No one wants to pay more income tax than they have to. The best way to make sure you don’t overpay the IRS is to stay on top of all the tax deductions and credits that you’re eligible for. If your income was down in 2010, you got married, or had a child, you may be eligible for tax benefits that weren’t available to you before.
If you’re concerned that getting a tax refund might mess up your eligibility for any kind of federally-funded public benefit program, don’t sweat it. There’s a new rule that says refunds received from from 2010 through 2012 due to a tax credit will not be considered income for the purposes of a federal program.
Here are 7 simple ways to save money on taxes:
Tax Tip #1: Make Contributions to a Retirement Account
Funding a retirement account—like a traditional IRA, 401(k), or 403(b)—is a smart way to double up on benefits. Not only do you build wealth for the future, but you also avoid having to pay tax on your contributions. For example, if you put $200 a month in a 401(k) and have an average tax rate of 25%, you’ll save $600 on your taxes ($200 x 12 months x 0.25). In my new book, Money Girl’s Smart Moves to Grow Rich, there’s an entire chapter devoted to all the different types of retirement accounts so you can find out which type or types are right for you.
Tax Tip #2: Claim the Saver’s Tax Credit
If you contribute to just about any type of qualified retirement account and your income is below a certain limit, you can claim the Saver’s Tax Credit on Form 8880. The credit amount is based on your contributions and income—but can slash up to $1,000 off your tax bill if you’re single or up to $2,000 if you’re married and file a joint tax return. The income limits are as follows:
- $27,750 for all Single, Married Filing Separately, and Qualifying Widow(er)
- $41,625 for Head of Household
- $55,500 for Married Filing Jointly
Tax Tip #3: Use a Health Savings Account (HSA)
A Health Savings Account (HSA) is special type of spending account that you can fund when you have a high-deductible health plan (HDHP) through work or purchase one on your own. You and your employer can make tax-free contributions that are used to pay for qualified medical expenses, such as prescription drugs, visits to the dentist, and eye-glasses.
For 2011, the total of all your HSA contributions can’t exceed $3,050 if you insure yourself only or $6,150 for a family plan. If you contribute $200 per month and have an average tax rate of 25%, you’ll save $600 on your taxes ($200 x 12 months x 0.25). HSA contributions and distributions are claimed on Form 8889. There’s no deadline to spend the money you contribute and if you still have funds sitting in the account when you retire, you can spend them any way you like.
Tax Tip #4: Deduct Job Expenses
If you’re an employee who itemizes tax deductions on Schedule A, you can include most of your unreimbursed job-related expenses—such as travel, education, association dues, journal subscriptions, license fees, tools, office supplies, and uniforms—that are ordinary for your type of work. You can even deduct job search costs, like preparing a resume, employment agency fees, and travel to interviews. The total amount of job expenses that exceed 2% of your adjusted gross income is deductible. See Publication 529 for more information.
Tax Tip #5: Start a Business
A powerful way to create extra income and tax deductions is to start a business. It doesn’t matter if you’re a full-time entrepreneur or just trying to make your photography hobby profitable. Even if you end up losing money for a while, you can still deduct expenses that are ordinary and necessary for the business, like the cost of materials, storage, labor, software, equipment, and travel. Refer to Publication 535 for more details.
Tax Tip #6: Claim a Home Office
Whether you’re an employee or work for yourself, you may be eligible to deduct certain expenses that relate to the business use of your home if you itemize deductions. You can deduct a percentage of expenses—like rent, insurance, utilities, real estate taxes, mortgage interest, depreciation, maintenance, and repairs—based on the size of your office. If your employer provides an office, but you choose to occasionally work at home in the evenings, that doesn’t qualify as a home office for tax purposes. Read Publication 587 for more information.
Tax Tip #7: Claim the Earned Income Tax Credit (EITC)
The government estimates that 20% of taxpayers who are eligible to receive the Earned Income Tax Credit don’t claim it—even though it averaged $2,100 last year! The credit amount is based on how much you make and the size of your family—but you don’t have to be married or have kids to qualify. It reduces tax for workers who earn $48,362 or less and could be worth up to $5,666 in reduced taxes or a refund. Use an online tool called the EITC Assistant at irs.gov/eitc to find out if you qualify for the credit.
If you qualify to claim EITC on your federal tax return, you also may be eligible for a similar credit on your state or local income tax return. Twenty-two states, the District of Columbia, New York City, and Montgomery County, Maryland, offer residents an earned income tax credit. Learn about about states with EITC.
How to Correct a Tax Return Error
If you already filed your tax return and happened to miss a tax deduction or credit that could have saved you money, don’t worry. You can file Form 1040X to correct any errors for three years from the date of your original return or within two years from the date you paid tax, whichever is later. If you’re filing to claim an additional refund, be sure to wait until you receive the original refund. Note that you can’t file an amended tax return electronically; the IRS requires that you submit a paper return with attached copies of any forms or schedules that you need to change. If you find yourself in a situation that is fairly complicated, you may wish to use the services of a tax professional to help you find the best deductions.