income and AGI can be as high as $53,505. The exceptions are considerable—more complicated than we can list here—but the Center for Budget and Policy Priorities has a helpful online calculator to help you determine eligibility.
With a new baby also comes a $1,000 child tax credit to lower- and middle-income earners, and this is a gift that keeps on giving every year until your dependent son or daughter turns 17.
You get the full $1,000 credit no matter when during the year the child was born (which is why people make gags about speeding deliveries as the New Year approaches).
Unlike a deduction that reduces the amount of income the government gets to tax, a credit reduces your tax bill dollar for dollar. So the $1,000-per-child credit will reduce your tax bill by $1,000. The credit begins to disappear as income rises above $110,000 on joint returns and above $75,000 on single and head-of-household returns—although there's no limit to how many kids you may claim on a return, as long as they qualify.
And for some lower-income taxpayers, the credit is "refundable," meaning that if it’s worth more than your income tax liability, the IRS will issue you a check for the difference, as with the EITC.
SEE ALSO: 7 Ways to File Your Taxes Free This Year
You may also qualify for a tax credit that will reduce the cost of child care. If your children are younger than 13, you’re eligible for a 20% to 35% credit for up to $3,000 in child-care expenses for one child or $6,000 for two or more. The percentage decreases as income increases. Eligible expenses include the cost of a nanny, preschool, before- or after-school care and summer day camp.
Another way to reduce child-care expenses is to participate in your employer’s flexible spending account for dependent-care expenses. With these accounts, money is deducted from your gross salary before income, Social Security and Medicare taxes. You can contribute up to $5,000 per year.
You can’t claim the child-care credit for expenses covered by a flexible spending account. In general, families that earn more than $43,000 will save more with a flexible spending account, says Laurie Ziegler, an enrolled agent in Saukville, Wis. However, even then, you may be able to use the child-care credit to offset expenses not covered by your flex account. If you paid for the care of two or more children and contributed the maximum, you can use the dependent-care credit to cover up to an additional $1,000 in child-care costs.
For most people, long-term capital gains (and qualified dividends) are taxed at 15% or 20%—a bargain by historical standards.
That's why some people get so exercised about a rule that allows hedge-fund managers to pay tax at the capital-gains rate rather than at rates for ordinary income, which top out at 39.6%.
But investors in the two lowest income tax brackets pay no tax at all on their capital gains and dividends. That could be a boon to retirees, who have a higher standard deduction than younger taxpayers and who are not taxed on some or all of their Social Security benefits, and the unemployed, who may have had to tap their investments to make ends meet.
To take advantage of the 0% capital-gains rate for 2016, your taxable income can't exceed $37,650 if you are single; $50,400 if you are a single head of household with dependents; or $75,300 if you are married filing jointly. Note that this is taxable income. That's what's left after you subtract personal exemptions—worth $4,050 each in 2016 for you, your spouse and your dependents—and your itemized deductions or standard deduction from your adjusted gross income.
In 2017, your taxable income can't exceed $37,950 if you are single; $50,800 if you are a single head of household with dependents; or $75,900 if you are married filing jointly -- although it's possible this tax break may disappear if President Trump and the Republican-led Congress enact a tax-reform plan they've been championing.
SEE ALSO: 9 Surprising Things That Are Taxable
This tax credit is available for up to $2,500 of college tuition and related expenses (but not room and board) paid during the year. The full credit is available to individuals whose modified adjusted gross income is $80,000 or less ($160,000 or less for married couples filing a joint return). Single taxpayers with MAGI above $90,000 and married couples with MAGI above $180,000 are ineligible for the credit.
The American Opportunity Credit is juicier than the old Hope Credit—it has higher income limits and bigger tax breaks, and it covers all four years of college. And if the credit exceeds your tax liability (whether derived from the regular income tax or the alternative minimum tax), up to 40% of it is refundable. For example, suppose you owe $1,900 in federal taxes and qualify for the full credit. The nonrefundable portion of the credit will reduce your tax bill to $400, and the first $400 of the refundable portion will lower your bill to zero. You’ll receive the remaining $600 as a tax refund.
If you want to get additional education—for virtually any reason and at virtually any school—you can tap the Lifetime Learning Credit. The credit is calculated as 20% of up to $10,000 of qualified expenses, so you can get back $2,000 per year.
The income limits for the Lifetime Learning Credit are $65,000 if single and $130,000 if married, and you can’t claim both this credit and the American Opportunity Credit for the same student in the same year. Also, no double dipping allowed: Expenses paid with funds from other tax-favored tuition programs, such as a Coverdell ESA, don’t count when figuring either credit.
SEE ALSO: 7 Tax Forms That Can Accidentally Increase Your Tax Bill
If neither the American Opportunity Credit nor the Lifetime Learning Credit works for you, there are still other ways the government offers favorable tax treatment for learning—and limits the breaks to the middle class and below.
1) Got a student loan around your neck? You can deduct up to $2,500 of interest paid on the loan each year, so long as your modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if filing a joint return). The former student can deduct this even if it's actually Mom and Dad who are paying the bill.
2) Interest on savings bonds is usually subject to federal income tax. However, interest on Series EE and I bonds issued after 1989 can be tax-free when used to pay for qualified education expenses, if you meet certain requirements. This benefit phases out gradually as your 2016 MAGI rises between $116,300 and $146,300 for those filing jointly, and between $77,550 and $92,550 for single filers.
QUIZ: Is It Tax-Deductible?
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