Taxes: How Low Can You Go? (A Primer on Tax Deductions)
"You must pay taxes. But there's no law that says you gotta leave a tip." - Morgan Stanley
Very few of us are interested in paying the IRS more taxes than the IRS is entitled to. We work hard for our money and want to keep as much of it as possible.
One of the best ways to lower our tax bills is to be aware of all tax deductions available and how they are taxed.
The Tax Cuts and Jobs act of 2017 created a high bar for some itemized deductions to count, which means you need to deduct more than the standard deduction, which stands at $25,900 for 2022.
However, be aware that there are two types of deductions that affect your taxable income in different ways:
- Above-the-line deductions
- Below-the-line deductions
Above-the-line deductions lower your taxable income regardless of the standard deduction!
Benefits of above-the-line tax deductions
These deductions are called "above-the-line" because they are deducted before your Adjusted Gross Income (AGI) is calculated. (The standard deduction OR itemized deductions are then taken from your AGI to determine your taxable income.)
The reason many people find these deductions advantageous is that they can lower their tax bill—even if they don’t have enough below-the-line deductions to surpass the standard deduction.
Above-the-line tax deductions include:
- Trade or Business Expenses: If you are a business owner, expenses that reduce the net income of your business will reduce your gross income.
- Health Savings Accounts or HSAs: $3650 (single) or $7,300 (family) maximum contributions can be deducted for 2022, with a $1,000 catch-up provision for those 55 and older
- Traditional IRAs: $6,000 of a contribution or $7,000 for those age 50 and older are deductible in 2022, subject to income phaseouts
- Moving expenses (for members of the Armed Forces) pursuant to a military order
- Educator out-of-pocket expenses up to $250
- Student loan interest: up to $2,500. (The parent or student must have taken out the loan to deduct it from their income, subject to income phaseouts.)
- Alimony paid for divorces before 2018. (Alimony from Divorces finalized in 2019 or later is not deductible.)
Below-the-line Deductions must exceed the Standard Deduction to count,
but they can be effective at reducing the taxable income—if there are enough of them.
How below-the-line tax deductions work:
Unfortunately, you cannot reduce your taxable income unless you deduct enough expenses to beat the Standard deduction with below-the-line deductions.
The good news is that many times these deductions are “baked in” to our everyday lives, and many people’s annual spending approaches the Standard deduction amount with these “below-the-line” expenses.
Below-the-line expenses are itemized on IRS for schedule A, and these include:
- State and Local Taxes (SALT): These include property taxes, sales tax, state income tax, and other local taxes. The Tax Cuts and Jobs Act limits this deduction to $10,000, much to the consternation of people living in high-tax states.
- Medical Expenses: These are only deductible if they exceed 7.5% of your AGI. (For example, if you had $100,000 of AGI, then only medical expenses exceeding $7,500 in that year would be deductible). Medical Expenses include healthcare and long-term-care insurance premiums, as well as nursing-home care when medical treatment is the primary purpose.
- Interest paid: The interest must be from a purchase or improvement of a qualified residence (mortgage), interest paid from a trade or business, or to produce income (investment interest).
- Charitable contributions: This is where a charitably inclined household can really exert control over how much they can lower their taxable income. Up to 60% of your AGI can be deducted for a cash donation, and in many cases 30% for other tangible property, if it is given to a recognized non-profit charity. Creative donation strategies like Donor-Advised-Funds and highly appreciated real and personal property can multiply the tax savings of charitable donations.
- Casualty losses: This applies in areas declared a Federal Disaster by the President and must exceed 10% of AGI.
"Few of us ever test our powers of deduction,
except when filling out an income tax form."
- Laurence J. Peter
- In addition, there are other more obscure deductions that exceed the scope of this article.
- Furthermore, the Tax Cuts and Jobs act has many provisions that affect deductions. (These will change if the provisions of the Act are allowed to expire in 2025.)
Professionals who can support you in lowering your taxes:
For help maximizing your tax savings, it can be helpful to consult with a tax professional like an accountant or tax lawyer.
A financial advisor can also help you craft a financial plan that maximizes your tax savings.
Would You Like More Support?
- Do you have a well-defined Investment Policy Strategy that is used to drive your investments in support of a comprehensive financial plan?
- If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner while focusing on your desired outcomes?
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