Tax Deduction and Credit Phaseouts and Limits
Lately I’ve had a lot of tax clients asking questions about why they did not receive certain deductions or credits that they had received in prior years or may have heard about somewhere. The most common reason for this is income phaseouts and limits. Here is some information on some common ones.
What are these? Phaseout is when your income falls into a set range and the deduction or credit is reduced. How much it is reduced depends on where your income is in this range, with higher income amounts resulting in a lower deduction or credit. Limit is the amount of income when you will become ineligible to receive the deduction or credit.
Filing status affects all these items. Single and Head of Household (HOH) are the same. Married Filing Jointly (MFJ) is almost always twice the single amount when it comes to taxes. Married Filing Separately (MFS) is not common and I would not usually recommend because it is almost always less favorable with most items being not allowed or have a lower limit.
Most of these numbers are for 2020 but many are the same for 2021.
Student Loan Interest
If you are paying off a student loan the interest you paid can be a deduction from your income, reducing your taxable income. Unfortunately there are limits to this. Often those with the highest student loans are making higher income, such as those in medical fields, and are not eligible to use this deduction.
Education Expenses
American Opportunity Credit (AOTC) is limited to four year of undergraduate work and has many required such as at least half-time student and pursuing a degree. It tends to always be the best education credit for an undergraduate student. The Lifetime Learning Credit (LLC) can be used any year of education and less restrictions. This is often best to use when taking courses for a career change or continuing education in your field. Education Tuition and Fees Deduction is not often used but can provide some minimal education deduction but occasionally can be larger than the LLC depending on your income and amount of school expenses.
All these education items have a lot more involved in calculating them. This is just a simple guide with part of the information involved in them. Please speak to a tax professional to find out more about these.
Retirement Accounts
Traditional IRA plans have a contribution limit of $6,000 per year, or $7,000 if you are 50 or older. Traditional IRA contributions help reduce your income, up to your limit, which makes it tax free income. However, with a Traditional IRA you will pay tax on your earnings/gains when you take distributions (withdrawals). So this is a way to save on taxes now, but will be paying taxes later. If under the limits it is a good way to reduce your taxable income.
The limit here depends on if you currently participate in a retirement plan at your work. For example if you, or your spouse, participate in a 401(k) through work than you may not be able to deduct your entire Traditional IRA contribution.
Roth IRA plans are NOT tax deductible. However, they have a different advantage. While you do pay tax on that income now, with you take distributions (withdrawals) any earnings/gains with NOT be taxes. It is a great way to have tax free income during retirement. It has the same contribution limit of $6,000 per year, or $7,000 if you are 50 or older. However, your contribution amount can be limited based on your income and filing status. If limited here you may still contribute to a Traditional IRA.
Child Credit & Care
Child Tax Credit gives the parent a $2,000 credit for qualifying child under the age of 17. There is a credit of $500 for any other qualifying dependents such students 17 or older or parents who live with taxpayer. These amounts have been known to change through the year and with current Covid environment could change again before the current amount of $2,000 reduces after 2025.
The Child and Dependent Care Credit is made it help those with lower income pay for a care provider such as child daycare while at work. The total expenses that you may use to calculate the credit may not be more than $3,000 (for one qualifying individual) or $6,000 (for two or more qualifying individuals). Expenses paid for the care of a qualifying individual are eligible expenses if the primary reason for paying the expense is to assure the individual's well-being and protection. These calculations are also affected if you receive assistance with care expense through your employer and child must be 12 years or younger.
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