20 Most-Overlooked Tax Deductions, Credits and Exemptions

Don't Unnecessarily Report a State Income Tax Refund

There's a line on the tax form for reporting a state income tax refund, but most taxpayers 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 people, you claimed the standard deduction on your previous federal return, the state tax refund is tax-free.

However, even if you itemized deductions on your last return (rather than taking the standard deduction), part of your state tax refund still 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 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.

Out-of-Pocket Charitable Deductions

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.

State Sales Taxes

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 (opens in new tab) 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-per-year maximum for the combined total of these taxes ($5,000 if you're married but filing a separate return). This limit is commonly referred to as the SALT deduction cap ("SALT" stands for state and local taxes). The Build Back Better Act, which is currently working it's way through Congress, would provide some relief for taxpayers snared by this limit. However, at this point, we don't know if the legislation will pass or if the SALT cap provisions currently in the bill will be modified or removed. Stay tuned!

Gambling Losses

If you took a trip to Las Vegas this year but didn't do so well, at least you might be able to deduct your gambling losses. This deduction is only available if you itemize, and it's limited to the amount of gambling winnings you report as taxable income. Also remember that, in addition to "traditional" gambling losses (e.g., at a casino or racetrack), deductible gambling losses 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.

State Tax Paid for Previous Year

Did you owe tax when you filed your 2020 state income tax return earlier this year? Then, for goodness' sake, remember to include that amount in your state-tax deduction on your 2021 federal return, along with state income taxes withheld from your paychecks or paid via quarterly estimated payments during the year.

Just remember, as we mentioned above, that the deduction for state and local taxes is limited to $10,000 a year ($5,000 if married filing separately). That limit may change soon if the Build Back Better Act is enacted into law, but for now the $10,000 cap still applies.

Jury Pay Given to Employer

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.

Child and Dependent Care Credit

Affording childcare can be one of the more difficult challenges parents face. That's where the child and dependent care credit comes in – especially this year, because the credit was improved for 2021 to help families struggling during the pandemic.

For previous years, if your children were younger than 13, you were eligible for a 20% to 35% non-refundable credit for up to $3,000 in childcare expenses for one child or $6,000 for two or more. The percentage decreased as income exceeded $15,000. However, for the 2021 tax year, the maximum credit percentage jumps from 35% to 50%, up to $8,000 in expenses for one child and $16,000 for multiple children qualify for the credit, the phase-out doesn't start until income hits $125,000, and the credit is fully refundable. (For more information, see Child Care Credit Expanded for 2021.)

The credit can also help pay for the costs of caring for other dependents, too. For example, expenses related to care for an elderly parent living with an adult child qualify for the credit if the parent is claimed as a dependent on the child's tax return.

Credit for Dependents

You're probably familiar with the child tax credit and the related monthly payments the IRS has been sending American parents since July. Unfortunately, for 2021, if your son or daughter is over 17 years old (over 16 in other years), 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).

Recovery Rebate Credit

If you didn't get a third stimulus check earlier this year, or you didn't get the full amount, make sure you check out the recovery rebate credit on your 2021 tax return. Your third stimulus check was simply an advance payment of the credit. So, if your third stimulus check (i.e., advance payment) was less than the recovery rebate credit amount, you may be able to get the difference back on your 2021 tax return in the form of a larger tax refund or a lower tax bill. On the other hand, if your stimulus check was more than the amount of the credit, you don't have to repay the difference. So, you can't lose!

The eligibility rules for the recovery rebate credit are basically the same as they were for the third round of stimulus checks. The big difference is that eligibility for the stimulus check was typically based on information found on your 2020 tax return, while eligibility for the recovery rebate credit is based on information from your 2021 return. As a result, you could qualify for a third stimulus check but not for the credit – and vice versa.

Social Security Taxes You Pay

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.

Refinancing Points

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.

Mortgage Insurance Premiums

Homeowners who pay private mortgage insurance on loans originated after 2006 can deduct their premiums if they itemize. (PMI is usually charged if you put down less than 20% when you buy a home.) The deduction is phased out if your adjusted gross income exceeds $100,000 and disappears if your AGI exceeds $109,000 ($50,000 and $54,500, respectively, if you're married but file a separate return).

Look at Box 5 on the Form 1098 you receive from your lender for the amount of premiums you paid during the year. Report the deductible amount on line 8d of Schedule A (Form 1040).

This deduction is set to expire after the 2021 tax year. (However, the deduction has expired and then been extended several times in the past.)

Private School Tuition (K-12)

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 can also pay your child's private school bill from savings accounts normally used for college tuition.

You can take a tax-free distribution from a 529 savings plan 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.

American Opportunity Credit

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. However, the credit is only available for the first four years of college.

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). But 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.)

A College Credit for Those Long Out of College

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 during the year, this credit can help pay the bills. Like the American Opportunity Credit, the right to claim this tax-saver on your 2021 return phases out as income rises from $80,000 to $90,000 on an individual return and from $160,000 to $180,000 for couples filing jointly.

Student-Loan Interest Paid by Mom and Dad

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 the child 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're not liable for the debt.)

Deduction of Medicare Premiums for the Self-Employed

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 7.5% 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).

Waiver of Penalty for the Newly Retired

This isn't a deduction or other tax break that you claim on your return, but it can save you money if it protects you from an IRS 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 (opens in new tab) — if you have "reasonable cause."

Military Reservists' Travel Expenses

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 2021 travel, the rate is 56 cents per mile (58.5 cents per mile for 2022), plus what you paid for parking fees and tolls. You may claim this deduction even if you use the standard deduction rather than itemizing.

Amortizing Bond Premiums

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 on 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.