Federal tax season is here! And with it comes a new set of opportunities to reduce your tax bill and maximize your refund.
Here’s a brief look at different tax advantages and the most common tax deductions and credits available to your family in 2020.
What is a tax deduction?
A federal tax deduction is any tax break you can use to lower your taxable income and, by extension, your tax liability. Essentially, deductions are any qualified expenses you’ve paid during the year that the IRS allows you to subtract from your individual gross income, thereby reducing the amount of personal income subject to federal income tax.
Tax deductions provide a legal means by which to reduce your end-of-year tax bill. The right application of 2020 tax deductions can result in significant tax savings for you and your loved ones, ensuring your family faces the lowest tax burden possible.
What are tax credits?
Tax credits are legally available ways to reduce your state and federal income tax liability on a dollar-for-dollar basis. Any credits you qualify for are applied to the amount of tax you owe rather than to your gross or taxable income, providing an effective way to lower your tax bill and (potentially) increase your federal refund.
Tax credits are considered tax incentives in that they’re usually designed to reward a certain type of behavior, including activities that may benefit the economy, environment or any other purpose deemed important by the federal government. Each tax credit comes with an explicit set of requirements you must meet before you qualify.
What is the difference between tax credits and tax deductions?
While both tax credits and tax deductions can result in lowered tax liability, each is unique in how it is applied and the impact it may have on your federal tax liability.
For example, tax credits:
- Are dollar-to-dollar reductions
- Are applied only to your federal tax balance (what you owe)
- Can be refundable (increasing your tax refund) or nonrefundable (affecting your tax liability only)
Whereas tax deductions:
- Are used to reduce how much income is subject to tax
- Have no direct impact on your federal refund
Knowing the distinction between credits and deductions can provide a clearer picture not only of how tax breaks work, but also which advantages work best for your 2020 tax situation.
Common 2020 tax deductions and credits
Some of the commonly used tax deductions and credits in 2020 include:
Charity tax deductions
Cash and property donations to charities and other qualified organizations can often be used to lower your federal tax burden. In many cases, you can deduct up to 60% of your adjusted gross income on your 2020 return.
Child tax credits
The nonrefundable Child Tax Credit and Additional Child Tax Credit can provide significant tax savings to taxpayers with qualifying children or dependents. The amount you’re eligible for depends largely on your gross income and tax rate.
Disability tax credits
If you’re 65 or older, or are unable to work due to a permanent and total disability, you may qualify for the Credit for the Elderly or the Disabled. This credit ranges between $3,750 and $7,500, depending on your income.
Education tax credits
Popular education tax credits like the Lifetime Learning Credit (LLC) and American Opportunity Tax Credit (AOTC) can help reduce the costs of higher education and may help increase your federal tax refund.
Electric car tax credits
If you purchased an electric vehicle in 2019, you may qualify for as much as $7,500 in tax credits on your 2020 tax return. Learn if your new car qualifies for the Electric Car and Vehicle Tax Credit and how much you may be eligible for here.
Federal solar tax credits
Did you install solar panels on your home last year? Going green in 2019 may have qualified your household for the Federal Solar Tax Credit, allowing you to deduct up to 26% of the total installation and equipment costs on your federal return.
First-time homebuyer tax credits
While the federal first-time homebuyer tax credit is no longer available, there are many states that continue to incentivize home buying through their own homebuyer credit programs. Contact your local tax pro to learn more.
IRA tax deductions
For many, contributions to an individual retirement account (IRA) are tax deductible, though the amount you can deduct depends on a number of factors. IRA deduction limits are listed on the IRS website.
Low-income housing tax credits
Though not an individual tax credit, the federal Low-Income Housing Tax Credit (LIHTC) is offered through the IRS to encourage investment in and the development of low-income housing across the U.S.
Property tax deductions
If you paid state and local property taxes on your home in 2019, you may be able to deduct up to $10,000 of that on your return total courtesy of the federal property tax deduction. If you qualify, you can claim personal real estate taxes by itemizing deductions on Form 1040, Schedule A.
Renters tax credits
The bad news? There’s currently no tax credit available to renters at the federal level. Fortunately, many states do offer renters valuable tax benefits to take a bite out of their state and local tax burden. Learn if your state offers a renter’s credit by locating your state income tax form.
Work opportunity tax credits
If you own a small business, you may be eligible for the Work Opportunity Tax Credit (WOTC), a tax reduction tool designed to encourage the hiring of workers from more vulnerable and/or disadvantaged populations.
401k tax deductions
Much like those made to an IRA, contributions to your traditional 401(k) may be used to lower your taxable income and your federal tax bill. You may deduct part of all of your 401(k) contributions depending on IRS limitations.
Want to learn more about 2020 tax credits and deductions that’ll lower your federal taxes? Visit your local Liberty Tax® pro today.