This article summarizes 8 important tax write-offs (credits and deductions) for individuals for the 2021 tax year. These tax write-offs are for certain expenses, losses, or investments incurred or borne by the taxpayer in 2021. Tax write-offs are a term that encompasses a variety of tax “benefits” for specified expenditures or losses incurred in a tax year. In our case – 2021.
Tax credit is a dollar-for-dollar reduction of your tax liability or refund of tax already paid. Some unique “refundable” tax credits are paid out as a cash subsidy, whether or not you owe or pay taxes.
Tax Write-offs Make a Difference
Your individual taxable income can be lowered when you take advantage of various tax write-offs. This can have an effect on what you are obligated to pay in federal taxes. In addition, when you use tax write-offs to lower your taxable income, you will put yourself in a different tax bracket, which will overall lower the amount of tax that you owe.
A tax deduction is a subtraction from your taxable income. It reduces the amount of your income that is subject to income tax. For example, if your effective tax rate is 18% then the tax you owe is reduced, not dollar-for-dollar, but by 18% of your deductible expense. Let’s take a look at some top tax credits for individuals.
Child Tax Credit
Present law provides for a refundable tax credit for taxpayers with children. The credits are dollar-for-dollar tax write-offs (offsets) against your tax liability and are refundable cash payments for taxpayers who have no tax liability. For the 2021 tax year, the credit is $2,000 for each qualified dependent child who is under age 17 at the end of 2020. A child is dependent if they do not provide more than half of their support for 2021.
Paid In Monthly Installments
The child tax credit is not only refundable, it is also paid in advance in monthly installments before the due date of your 2021 return. You must apply to qualify for the advance credit payment. The child tax credit will expire after 2021. However, a permanent extension is included in the pending legislation.
Child or Dependent Care Credit
Besides the child tax credit, you might be eligible for a credit for your child care expenses. The American Rescue Plan Act of 2021 increased the annual credit effective for your 2021 tax return to $4,000. You may be eligible for a tax credit of up to $4,000 for each qualified person, not to exceed $8,000 for two or more qualified persons.
Work Related Credit
It is a dollar-for-dollar credit for work-related expenditures–that is, expenses that allow you to work or look for work. However, you are not eligible if your adjusted gross income for 2021 exceeds $438,000. A qualified person is a dependent child under the age of 13, a spouse unable to care for him or herself, and a disabled person living with you for more than half the year.
Earned Income
For eligibility for child care credit (tax write-offs), you must have so-called “earned income”. Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment.
Home Mortgage Interest
One of the most impactful tax write-offs for individuals is the home mortgage interest deduction. Normally, interest is not a deductible expense. It is allowed for mortgage interest to encourage homeownership. You can use only the loan proceeds to buy, build, or substantially improve a dwelling that you live in. It can include a second home if you use it as a residence.
Includes Points Paid For Mortgage
Tax write-offs for home mortgage interest are for interest you pay on a loan secured by your home. It includes “points” paid to get a home mortgage. Deductible points include loan origination fees, maximum loan charges, loan discount, or discount points. Normally, points are deductible over the life of a loan. However, in most cases, home mortgages points can be deducted in the year paid.
Education Tax Credits
There are two kinds of tax write-offs as credits for education expenses. Both are dollar-for-dollar credits against your tax liability. The first is the annual American opportunity credit; the second is the lifetime learning credit.
The American opportunity credit is a dollar-for-dollar annual credit for up to $2,500 for qualified expenses, including tuition, books, and materials. The credit is limited to 4 years. It is also refundable if the credit exceeds your tax liability, but only up to 40% of your credit. Also, you are not eligible for the full credit if your income exceeds $90,000 ($180,000 if married filing a joint return).
Lifetime Learning Credits
Lifetime learning credits are also a dollar-for-dollar tax write-offs that reduce your tax liability for qualified education expenditures. The onetime lifetime credit is $2,000 for each student, which can be claimed over many years. You cannot claim the full credit if your adjusted gross income exceeds $69,000 ($138,000 if married filing a joint return).
The lifetime credit is non-refundable and can be claimed only as an offset to your tax liability. However, you can carry over the credit you don’t use until you have a tax liability to offset.
Student Loan Interest
Student loan interest is another exception to the non-deductibility of interest. Student loan interest is the interest you paid during the year on a qualified student loan. A qualified student loan is taken out solely to pay qualified education expenses of the taxpayer, spouse, or dependent.
The amount of your student loan interest tax write-offs is phased out if your adjusted gross income is between $70,000 and $85,000 ($140,000 and $170,000 if you file a joint return).
Individual Retirement Accounts
IRAs are tax-subsidized savings accounts. Contributions into one’s account are deductible. Earnings on the account are not taxable. The growth of the value of the account is not taxable until they are distributed at retirement. Effectively, you are building a retirement fund with “before tax” dollars, which is not the case with normal investments.
Over the years, the law has expanded the advantages of IRA tax write-offs. Today, there are different IRAs, including traditional IRAs and Roth IRAs, with different tax treatments. You can set up an IRA with a bank, insurance company, or other financial institution. You can now, within limits, direct the investments of your IRA.
Qualifying For An IRA
You must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or self-employment income. While IRA tax write-offs are intended for retirement savings, there now is no age limit for deductible contribution to your IRA. Your maximum deductible contribution is $6,000 ($7,000 if you are older than 50)
Distributions are taxable at the rate applicable to you. Since you will be retired, your applicable rate will normally be lower than for your working years. Distributions made before you are 591/2 are subject to an additional 10% surtax.
What are the Best Types of IRA Accounts?
There are several types of IRA accounts, including traditional, Roth and SEP-IRA. Traditional IRAs are funded with pre-tax dollars but must be withdrawn at age 70/ Distributions made before you are 59 ½ years old may also face a ten percent surcharge on top of normal income tax rates.
Roth IRAs do not have required minimum distributions however, contributions can only be made during your working life. Simpler Employer Plans or SEPs allow employees to contribute up to 25% of their salary into an IRA account through payroll deductions. Contributions reduce taxable compensation and provide a lower rate deduction than other retirement plans such as profit sharing plan.
Traditional: The Traditional IRA is the most common type of IRA. The tax benefits are received in two ways: an upfront deduction on taxable income and tax-deferred growth inside the account.
Roth: The Roth IRA is funded with after tax dollars and offers no up front tax deduction but provides greater flexibility in distributions.
SEP: The Simplified Employee Pension Plan, or SEP IRA is a retirement plan that can be established by self employed individuals or small businesses. Employees can contribute up to 25% of their salary into an IRA account through payroll deductions. Contributions reduce taxable compensation and provide a lower rate deduction than other retirement plans such as profit sharing plan.
Roth IRA’s Tax Write-Offs
A Roth IRA is one where contributions are not deductible. But the IRA assets earn income tax-free. When distributions are made, they are not taxable to the extent they represent a return of nondeductible contributions. There are only limited cases where Roth IRAs are suitable for a taxpayer.
Health Care Deductions
Medical and dental expenditures are deductible up to 7.5% of your adjusted gross income. Deductible medical care expenses include payments for the diagnosis, cure, mitigation, treatment, or prevention of disease. Dental expenses are also eligible for deduction.
You can set up a Health Savings Account and deduct An HSA may receive your contributions. Your employer can make deductible contributions and they are not taxable to you. The HSA must be held by a trustee such as a bank, insurance company, or other institution approved by the IRS.
Eligibility for an HSA is limited to taxpayers who are not enrolled in Medicare and you have only limited other coverage plans. Your maximum deduction for contributions depends on the type of your other coverage plans.
State and Local Tax Deductions
The law limits the deduction of state and local income, sales, and property taxes are deductible. Each tax is limited by applicable tables according to the taxpayer’s income. Also, they are limited to a combined, total deduction of $10,000. Taxpayers cannot deduct any state and local taxes paid above this amount.
Individual Business Deductions
Whether you are a self-employed individual or a wage earner employee, there are tax write-offs available. Most often, business tax write-offs are available to self-employed individuals. Deductible business expenses are the costs of carrying on a business for profit.
Deductible business expenses do not include personal expenses. They do not include capital costs, which means the cost of any asset that has a useful life of over one year. In that case, the deduction for capital cost is prorated and deducted over the useful life of the asset.
Ordinary and Necessary Expenses
Individuals can deduct expenditures if they are ordinary and necessary for the business, are not capital expenses, and are not personal expenses. When you can deduct business depends on whether you use the cash method or accrual method of accounting. An individual business will almost always be cash. With the cash method, you will deduct expenses for the tax year in which they are spent.
Get Expert Advice
In order to get the greatest benefit from tax write-offs, be sure to get expert advice from tax professionals. Even though they charge a fee, what they save you in tax dollars may be well worth the money you spend to receive their professional advice.