A $5,000 or $6,000 deduction for IRA contributions, a $4,000 deduction for college tuition and fees, a $1,000 child tax credit — these are hefty tax breaks for which a taxpayer may understandably yearn. But they’re small beans when compared with the tens of thousands of dollars in savings some reap through deductions and credits.
How about taking a $50,000 deduction for state and local taxes paid, a $37,000 deduction for medical expenses, a $28,000 deduction for mortgage interest, or a $21,000 deduction for charitable contributions?
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Those are the average amounts claimed for each of those deductions in 2008 by taxpayers with adjusted gross income higher than $250,000, the group with the highest average claim for each of those deductions that year, said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based tax publisher and unit of Wolters Kluwer. (The average dollar amounts are rounded, and count only those taxpayers who claimed that particular deduction.)
Some tax breaks “basically don’t have any limit,” Luscombe said. For example, to take the medical-expense deduction your expenses must exceed 7.5% of your adjusted gross income.
“That puts a floor on it, but as far as a top number, the more medical expenses you have, the higher the deduction,” Luscombe said. (Some deductions discussed here are restricted or disallowed under the alternative minimum tax.)
For taxpayers with adjusted gross income of $30,000 to $50,000 in 2008, the average deduction for state and local taxes was about $3,800; for medical expenses, $6,000; mortgage interest, $9,000; charitable contributions, $2,200, according to CCH.
For taxpayers with AGI of $50,000 to $100,000, the average deduction for state and local taxes was about $6,000; medical expenses, $7,000; mortgage interest, $10,600; charitable contributions, $2,700.
The mortgage-interest deduction is limited by the value of your home — generally speaking, you can claim it for interest paid on mortgage indebtedness up to $1 million, plus another $100,000 of home-equity debt. See this IRS page for more on the mortgage-interest deduction.
Meanwhile, some credits don’t have an upper limit, Luscombe said. The residential energy-efficient property credit for installing solar, wind or geothermal systems is worth 30% of the amount spent — whatever that amount is.
But don’t confuse that credit with the one for home energy-efficient upgrades, such as new windows and doors. That credit was worth up to $1,500 in 2010 but lawmakers reduced it for 2011, in the Tax Relief Act passed in December.
Other credits have a top limit, but it’s hefty: The adoption tax credit is worth up to $13,170 in 2010, up from $12,150, and it’s now refundable. Read more about the adoption credit on IRS.gov.
Almost Half of Taxpayers Don’t Owe Federal Income Tax
Taxpayers may enjoy the bounty, but these deductions and credits — plus other tax breaks that never show up on our returns, including those we get through 401(k), Roth IRA and 529 plans — all add up to a lot of money the U.S. government is not collecting.
While the definition of what should be counted as a so-called “tax expenditure” varies, “by any measure, the revenue losses from tax expenditures are large,” according to a Tax Policy Center report, co-authored by Eric Toder.
“Adding up all the tax expenditure estimates in the 2010 federal budget, we calculate a sum of about $1.1 trillion in fiscal year 2012, or about 6.7% of projected gross domestic product.” Read the report.
That’s a lot of tax breaks.
“Our tax system is such that for 2010 we estimate 45% of American households will pay no income tax, because of the combination of credits and deductions and so forth,” said Roberton Williams, a senior fellow at the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution in Washington.
And that includes high-income people, he said. For instance, recent IRS statistics showed that about 2,000 people with income of $1 million or more don’t pay income tax, Williams said. “A part of it is that money is earned overseas and is subject to foreign taxes; a part of it is they have a lot of money in tax-exempt bonds so they don’t pay tax on that income,” he said.
“For one reason or another these very, very wealthy people have set up their financial situation in such a way that they avoid U.S. federal income taxes entirely.”
Keep in mind that some of the largest tax expenditures don’t show up on your tax return. For instance, the value of employer-provided health insurance isn’t counted as income for most taxpayers.
Few Deductions Available to Some Taxpayers
Still, for his clients — most of whom are high-net-worth retirees who’ve paid off their home mortgage — deductions can be hard to tap, said Rial Moulton, a certified financial planner and certified public accountant in Spokane, Wash.
For a married couple filing jointly, the standard deduction in 2010 is $11,400, and it’s $5,700 for a single filer. “To think about itemizing, you have to have [deductions that total] more than that,” Moulton said. “For most people in our area, if you have your house paid off, it’s hard to get above that number unless you have significant health-care costs.”
Meanwhile, for taxpayers at a lower income level, one of the most valuable deductions is the earned income tax credit, worth as much as $5,666 for those with three qualifying children in 2010. For a family with three children to be eligible, AGI can’t exceed $43,352 for head-of-household filers and $48,362 for married-filing-jointly filers. Read this IRS page for more information.
There’s also a saver’s credit, worth up to $2,000 for married-filing-jointly couples and up to $1,000 for single filers, but that maximum credit phases out as income rises. And the maximum adjusted-gross-income limit to get any of the credit is $55,500 for married-filing-jointly filers and $27,750 for single filers. See this IRS page for more information.
Andrea Coombes is MarketWatch's personal finance editor, based in San Francisco.