What if you realized that a small amount of tax knowledge could save you from unnecessarily paying hundreds, if not thousands of dollars in taxes? How much faster could you reach your financial goals?
With tax deductions, you can lower your tax bill and keep more of what you earn.
Conscientiously managing your investments for tax efficiency and gaining the knowledge you need about individual tax write-offs can ultimately mean the difference between arriving at your financial goals a decade early or never getting there at all.
To help you reduce your tax hit and enhance your after-tax returns, check out these often-overlooked tax deductions and make sure you aren’t missing any of them.
What is a tax deduction?
Tax deductions are expenses incurred during the course of the year that the taxpayer can deduct from their gross income before the tax bill is calculated. By deducting expenses from your pre-tax income, you lower your total taxable income – and pay fewer taxes. Deductions are often called “tax write-offs” because you “write them off” of your total income.
Taxpayers have the option of taking a standard deduction or itemizing their deductions. The standard deduction is a set amount that every taxpayer is allowed to claim each year. This year, the standard deduction is $12,400 for singles and $24,800 for married couples filing jointly. However, many people can save more money by itemizing their tax deductions. Tax deduction examples like mortgage interest and charitable donations can really add up – and investors can save even more.
What can I claim on my taxes?
Taxpayers who choose to itemize tax deductions have many options. Some tax deduction examples are more well-known than others, so it’s vital to familiarize yourself with the tax write-offs that may be available to you. Here are six tax deduction examples to think about.
Tax deduction #1: Retirement plans
One of the smartest moves you can make as an investor is investing in a way that allows you to defer your taxes. And one of the best ways to do that is through retirement funds.
With tax-efficient retirement accounts like IRAs and 401(k)s, all contributions are tax-deductible (though are subject to income limits). Investing in these accounts also allows you to grow your money tax-free, providing you with maximum compounded growth for the expansion of your Freedom Fund!
While you can claim tax write-offs now, you will eventually still have to pay taxes on your investments. But the whole idea behind retirement funds is that by the time you are ready to make your withdrawals, you will be in a much lower tax bracket than you are now. Besides, the money you save in income tax and the money you create through tax-free compounding is almost guaranteed to offset the taxes you’ll pay at that point. And don’t forget the importance of sleeping soundly, knowing that you are taking care of your future self by saving and planning wisely.
Tax deduction #2: Investment interest
Back in 1986, the IRS stopped allowing Americans to deduct personal interest, like credit cards and car financing. But one of the key tax deductions it still allows has to do with investment interest. This is any interest paid on money you borrow to make an investment. So what can you claim on your taxes? In any given year, you can deduct up to the amount you earned in investment income. But as a bonus, any leftover interest expenses can be carried over for future use, without expiration
Say you have an account with a financial advisor. You then decide to borrow money to purchase more stocks. Your financial advisor will charge you margin interest. This interest is considered investment interest and is tax-deductible. Another example is when you borrow money to purchase property for investment purposes. Any interest you pay on that loan is considered investment interest, and again, is tax-deductible.
Remember that the deduction can only apply to interest on money borrowed to make an investment that you expect to provide you a return. You cannot deduct interest if you are making an investment in a product or piece of property that only produces non-taxable income, like a tax-exempt bond.
Tax deduction #3: Capital losses
Believe it or not, there is an upside to capital losses. If your capital losses exceed your capital gains, you can actually use your losses to offset your gains, or even a portion of your everyday income, reducing your taxes and increasing your overall savings.
There are short-term sales and long-term sales. Each is netted separately to determine whether or not you have short-term gains or losses and long-term gains or losses. These net gains or losses can then be netted together to produce the final result. If you have an overall net loss, the IRS allows you to deduct $3,000 of that (or $1,500 if you are married and filing separately) on your tax returns. Any remainder can then be applied to offset future capital gains.
Let’s look at an example of this tax deduction. Larry has a short-term gain of $2,500 and a short-term loss of $1,000. This makes for a net short-term gain of $1,500. Larry also has a long-term gain of $3,000 and a long-term loss of $8,000. This makes for a net long-term loss of $5,000. When we net Larry’s net short-term gain of $1,500 against his net long-term loss of $5,000, we see that he ends up with an overall net loss of $3,500.
The IRS allows Larry to deduct $3,000 (or $1,500 were he married and filing separately) of his overall loss against any kind of income, including his salary and interest income. Any amount of capital loss exceeding that threshold, which in Larry’s case is $500, can then be carried over to subsequent years and deducted against future capital gains.
Tax deduction #4: The 20% pass-through deduction
If you conduct your business or investments through a “pass-through entity” like an LLC, S-corp or limited partnership, you may be able to take advantage of a new tax write-off created by the Tax Cuts and Jobs Act of 2017. Section 199A, or the pass-through deduction, allows these taxpayers to deduct 20% of their qualified business income on their personal tax return.
The pass-through deduction applies only to joint filers who earn $315,000 or less and single filers who earn $157,500 or less, and does not apply to corporations or employee income. However, it’s a useful deduction for many small business owners and investors, such as real estate investors who earn income through an LLC.
Here’s an example of this tax deduction: Sharon owns and manages rental properties through an LLC. After expenses and other deductions, the LLC made a net income of $140,000. Sharon can take 20% of that income, or $28,000, and use it as a tax write-off on her personal taxes.
Tax deduction #5: Medical expenses
Health care isn’t cheap, especially if you’ve had unanticipated injuries or illness in the past year. The good news is that there is a tax deduction for medical expenses. For the tax year 2019 (the taxes you are filing in 2020), you can claim expenses that exceed 7.5% of your adjusted gross income, that is, your income after deductions and credits. For the tax year 2020, that will rise to 10%.
Let’s say Stewart has an adjusted gross income of $84,000. He can deduct any medical expenses over $6,300, or 7.5% of $84,000. Stewart paid $9,500 in medical expenses. That means he can deduct $3,200 on his tax return, or the amount exceeding $6,300.
What can you claim on your taxes in this case? Expenses like preventative care, surgeries, vision and dental care, prescription medications, glasses, contacts and hearing aids all count toward your medical expenses. In addition, if you paid for your own health insurance premiums out-of-pocket (like self-employed individuals do), you can deduct those payments. If you get health insurance through an employer, your premiums aren’t eligible for this tax write-off, but you can still write off the other expenses listed above.
Maximizing your income takes ingenuity, focus and, most of all, knowing how to play the game. With an understanding of tax deductions, you can find ways to create value even during a loss – and you’ll have the chance to create economic value in ways you never thought possible.
