Tax Deductions to Start Thinking About Now
Unlike most people, I love taxes. In fact, I enjoy taxes so much that one of my first posts as a Wise Bread writer was I Love Tax Season, and Why It's Like Christmas. So before we get too close to Christmas — and hence the end of the year — it's important to begin thinking about taxes.
Specifically, what tax deductions should you think about now, so you aren't left scrambling on December 30th?
Here's my three-step process to determining which tax deductions to start thinking about now. Do note, though, that tax laws may change before the end of the year. Always consult a tax advisor if you are planning on making any major changes to your finances based on this information. (See also: How to Hire an Accountant)
Determine: Will You Itemize?
Many people don't need to even think about most tax deductions. For most people, whether they donate money to charity on December 31st or January 1st won't affect their taxes. That's because most people don't "itemize" their deductions. That is, the vast majority of Americans take a standard deduction and don't individually compute all the smaller deductions that they might otherwise be able to take. If you take the standard deduction, you don't need to think about all that many deductions (see the exceptions in the next section).
So how do you know if you'll itemize next year or not? Look at this past year's return. Now ask yourself, "Have I had any major life changes in the past year — bought (or sold) a house, increased or decreased my income, gotten married or divorced, started or graduated school, had a baby?" Many major life changes will affect your filing. But if you haven't had any major life changes during this year, chances are that you you will file the same way you did last year. You should simply consult last year's return and see if you filed a Schedule A.
Regardless of Whether You Itemize: Consider These Deductions
Only a handful of deductions are considered "above the line" deductions. You can take these deductions regardless of whether or not you itemize. So, no matter whether or not you itemize (this means YOU as everyone who pays taxes will either itemize or take the standard deduction), start thinking about these deductions. If you can afford you pay more into these categories now, you'll save more tax dollars next year.
As a "qualified educator," you can deduct up to $250 for unreimbursed expenses that you incurred for classroom materials. See the IRS educator expenses page for more information
Health Savings Account
Unlike flexible spending accounts, health savings accounts (HSAs) rollover from year to year, and you can even take them with you when you leave your job. So, if you have extra money and anticipate higher-than-usual health care expenses in the next few years, up your contributions this year. More information is available in IRS Publication 969.
If you currently pay alimony, consider prepaying part of next year's alimony. Just be sure to consult your dissolution agreement and lawyer if you wish to do this.
If you contribute to an IRA (but not a Roth IRA) you can deduct your contributions from your taxes. (Most people do this through a plan at work.) The IRS's Deduction Limits page directs you to all the current IRA limits depending on your situation, but the most important thing to know is that if you have extra money this year, you should save more for retirement. You'll thank yourself later.
Tuition and Fees
If you are currently in school, you may be able to prepay next semester's tuition and take the tax break sooner rather than later. Check with your school about paying tuition early.
Student Loan Interest
If you've now graduated from school and are paying back your loans, talk to your student loan provider to find out if you can prepay a few student loan payments — you'll get to deduct the interest this year instead of next.
Personally, if I had extra money this year that I wanted to use towards lowering my tax liability, the two biggest things I would focus on my increasing contributions to my Health Savings Account and IRA.
If You Itemize, Also Think About These Deductions
If you itemized your deductions last year, pull out your tax return and see what deductions you took. There are a lot of hidden deductions or deductions that are only available if you spend a certain amount of your income on that category (like medical expenses — not all are deductible — you can only deduct medical expenses if they reach 7.5% of adjusted gross income). When you know which deduction you took last year, you'll have a better sense of what areas you may want to contribute more to by this year's end.
Here are my favorite itemized tax deductions to consider adjusting for this year.
My spouse and I have set up automatic monthly giving to charity so that our contributions to our favorite charities are spread throughout the year and the nonprofit knows they can depend on our gift. But around mid-October to early November every year we also make a list of all the other charities we want to give to and how much we can give. It's a great feeling to be able to be generous. Plus, when you itemize your taxes, every dollar you give away only costs you cents on the dollar. For instance, if you're in a 25% tax bracket, for every dollar you donate to charity it only costs you $0.75.
Just like you may be able to prepay your student loans, you should also think about making additional payments on your mortgage. If you itemize deductions, you can deduct your mortgage interest.
If you own a home and have the extra money to prepay your mortgage, there's also a chance you can prepay your property tax. However, depending on your mortgage company, your property taxes may be paid directly by the bank from an amount in escrow. (This is because you pay the bank monthly for the amount due on your property taxes and then, when property taxes are due, the bank sends the check.) So don't go sending checks to your city without first determining whether or not you pay property taxes out of pocket or through your mortgage company.
There are a whole host of miscellaneous deductions you can take. These include everything from gambling losses (but only to the extent of your gambling winnings) to losses from "Ponzi-type investment schemes" to certain legal expenses. A full list of deductions with explanations is available on the IRS website. Some of these miscellaneous deductions are subject to a 2% limit, which requires that the expenses add up to 2% of your adjusted gross income.
If you own a business and use the cash basis method of accounting, whatever business purchases you make this year can likely be deducted this year. So, for instance, if you have a conference early next year, you may want to purchase your plane ticket now, instead of waiting until the new year.
Start doing some tax deduction planning now and you'll save yourself a lot of stress around the holidays (and some money when it comes to tax time).
Which deductions are you currently planning to take?