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All Contents © 2020The Kiplinger Washington Editors
By Sandra Block, Senior Editor
David Muhlbaum, Senior Online Editor
| December 20, 2019
If you believe that tax breaks are only available for hedge fund managers and companies with offshore subsidiaries, you're probably paying too much to the IRS. The fact is that lawmakers have enacted dozens of tax incentives targeted at middle- and lower-class families. If you're not taking full advantage of them, it's probably because you're not aware of them.
Take a look at these 10 tax breaks for ordinary Americans and make sure you're not missing out. All of these breaks survived the tax reform enacted in late 2017, and one, the child tax credit, even got a big boost.
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 37%.
But investors with lower taxable incomes 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 on sales you made in 2019, your taxable income couldn't exceed $39,375 if you are single; or $78,750 if you are married filing jointly in that year. Note that this is taxable income. That's what's left after you subtract itemized deductions or the standard deduction from your adjusted gross income. For 2020, the 0% rate for long-term gains and qualified dividends will apply for taxpayers with taxable income under $40,000 on individual returns and $80,000 on joint returns.
The government provides an incentive for people to work: the Earned Income Tax Credit.
For 2019 tax filing, the maximum EITC ranges from $529 to $6,557 depending on your income and how many children you have. (For your 2020 return, the range will be $538 to $6,660.) 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 2019 earned income and adjusted gross income (AGI) must each be less than $15,570 for singles and $21,370 for joint filers. (For 2020, those income limits rise to $15,820 and $21,710, respectively.) If you have three or more kids and are married, though, your 2019 earned income and AGI can be as high as $55,952 ($56,844 in 2020). The exceptions are considerable—more complicated than we can list here—but the Center for Budget and Policy Priorities has a handy online calculator to help you determine eligibility.
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—$6,000 for 2019 ($7,000 if you'll be at least 50 years old by the end of the year) or 100% of your earned income, whichever is less. The limits are the same for 2020.
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 2019 income rises between $64,000 and $74,000 on a single return or between $103,000 and $123,000 if you're married and file jointly with your spouse. (For 2020, the deduction phases out for income between $65,000 and $75,000 for singles and between $104,000 and $124,000 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 $6,000 ($7,000 if 50 or older) as long as the other spouse has sufficient earned income to cover both contributions. The 2020 values are also $6,000 and $7,000. For 2019, the contribution is tax-deductible as long as income doesn't exceed $193,000 on a joint return. You can take a partial tax deduction if your combined income is between $193,000 and $203,000. (For 2020, the contribution is tax-deductible as long as income doesn't exceed $196,000 on a joint return; you can take a partial tax deduction if your combined income is between $196,000 and $206,000.)
If you are single and have 2019 adjusted gross income of $32,000 or less, or you are married and have AGI of $64,000 or less, you can make out even better on a retirement contribution through the Saver's Tax Credit. (The income limits rise to $32,500 for singles and $65,000 for couples in 2020.)
The credit is a potential bonanza for part-time workers who fall within the income limits. You can claim a tax credit worth 10%, 20% or 50% of the first $2,000 ($4,000 for joint filers) you put in—that means a credit of up to $1,000 ($2,000 for joint filers). The lower your income, the higher the percentage you get back via the credit. 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.
People with disabilities who have an ABLE account can also take advantage of the Saver's Credit. Contributions to these accounts qualify for the credit, so long as they're from the designated beneficiary.
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 to submit IRS Form 8880.
With a new baby also comes a $2,000 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 $2,000 credit no matter when during the year the child was born (which is why people make gags about rushing 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 $2,000-per-child credit will reduce your tax bill by $2,000. The credit begins to disappear as income rises above $400,000 on joint returns and above $200,000 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" (up to $1,400 per qualifying child), 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.
You may also qualify for a tax credit that will reduce the cost of childcare. 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.
If you claim someone other than a child as a dependent (say, an elderly parent or a kid off to college), you can get a $500 tax credit for each of them.
Like the child-care credit, the Credit for Other Dependents begins to disappear as income rises above $400,000 on joint returns and above $200,000 on single and head-of-household returns—although there's no limit to how many dependents you may claim on a return, as long as they qualify. Whom can you claim as a dependent? It, well, depends, but the IRS has a helpful tool to guide you through the qualifications.
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 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 as much as $2,000 per year.
For 2019, the income limits for the Lifetime Learning Credit are $68,000 if single and $136,000 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.
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.
For example, if you paid college tuition for yourself, your spouse or a dependent, you may be able to deduct up to $4,000 in college tuition and fees. To qualify for the full deduction, your adjusted gross income must be $130,000 or less if married filing jointly ($65,000 or less if single). You can deduct up to $2,000 in tuition and fees if your joint income was $160,000 or less ($80,000 or less if single). There is no deduction if you earn more than that. You don't need to itemize to qualify. (This deduction expired at the end of 2017; however, it was retroactively extended through 2020 in December 2019. You can file an amended return to claim it for the 2018 tax year.)
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 2019 modified adjusted gross income (MAGI) is less than $85,000 ($170,000 if filing a joint return). The deduction starts to phase out at a MAGI of $70,000 (for singles) and $140,000 (for joint filers). The income thresholds are the same for 2020. The former student can deduct this even if it's actually Mom and Dad who are paying the bill.
Finally, 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 2019 MAGI rises between $81,100 to $96,100 for singles and 121,600 to $151,600 for joint filers. For 2020, the phase-out range is from $123,550 to $153,550 for joint filers and from $82,350 to $97,350 for singles. Important note: If you're using savings bonds to pay for a child's education, the bonds must be in your name to qualify for the exclusion. Savings bonds in the child's name aren't eligible.