Tax Miniseries 2016 - Part 2 — Financial Follies

Tax Miniseries 2016 index:

Things Single Tax Filers can do to find tax breaks
Lowering taxable income
Common overlooked tax deductible items
Common deductions that may trigger an audit
How marriage may impact taxes and returns
Using tax software vs a tax preparer
The importance of documenting all sources of income

The easiest and most common way to get a tax return is through a deduction on your taxes. A deduction is simply the lowering of your taxable income by a certain amount based on your tax bracket. Not to be confused with a credit, which is a dollar for dollar reduction of your income tax liability.

For example, if a person is in the 25% tax bracket and receives a $1,000 tax deduction they only receive a $250 tax reduction (0.25 x $1000 = $250). However, if that same person received a $1,000 tax credit that same person would receive a $1,000 tax reduction.

As widespread as tax credits are, they phase out for many people as income increases and situations change. For this reason, tax deductions begin to become safe havens for many tax payers looking to keep more of their money. The downside to deductions are that you must have enough of them to truly make a difference at tax time. Many filers attempt deductions but don't see a change because they run into the common issue of itemized deductions being lower than the standard deduction.

The standard deduction is a fixed dollar amount set annually (by the IRS) that gets subtracted from a filer's AGI (adjusted gross income).

Below are the standard deductions for the 2015 tax year:

$6,300 for single
$12,600 for married filing jointly
$6,300 for married filing single
$9,250 for head of household
$12,600 for qualifying widow(er)

For a single filer, to itemize deductions your itemized deductions must be greater than the standard deduction to see a benefit. In other words, the items that a filer is claiming for deduction must be greater than $6,300. For most people without property or very expensive medical expenses this is out of reach and is why property is recommended for itemizing. For instance, suppose a filer paid $7,000 in mortgage interest and $2,000 in property tax and is in the 28% tax bracket. That filer could reduce their taxable income by about (($7000 + $2000) x 0.28 = $2,520) $2,520. That could be enough to bump a person down a bracket or at least make a significant difference in a refund check. There are several ways to find deductions such as charities, small businesses and moving that should be reviewed as well. Just keep in mind that lowering your taxable income by deduction is much different than taking a tax credit.