Here’s ALL You Need to Know to About Tax Credits and Deductions (Maximize Your Tax Returns)

Tax time can be a very confusing and stressful time.  Most of us probably don't know about all the tax credits and deductions available to us.  

We just head over to Turbotax or other online software, fill in our details, take the standard deduction, and hope that that software will provide us with the best possible tax return.

But could you be missing out on lots of cash simply because you don’t know what deductions and credits you should be taking?

Here are the 3 things you need to know about to maximize your return:

• Above-the-Line Deductions 
• Itemized Deductions
• Tax Credits

Ok now lets dive a little deeper and look at what each of these things mean to you and your tax return. You may want to grab a drink and a few snacks cause this is gonna be one long deep dive.

~ Note:  Because we have so much ground to cover with all these deductions and credits, I won't talk about choosing the right filing status for you.  Be sure to look into this further as it can greatly affect your tax return.

What is the difference between a tax credit and a tax deduction?

Before we get into the deets, I think its best to know what deductions and credits are to be able to truly maximize your tax return.  So here’s a quick crash course.

Deductions

A deduction is a reduction in the amount of money (your income) that the IRS will consider taxable.  By taking tax deductions, you are reducing your taxable income and therefore decreasing your tax bill.

An above-the-line deduction is a deduction that is taken from your gross income.  After subtracting these deductions you will get your adjusted gross income (AGI). 

Above-the-line deductions are particularly beneficial because even if you are unable to take itemized deductions you can always take these.  

Furthermore, because these deductions determine your AGI they play a critical part in determining your eligibility for other itemized deductions and credits later.  

For the most part, the lower your AGI, the more credits and deductions are available to you and the higher those deductions will be.

Credits

A credit, on the other hand, is a direct reduction of your tax bill.  It is a dollar for dollar decrease in the amount of taxes you owe.  If you have enough tax credits you can essentially reduce your tax bill to zero.  

What’s more, if you qualify for refundable tax credits you can, not only reduce your bill to zero but past zero, meaning the government will owe you money.

Above-the-Line Deductions

Sometimes known as 'adjustments to income', here are the main above-the-line deductions you should be taking if you qualify:

Moving Expenses

Before the Tax Cuts and Jobs Act of 2017, you could have deducted your moving expenses if you had had to move for your job.  

Now, however, this tax break only applies to people who are on active duty in the military.  Hopefully, after 2025 most people will be able to deduct these again.

Educator Expenses

If you are a K-12 teacher, instructor, counselor, principal, or aide and have worked at least 900 hours in a given tax year, you are eligible for this deduction.

Qualified expenses include supplies, equipment, etc. that you buy for your classroom as well as professional development workshops you attend that relate to your subject or students.  The deduction is capped at $250 or $500 for joint filers who are both educators.

Student Loan Interest

The student must be you, your spouse, or dependent, and be enrolled at least half-time in a program at an eligible educational institution.

You may deduct the student loan interest you pay as long as your modified adjusted gross income (MAGI) is less than $75,000 if filing single, etc. or $150,000 if filing jointly.  

This deduction begins to fade out as your income increases.  See the table below.  The amount you can deduct is capped at $2,500.

In addition to regular student loan interest, loan origination fees, capitalized interest, credit card debt interest (if used solely to pay for educational expenses), and refinanced/consolidated loan interest can also be deducted. 

You cannot take this deduction if you file your taxes married filing separately and if either you or your spouse can be claimed on someone else's taxes if filing jointly.  

You cannot deduct interest from loans that you were not legally obligated to pay the interest such as federal loans that are in deferment.

*MAGI is the AGI on line 8b of the 1040 IRS form.  All numbers shown in this table are for the 2019 tax year.

Tuition and Fees

If you paid for qualified educational expenses from an eligible institution, you can take this deduction.  You will need to use Form 8917 to take and calculate your deduction.  

There is a maximum $4,000 deduction and it can be used for undergrad and graduate education.

Like the interest deduction, there is an income limit.  For single individuals, you must make less than $80,000.  For married filing jointly, you must make less than $160,000 to claim.

If you make more than $80,000 as a single filer, you do not qualify for the deduction ($160,000 for joint filers).

Business Expenses

Equipment, supplies, insurance, rent, utilities, vehicle expenses, depreciation, and miles, and even legal fees can be deducted from your taxes if you are a fee based state or local government official, reservist, disabled employee with impairment related expenses, or a performing artist.

*Regular business owners with ordinary and necessary expenses should take their deductions below-the-line (or itemized later).

Self-Employed Deductions

If you are self-employed, you can deduct ½ of your self-employment tax as well as contributions made to your SEP, SIMPLE or other qualified retirement account.  

Your health insurance premiums are also deductible for you and your family members, including children up to 27 years of age.

To deduct health insurance however, you would have had to have received income from your business or the business you have part ownership in.  

Also, if you are eligible to be on your spouse’s insurance plan at any time, those months are not deductible.

See Publication 535 for more information about Business and Self-Employment deductions.

Medical/Health Savings Account (HSAs/MSAs)

Individual contributions made to your HSA are above-the-line deductions that you should take advantage of if you can.  Use Form 8889. 

The Archer Medical Savings accounts are not used much anymore but I thought I’d include it in here anyway.  If you do have an MSA, you will need Form 8853.

Contributions to Your IRA

Contributions made to your IRA account are deductible so long as you or your spouse has earned income for the year.  These contributions are deductible up to $6,000 for people under 50 and $7,000 for anyone 50 and over.  Broker’s fees may also be deductible.

Contributions to a 501c plan will reduce the amount of contributions you can make as well as your deductions.  In addition, if you or your spouse is covered by another retirement plan at work, you may only qualify for a partial deduction if any.  

Check IRS Publication 590A for more information or check out another post I wrote about retirement accounts.

Note:  If you make nondeductible contributions to your traditional IRA, you must report it with Form 8606.

Penalties on Early Withdrawals of Savings

If you withdraw funds from savings bonds or CDs before its maturity date, you will have to pay a penalty.  As long as it is from a savings account, these penalties can be deducted from your gross income.  Early withdrawal penalties from IRAs etc. do not count.

Alimony

If you have been making alimony payments for a divorce or separation agreement made before December 31, 2018, you may qualify for the deduction.  However, if your divorce or separation agreement was made after 2018 you do not qualify for this deduction. 

This also includes people who have had their agreements changed after 2018 to state that the alimony payments are not deductible for the payer and also, not includible as income for the receiver.

~ Note:  There are some other miscellaneous deductions such as jury pay and rental property expenses.  Look over instructions for Form 1040 carefully.

Itemized Deductions

These deductions can greatly reduce your taxable income if it is greater than the standard deduction.  To be sure, you may want to do some quick calculations to check.  Itemized deductions should be written in on Schedule A of the 1040 Form.

Mortgage Interest

If you are paying for a mortgage, you are no doubt paying interest on that mortgage.  This interest is deductible on your tax return.  

And this deduction applies to loans for first and second homes and can be in the form of a 1^st/2^nd mortgage, home equity loans, and refinanced mortgages.  Points that you pay are deductible as well.

In most cases, your home mortgage interest will be fully deductible. However, there are limits depending on when the mortgage was taken out.  

For loans acquired on or before December 15, 2017, the interest is deductible on principles up to $1 million ($500,000 if married filing separately).  For loans taken out after that date, the principle is limited to $750,000 ($375,000 if filing separately).

For interest paid on seller-financed homes, you will need the person's name, SSN, and address (if you did not get a Form 1098 from them).

See IRS Publication 936 for more details.

Mortgage Insurance Premiums

This was extended for the 2019 tax year and just recently extended for the 2020 tax year as well.   *UPDATE: This will not be extended for 2022 tax year.

For those of you who have had to pay private mortgage insurance (PMI) or mortgage insurance issued by the Department of Veteran Affairs, Rural Housing, or Federal Housing Administration, you’ll be glad to hear that you can deduct this from your income.

This applies to any first or second home purchased with a loan after 2006.  If you are splitting payments with another person, only write in your portion.  Funding fees and guarantee fees are also fully deductible.

There is a limit on the amount you can deduct.  If your AGI is less than $50,000 (filing separately) or $100,000 (filing jointly), it is fully deductible. 

However, over this amount it starts to phase out until it reaches $54,500 and $109,000 for separate and joint filers, respectively.  See table below.

*Use Mortgage Insurance Premiums Deduction Worksheet to figure out how much you can deduct.

Investment Interest

If you borrowed money for an investment, you can write off the investment interest as long as it is not from a ‘passive activity’.  Money used to buy stocks, real estate, or a business are some examples that could be written off.

Receiving the money in cash excludes your from this deduction.  However, if the money is deposited into an account before it is used, the interest for the months that it was in the bank account is deductible.

There are limits on how much you can deduct.  Depending on the investment type, it can be limited to how much income you received from the investment.  Interest that you cannot deduct this year can be carried over to next year.

See IRS Publication 550 for more details.

Charitable Donations

Contributions made to qualified organizations are deductible on your tax return.  You may want to check with the organization to be sure that it qualifies.

The IRS also has a website (IRS.gov/TEOS) you can use to see if your organization is eligible and that your contributions are deductible.

Contributions are not restricted to just cash.  It can be property as well as out of pocket expenses you paid while volunteering such as buying candy to sell or ingredients to make cupcakes for a bake sale, etc.

Any amount paid back to you cannot be written off even if it is paid back as a benefit.  For instance, if you donate $50 to a charity and in return receive a $10 T-shirt, you would only be able to deduct $40.  

Also, for any cash contribution over $250 you will need to get a statement from the organization for your records.

If you donate property, such as clothes, household items, or even a car that is more than $500 in value, you will need to fill out Form 8283 and may be required to get an appraisal.

Deduction Limits

There are also limits on the amount you can deduct. Limits are sometimes determined by the kind of organization you donate to: church vs. a private non-operating foundation.  

The type of property you give can also determine these limits. For example, the deduction for your donation of a car may be limited to 20% or 30% of your AGI. 

Deductions are generally limited to no more than 60% of your AGI. However, contributions for disaster relief efforts can be up to 100% of your AGI.

Some contributions are not deductible such as contributions made to universities to get the right to buy seasonal tickets to games, political contributions, gifts made to foreign organizations, etc.

 See IRS Publication 526 for more details.

Charity Miles

Driving to and from charitable or volunteer events requires you to spend money on gas, tolls, and possibly parking.  All of which, you can deduct from your taxable income.

For gas, you can either choose to use the standard deduction rate of 14 cents per mile or calculate the actual cost for you.  The choice is yours. 

If I were you, for tax purposes, I would keep detailed notes for every volunteer activity I plan to write off.  It's good for your records and in case you get audited.

Medical and Dental Expenses:

Unreimbursed medical and dental expenses can be deducted if the amount you paid out of pocket exceeds 7.5% of your adjusted gross income (AGI).  

You may deduct insurance premiums, long-term care insurance premiums, medical exams, prescriptions, weight loss programs (to help combat an illness), and so much more.

These medical and dental expenses can be for you, your spouse, anyone whom you can claim as a dependent (child, relative, friend), and even your child or relative whom you cannot claim as a dependent on your return but whom you have supported, paying at least ½ of expenses.

If you claim self-employed deductions for insurance on Schedule 1, you must reduce the premiums you claim on schedule A by that amount.

There are limits for how much you can deduct for long-term care insurance that is based on your age.

• Age 40 or under—$420.
• Age 41 to 50—$790.
• Age 51 to 60—$1,580.
• Age 61 to 70—$4,220.
• Age 71 or over—$5,270.

Medical Miles

Medical miles are deductible for a standard mileage rate of 17 cents per mile for the 2020 tax year and 20 cents per mile for the 2019 tax year.  There is always the option to do your own calculations but adequate records must be kept.

State and Local Taxes (SALT)

Under the Tax Cut and Jobs Act of 2017, the amount of tax that is deductible is limited to $10,000 (or $5,000 if filing separately).   Any state or local tax credit you receive will reduce the amount that you can deduct. 

You may choose to deduct state and local sales taxes instead of the taxes to your income.  This is a good alternative for those states that do not have income tax.  Be aware though that you cannot choose both.

Deducting the Income Tax

If you go the income tax route, you may deduct taxes withheld during the tax year, taxes you paid that year (including estimates), and mandatory taxes paid to disability funds, unemployment funds, and family leave programs. 

You don’t need to take into account your expected refund after filing taxes nor any refunds received the year before.

Deducting the Sales Tax

If you choose to go the sales tax route, you can choose to do your own calculations of actual expenses or use the optional sales tax tables provided. 

For calculating your actual expenses, you may deduct the sales tax if it is the same as the general sales tax. You can deduct food, clothing, and medical supplies at the general sales rate even if the actual tax rate was less.  

Sales tax paid on cars are limited to the general sales tax rate if the taxes you actually paid were higher.  Keep your receipts.

For items purchased for your business, do not deduct the taxes here. Also, if you received a refund on your general sales taxes for last year, then you must reduce your actual tax amount.

State and Local Real Estate Taxes 

These property taxes are deductible from your income.  If you received a refund for these taxes that will reduce the amount you can deduct.

State and Local Personal Property Taxes 

If you had to pay taxes based on the value of your property every year, then these would be deductible.  For example, if you have to pay registration fees for your car every year, you may deduct it.

Other Taxes

Taxes paid to a foreign country can be written off here although you may want to check and see if taking the credit for this will be more beneficial.

Generations skipping tax is a tax resulting from the inheritance of money or property by grandchildren from their grandparents.  The grandparents essentially skip over their children.  This tax is deductible on Schedule A as well.

Car Interest and Fees

If you elect to deduct state and local sales tax instead of income tax, you may deduct the sales tax you paid in purchasing your car.

Casualty and Theft Losses

If you live or have property in a federally declared disaster zone, you will be able to deduct personal loss on your tax returns.  These losses also include theft and if your bank goes bankrupt and you lose the money you had invested with them.  

The losses must be more than $100 and more than 10% of your AGI before you can begin taking the deduction.

Some of the casualty losses include fires, car accidents, floods, vandalism, earthquakes, and storms.  However, normal wear and tear, damage done by pets, and car accidents resulting from your negligence are not deductible.

Limits are determined by that $100 (*disaster area losses must be reduced by $500) and 10% rule.  So with your given loss amount you must subtract out $100 and 10% of your AGI to arrive at the amount you can deduct.

To claim this deduction you need to fill out Form 4684, which will help you determine the amount of your loss.

Increased Standard Deduction: 

If you do not itemize, you can claim an increased standard deduction for your losses. To calculate simply combine your “Net Qualified Disaster Loss” with your standard deduction.

An exception to the federal disaster rule is if you have casualty gains for the tax year.  In that instance, you can reduce your gains by your losses (not resulting from a federal disaster).  But any left over gains must be used to reduce losses in a federal disaster zone.

See IRS Publication 547 for more details.

Other Itemized Deductions

There are other itemized deductions that are not used very often but include gambling losses (limited to amount of gambling wins), federal estate tax on income, losses for income producing properties, and more.

Tax Credits 

These credits are the holy grail of taxes as they directly reduce the amount of taxes you owe the IRS. You may need to fill out Schedule 3 for nonrefundable tax credits.

Earned Income Tax Credit

One of the most forgotten about credits, this credit is for people with low to moderate income.  It is refundable so even if you do not owe any taxes you can receive money back from the government.  

Check out the income limits and how the credit amount varies with the amount of children you have below.

See EITC IRS for more information.

Child Tax Credit

This credit (CTC) is available to anyone with 3 or more children.  The max credit you can receive has been increased to $2,000 per child.

A qualifying child is a son, daughter, step child/sister/brother, foster child, adopted child, half brother/sister and any of their children, etc. who are under 17. 

They must be a US citizen/national/resident alien, have lived with you for more than half a year, and be claimed as a dependent on your tax return.

There is a new credit for other dependents (ODC) that you may use for dependents who are not your child but whom you claim as a dependent or who do not qualify for the child tax credit.  You can take up to $500 for each eligible dependent.

There are income restrictions however, and those who make over $200,000 ($400,000 if filing jointly) cannot claim this credit.

Additional Child Tax Credit (ACTC)

If you get less than the full amount of the Child tax credit you may use what is called the Additional Child Tax Credit (ACTC) to make up for it.  

The limit for the ACTC has been increased to $1,400 per child and the income threshold has been decreased to $2,500.  So you only need to make more than $2,500 to take this.

You cannot claim the ACTC if you are only claiming the ODC.  You must first qualify and take the CTC.  The ACTC is a refundable credit while the CTC and ODC are not.

Form 8862 (if you have been disallowed) as well as Schedule 8812 may be required.

See Publication 972 for more information.

Child and Dependent Care Credit

If you are paying for the care of your child (under age 13), a disabled spouse, or other disabled dependent that lived with you more than half the year, then you can claim this tax credit.  

Even if you cannot claim your child due to a divorce agreement you can still claim this credit.

You must have earned income to claim this credit however.  And generally, married couples must file jointly to claim this credit unless legally separated.

The amount of the credit you receive will be dependent on your adjusted gross income (AGI) and the work-related expenses you have.  It is also limited to the amount of income either spouse earned that year.  

So if one spouse only makes $1000 that year, you can only take $1000 credit.

The limit for this credit is $3,000 for one qualifying dependent and $6,000 for two or more.

See Publication 503 for more information.

Saver’s Credit

This is a credit reserved for people who contributed to a qualified retirement savings account including your ABLE (Achieving a Better Life Experience) account.  

You cannot take this credit if you are a student and were enrolled full-time at any time during the year, are under 18, and/ or can be claimed as a dependent.

Eligible Retirement Accounts:

Depending on your AGI, the amount of your credit can be up to 50% of your contributions.  However, it is capped at $1,000 ($2,000 if married filing jointly).

See Instructions for Form 8880 for more details.

American Opportunity Credit

This credit is available to you if you paid expenses for you, your spouse, or your child to attend an educational institution.  You may be eligible to claim up to $2,500 per eligible student for these expenses.  

Furthermore, 40% of this credit is refundable. The credit begins to phase out (for 2019) if you make between $80,000 and $90,000 ($160,000 and $180,000 for filing jointly)

You may use it for undergrad and graduate studies and must be enrolled at least half-time in a degree program.  To claim this credit you should have received Form 1098-T from the educational institution and will need to complete Form 8863 (and possible 8862 as well).  

Some institutions are not required to give you a 1098-T so you may be able to file without one.

You cannot take this credit if you are married and filing separately, if you can be claimed as a dependent, if you make more than $90,000 ($180,000 if filing jointly) or if you have felony drug convictions.  

The credit is also limited to four years including the years you claim the Hope Scholarship Credit.

Hope Scholarship Credit

This credit is available to undergraduate students attending a qualified educational institution and is used to offset qualified expenses.  It is specifically for students who are otherwise ineligible to receive scholarships and grants.  

And it is limited to the first four years of undergraduate education.

You may claim up to $2,500 for this credit.  For Gulf Opportunity Zone students the limit is $3,600.  Rules and restrictions are much like that for the American Opportunity credit. 

I believe it has pretty much been absorbed by the American Opportunity Credit.

Lifelong Learning Credit

Much of the same rules apply as for the American Opportunity credit. This credit however is nonrefundable and there is an annual limit of $2,000 for this credit.  In calculating the credit it is 20% of the qualified expenses you paid.  

So if you only paid $5,000 in qualified expenses, the max credit you can receive is $1,000.  Your income can also limit the amount of the credit.

The main difference between the Lifelong Learning Credit and the American Opportunity credit is that this credit can be used for specialized study to improve or acquire job skills and it is not limited to just 4 years.  It is even available to people with felony drug convictions.

Also, unlike the American Credit, this credit is limited to the expenses you paid directly to the educational institution.

Phase out for 2019: If your income is between $58,000 and $68,000 ($116,000 and $136,000 for filing jointly)

Net Premium Tax Credit

This is a refundable credit designed to help low income families pay for healthcare insurance.  The insurance must have been purchased through the Marketplace.  Any credit you receive is based on a sliding scale that relies on your income (AGI).

To be eligible to receive this credit your income must at the federal poverty line or up to 4x the poverty line for your family size.  You can get an advance on this to help offset payments directly.

Residential Energy Credits

If in the past year you installed solar panels for electricity or water heating, small wind energy systems, fuel cell systems, or geothermal heat pumps to your home(s), you may be able to take this credit.  

You may also be able to take this credit for any home improvement that meets energy efficiency requirements.

There are two parts to this credit: The Residential Energy Efficient Property Credit and the Nonbusiness Energy Property Credit.  The last one only applies to existing homes and not homes being constructed.

Residential Energy Efficient Property Credit

For the Residential Energy part you may be able to deduct up to 30% of the costs, including labor.  For fuel cells, it’s limited to $500 per ½ kilowatt of capacity.  

Also, if costs were shared between you and another person, you will need to split the costs that you can claim appropriately.

In addition to that, for the residential energy portion costs are restricted to $300 for any energy efficiency system, $150 for any qualified boilers, and $50 for advanced air fans. These are the max costs you can use in calculating your credit.

Nonbusiness Energy Property Credit

For the Nonbusiness Energy part, you may be able to claim 10% of the amount paid for the energy efficiency home improvements.  This can be in addition to the amount you claim for the Residential Energy credit.

The nonbusiness energy credit however has strict credit limits: a combined credit of $200 for windows and a combined total tax credit of $500 ($1000 for filing jointly) for all tax years after 2005.  

You will need to complete Form 5695 to calculate and claim your credit.  It may be possible to carry forward any unused portion of the residential energy efficiency credit.  However, any subsidy received for making the installation reduces the cost that you can claim

Alternative Motor Vehicle Credit / Electric Car Credit

This tax credit can only be claimed by the original purchaser of the hybrid vehicle.  And it must be purchased after 2006.  The full deduction amount is only available for a limited time sadly.  Use Form 8910.

If you purchased an electric vehicle, you can use Form 8936 to claim a credit so long as you are using the vehicle in the US and are the original owner.  

Similar to the alternative motor vehicle credit, this credit will began to phase out after 200,000 of such vehicles are sold.  The credit is limited to $7,500.

You cannot claim both credits.

There are also credits for alternative fuel vehicles and electric vehicle passive activity.

Foreign Tax Credit

If you had to pay taxes in a foreign country or US possession and have to pay taxes in the states, you may qualify for this credit.  You do have the option to take it as an itemized deduction so it's best to check and see which option gives you a better return.  Although, probably, taking the credit will be best.

You cannot take the credit if you decide to exclude your foreign earned income, which you can do with Form 2555 if your income is below $107,600 for 2020 and you live in a foreign country.

To take this credit you must fill out Form 1116.  There are exceptions however and you may not be required to use that form.  Be sure to read the instructions on the form carefully.

Adoption Credit

You may take this credit as well as exclude any employer provided benefits for the expenses you paid in the adoption of an eligible child.  

These expenses can include adoption fees, attorney fees, court costs, travel expenses (including meals and lodgings), and re-adoption expenses for a foreign child.

The maximum credit and exclusion you can take is $14,080 per child.  But you cannot take both for the same expense.  Use Form 8839 to determine how much you can exclude or credit you can take.

This credit begins to phase out if your AGI is more than $211,106.  If you earn more than $251,160 you cannot take the credit (for 2019 tax year).

Other Credits

• Credits for the Elderly or Disabled
• General Business Credit
• Credit for Alternative Minimum Tax payers
• District of Colombia, first-time home buyer credit (only if purchased before 2011)
• Holders of Tax Credit Bonds

All in All

With so many tax credits and deductions out there I know it can be overwhelming.  It is easy to just skip learning about taxes yourself and just hand it over to some software or program to do it for you.  

But knowing your options can really help guide how you spend your money and what you spend your money on.  Knowledge is powerful but only if you put it to work.

Good Luck with your taxes!