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All Contents © 2020The Kiplinger Washington Editors
By Rocky Mengle, Tax Editor
Kevin McCormally, Chief Content Officer
| December 2, 2019
You have to claim all the write-offs you're entitled to if you really want to cut your income tax bill to the bone. Unfortunately, though, people often miss great tax-saving opportunities because they don't know that certain tax breaks exist. And you're completely out of luck if you don't discover them before the amended return deadline has passed.
If you don't want that to happen to you, check out our list of 20 frequently overlooked tax breaks and deductions. You may uncover a hidden gem that turns your 2019 return into a money-saving masterpiece.
There's a line on the tax form for reporting a state income tax refund, but most people who get refunds can simply ignore it, even though the state sent the IRS a copy of the 1099-G you got reporting the refund. If, like most taxpayers, you didn't itemize deductions on your previous federal return, the state tax refund is tax-free.
Even if you did itemize, part of it might be tax-free. It's taxable only to the extent that your deduction of state income taxes the previous year actually saved you money. If you would have itemized (rather than taking the standard deduction) even without your state tax deduction, then 100% of your refund is taxable—because 100% of your write-off reduced your taxable income. But if part of the state tax write-off is what pushed you over the standard deduction threshold, then part of the refund is tax-free. Don't report any more than you have to.
It's hard to overlook the big charitable gifts you made during the year, by check or payroll deduction (check your pay stub in December).
But little things add up, too, and you can write off out-of-pocket costs incurred while doing work for a charity. For example, ingredients for dishes you prepare for a nonprofit organization's soup kitchen and stamps you buy for a school's fund-raising mailing count as charitable contributions. Keep your receipts. If your contribution totals more than $250, you'll also need an acknowledgement from the charity documenting the support you provided. If you drove your car for charity during the year, remember to deduct 14 cents per mile, plus parking and tolls paid, for your philanthropic journeys.
This deduction is particularly important if you live in a state that doesn't impose a state income tax. Itemizers have the choice between deducting the state income taxes or state and local sales taxes they paid. You choose whichever saves you the most money. So, if your state doesn't have an income tax, the sales tax write-off is clearly the way to go.
In some cases, even filers who pay state income taxes can come out ahead with the sales tax choice. And you don’t need a wheelbarrow full of receipts. The IRS has a calculator that shows how much residents of various states can deduct, based on their income and state and local sales tax rates. If you purchased a vehicle, boat or airplane, the calculator will also include the tax you paid on that big-ticket item when it spits out your total sales tax deduction amount.
Unfortunately, there's one wrinkle you won't like. The write-off for sales tax is added to your local property taxes, and there's a $10,000 a year maximum for the combined total of these taxes ($5,000 if you're married but filing a separate return).
If you took a trip to Las Vegas but didn't do so well, you might be able to deduct your gambling losses. This deduction is only available if you itemize, and it is limited to the amount of gambling winnings you report as taxable income. In addition to losses suffered at a casino or racetrack, deductible gambling losses also include the cost of non-winning bingo, lottery and raffle tickets.
If you plan to take this deduction, be sure you keep all your gambling receipts (e.g., losing tickets). The IRS also suggests that you keep a daily diary of gambling activity that includes the date and type of wagering, name and location of gambling establishments, names of people with you when you gamble, and amounts you won or lost.
Did you owe tax when you filed your 2018 state income tax return in the spring of 2019? Then, for goodness' sake, remember to include that amount in your state-tax deduction on your 2019 federal return, along with state income taxes withheld from your paychecks or paid via quarterly estimated payments during the year.
Just remember that the deduction for state and local taxes is limited to $10,000 a year ($5,000 if married filing separately).
Many employers continue to pay employees' full salary while they serve on jury duty, and some impose a quid pro quo: The employees have to turn over their jury pay to the company coffers. The only problem is that the IRS demands that you report those jury fees as taxable income. To even things out, you get to deduct the amount you give to your employer.
A credit is so much better than a deduction; it reduces your tax bill dollar for dollar. So missing one is even more painful than missing a deduction that simply reduces the amount of income that's subject to tax. In the 24% bracket, each dollar of deductions is worth 24 cents; each dollar of credits is worth a greenback.
You can qualify for a tax credit worth between 20% and 35% of what you pay for childcare while you work. But if your boss offers a childcare reimbursement account—which allows you to pay for the child care with pretax dollars—that's likely to be an even better deal. If you qualify for a 20% credit but are in the 24% tax bracket, for example, the reimbursement plan is the way to go. Not only does money run through a reimbursement account avoid federal income taxes, it also is protected from the 7.65% federal payroll tax. (In any case, only amounts paid for the care of children younger than age 13 count.)
You can't double dip. Expenses paid through a plan can't also be used to generate the tax credit. But get this: Although 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. So if you run the maximum through a plan at work but spend even more for work-related child care, you can claim the credit on as much as $1,000 of additional expenses. That would cut your tax bill by at least $200.
You're probably familiar with the $2,000 child tax credit, which has been putting money back in parents' pockets for decades. Unfortunately, if your son or daughter is over 16 years old, you can't use this credit to trim your tax bill.
However, there's a separate $500 credit for dependents who don't qualify for the child tax credit. So your older children can still save you some money at tax time – even if they're in college. You can also claim the credit for older relatives that you're caring for at home.
Note, though, that the combined total of both the child credit and the credit for other dependents is phased out if your adjusted gross income is more than $200,000 ($400,000 for married couples filing jointly).
Extra fees for baggage, online booking and to change travel plans are on the rise at airlines. Such fees add up to billions of dollars each year. If you get burned, maybe Uncle Sam will help ease the pain. If you're self-employed and travelling on business, be sure to add those costs to your deductible travel expenses.
This isn't a deduction, but it is an important move that can save you a bundle on your taxes.
If, like most investors, you have mutual fund dividends automatically reinvested to buy more shares, remember that each new purchase increases your tax basis in the fund. That, in turn, reduces the taxable capital gain (or increases the tax-saving loss) when you redeem shares. Forgetting to include reinvested dividends in your basis results in double taxation of the dividends—once in the year when they were paid out and immediately reinvested and later when they're included in the proceeds of the sale.
Don't make that costly mistake.
If you're not sure what your basis is, ask the fund for help. Funds often report to investors the tax basis of shares redeemed during the year. In fact, for the sale of shares purchased in 2012 and later years, funds must report the basis to investors and to the IRS.
This doesn't work for employees. You can't deduct the 7.65% of pay that's siphoned off for Social Security and Medicare. But if you're self-employed and have to pay the full 15.3% tax yourself (instead of splitting it 50-50 with an employer), you do get to write off half of what you pay. Plus, you don't have to itemize to take advantage of this deduction.
When you buy a house, you get to deduct in one fell swoop the points paid to get your mortgage. When you refinance, though, you generally have to deduct the points on the new loan over the life of that loan. That means you can deduct 1/30th of the points each year if it's a 30-year mortgage. That's $33 a year for each $1,000 of points you paid—not much, maybe, but don't throw it away.
Even better: If you use part of the refinanced loan to improve your home, you might be able to deduct points related to the improvements right away. (The rest of the points are deducted over the life of the loan.)
Either way, in the year you pay off the loan—because you sell the house or refinance again—you get to deduct all as-yet-undeducted points. There's one exception to this sweet rule: If you refinance a refinanced loan with the same lender, you add the points paid on the latest deal to the leftovers from the previous refinancing, then deduct that amount gradually over the life of the new loan. A pain? Yes, but at least you'll be compensated for the hassle.
In certain parts of the country, the tuition at private elementary and secondary schools is looking more and more like the tuition at some colleges. So it's a good thing that you now can pay your child's private school bill from savings accounts previously used only for college tuition.
The 2017 tax reform law allows tax-free distributions from 529 savings plans of up to $10,000 per student per year to pay tuition for kindergarten through 12th grade at religious and other private schools. Tuition can be paid from multiple 529 plan accounts, but the total amount can't exceed the annual limit.
If you're forking out big bucks for college tuition, the American Opportunity Credit is one tax break you really don't want to miss. This tax credit is based on 100% of the first $2,000 spent on qualifying college expenses and 25% of the next $2,000 ... for a maximum annual credit per student of $2,500. 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). The credit is phased out for taxpayers with income above those levels.
If the credit exceeds your tax liability, it can trigger a refund. (Most credits are "nonrefundable," meaning they can reduce your tax to $0 but not get you a check from the IRS.)
College credits aren't just for youngsters, nor are they limited to just the first four years of college. The Lifetime Learning credit can be claimed for any number of years and can be used to offset the cost of higher education for yourself or your spouse . . . not just for your children.
The credit is worth up to $2,000 a year, based on 20% of up to $10,000 you spend for post-high-school courses that lead to new or improved job skills. Classes you take even in retirement at a vocational school or community college can count. If you brushed up on skills in 2019, this credit can help pay the bills. The right to claim this tax-saver phases out as income rises from $58,000 to $68,000 on an individual return and from $116,000 to $136,000 for couples filing jointly.
Generally, you can deduct interest only if you are legally required to repay the debt. But if parents pay back a child's student loans, the IRS treats the transactions as if the money were given to the child, who then paid the debt. So as long as the child is no longer claimed as a dependent, he or she can deduct up to $2,500 of student-loan interest paid by Mom and Dad each year. And he or she doesn't have to itemize to use this money-saver. (Mom and Dad can't claim the interest deduction even though they actually foot the bill because they are not liable for the debt.)
Folks who continue to run their own businesses after qualifying for Medicare can deduct the premiums they pay for Medicare Part B and Part D, plus the cost of supplemental Medicare (medigap) policies or the cost of a Medicare Advantage plan.
This deduction is available whether or not you itemize and is not subject to the 10% of AGI test that applies to itemized medical expenses. One caveat: You can't claim this deduction for premiums paid for any month that you were eligible to be covered under an employer-subsidized health plan offered by either your employer (if you have a job as well as your business) or your spouse's employer (if he or she has a job that offers family medical coverage).
This isn't a deduction, but it can save you money if it protects you from a penalty. Because our tax system operates on a pay-as-you earn basis, taxpayers typically must pay 90% of what they owe during the year, or 100% of the previous year's tax, via withholding or estimated tax payments. If you don't and you owe more than $1,000 when you file your return, you can be hit with a penalty for underpayment of taxes. The penalty works like interest on a loan—as though you borrowed from the IRS the money you didn't pay.
There are several exceptions to the penalty, including a little-known one that can protect taxpayers age 62 and older in the year they retire and the following year. You can request a waiver of the penalty—using IRS Form 2210—if you have "reasonable cause."
Members of the National Guard or military reserves may write off the cost of travel to drills or meetings. To qualify, you must travel more than 100 miles from home and be away from home overnight. If you qualify, you can deduct the cost of lodging and half the cost of your meals, plus an allowance for driving your own car to get to and from drills.
For 2019 travel, the rate is 58 cents per mile, plus what you paid for parking fees and tolls. You may claim this deduction even if you use the standard deduction rather than itemizing.
If you purchased a taxable bond for more than its face value—as you might have to capture a yield higher than current market rates deliver—Uncle Sam will effectively help you pay that premium. That's only fair, because the IRS is also going to get to tax the extra interest that the higher yield produces.
You have two choices about how to handle the premium.
You can 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 you report on your tax return. Each year, you also reduce your tax basis for the bond by the amount of that year's amortization.
Or you can ignore the premium until you sell or redeem the bond. At that time, the full premium will be included in your tax basis, so it will reduce the taxable gain or increase the taxable loss dollar for dollar.
The amortization route can be a pain because it's up to you to both figure each year's share and keep track of the declining basis. But it could be more valuable because the interest you don't report will avoid being taxed in your top tax bracket for the year—as high as 40.8%, while the capital gain you reduce by waiting until you sell or redeem the bond would only be taxed at 0%, 15% or 20%.
If you buy a tax-free municipal bond at a premium, you must use the amortization method and reduce your basis each year ... but you don't get to deduct the amount amortized. After all, the IRS doesn't get to tax the interest.