Tax season is upon us and with it comes the search for deductions. Deductions allow us to reduce that tax bill a little, which in turn either increases our tax refund or decreases the amount we pay. In short, deductions lead to money in your pocket.
Here are five common deductions that people unknowingly skip, especially if they're filing taxes on their own.
State income tax or sales tax. If you live in a state where there is state income tax, you can deduct the amount you paid in state income tax over the tax year.
But what if you live in one of the seven states that don't have state income tax? In those states, it's worthwhile to save your receipts, because you can deduct your sales tax from the year. Over the course of a full year, that can wind up being a sizable amount.
If you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming, it's time to start saving your receipts -- all of them!
Lifetime learning. Going back to school to further your education can enhance your employment opportunities. For most people, however, the expense keeps them from making that choice. One big factor to keep in mind is that the tax man will actually relieve some of the burden of returning to school.
The Lifetime Learning Credit enables you to save up to $2,000 on your tax bill if you have educational expenses from an accredited institution. For example, if you're taking an evening class or two to work toward a degree, you can use the credit to save money on your tax bill.
How does it work? You can take 20 percent of your educational expenses as a credit on your taxes up to a total of $10,000 in eligable educational costs. So, if you have $5,000 in expenses, the credit is worth $1,000.
Job search costs. Struggling to find employment throughout the year? You can deduct the costs of related job search expenses that exceed 2 percent of your annual income. Let's say you earned $15,000 this year and spent $500 in fuel, travel, printing and mailing expenses during your job search. That translates to a $200 deduction on your taxes.
This is a particularly valuable credit for people who are actively searching for work but have spent much of the year unemployed due to a difficult job market. There are a few restrictions (aren't there always?) the IRS spells out in this useful summary. The biggest catch is that you can only use the deduction if you're staying within the same field of work.
Mortgage points. When you take out a mortgage on your home, you're often given the opportunity to pay "points," which is an upfront fee equal to a percentage of the value of your mortgage. Doing so results in a reduced interest rate over the life of your mortgage.
The value of "points" is debatable and has a lot to do with how long you intend to live there and how fast you plan on paying down your mortgage, but if you decide to pay a point or two, the amount you paid is tax deductible. This can be a very nice boost for homeowners who plan on staying in their house for a long time.
Often, lenders will give you the opportunity to purchase a 0.25 percent reduction in interest rate in exchange for paying 1 percent of the value of the mortgage upfront. For example, if you're borrowing $200,000 for your mortgage, you might pay $6,000 upfront to reduce your interest rate from 5 percent to 4.25 percent. That rate reduction will drop your monthly payment from $1,073.64 to $983.88 over the course of a 30-year mortgage. You'd have to stay there for 60 months to make it worthwhile, but if you also consider that the $6,000 is tax deductible, you're probably breaking even at around the 50-month mark. It's money in your pocket.
Reinvested dividends. If you're investing your money with a passive "buy and hold" strategy, you're likely just reinvesting your dividends. However, that means you're paying taxes on those dividends at the end of each year.
So, where's the savings? The savings comes when you're actually selling all those investments. Many people tend to forget about the reinvested dividends when calculating their capital gains on those investments.
For example, let's say you invested $100,000 over the years into an investment that's now worth $200,000. That would mean your taxes would be based on that $100,000 difference. What if, along the way, you reinvested $20,000 of your dividends? That would help you save even thousands of dollars more on taxes. For guidance, a financial advisor can help you calculate how your reinvested dividends might affect your taxes.
There are so many deductions out there that even the best tax advisor might miss one or two. It's worthwhile to be aware of some of the big ones, as they can save you some real money on your tax bill.
Trent Hamm is the founder of the personal finance website TheSimpleDollar.com, which provides consumers with resources and tools to make informed financial decisions.
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