TAX TIME
Guess what time it is?
! It's TAX TIME! Do I sound excited? Uh, no. I am not jumping up and down and I am not smiling; I am mostly just wondering how and why it always seems to be tax time. This year may be a bit more confusing than usual--is that even possible?--due to the government stimulus program. I have attached an article about it and if you read no others, you will want to take a closer look at that one, as it may very well affect you.
Even without extras, taxes are complicated. As a friend recently whispered to me, she was not quite sure what the difference was between tax deductions and tax credits. I am not sure if she was speaking so softly because she felt like she should know this or because she was concerned that the all-knowing IRS was listening in on our conversation. So, for her benefit and yours, read on to learn more about deductions and credits:
TAX DEDUCTIONS:
A tax deduction reduces your taxable income, i.e. the amount of your income that is taxed by the federal government. By lowering your taxable income, you can potentially reduce the amount of tax you have to pay for a given year. The most common type of deduction is the standard deduction. This is adjusted each year and is based on your filing status (for example, your marital status, age, etc.). Not everyone is eligible for the standard deduction, so it is wise to speak with a professional before filing. According to the IRS, you are NOT eligible for the standard deduction if you are:
An individual who chooses to itemize their deduction (when your eligible deduction is listed and added up, one by one).
A married individual who is filing separately but whose spouse itemizes deductions.
An individual who was a nonresident alien or dual status alien during the year (there are exceptions that may apply).
An individual who files a return for a period of less than twelve months due to a change in their annual accounting period.
An estate or trust, common trust fund, or partnership.
There are other types of deductions:
Health Savings Account
Health Savings Account, or HSA (a tax-free savings account that can be used to pay for medical expenses not covered by high-deductible health plans).
a.) Traditional IRA contribution
b.) Charitable contribution
c.) Mortgage interest
d.) State and local tax
TAX CREDITS:
A tax credit lowers your tax liability. For example, if you owed $10,000 in taxes and had a $2,000 tax credit, your bill would be lowered to $8,000. While a tax deduction is tied to your income tax bracket, a tax credit is not. There are two different types of tax credits:
Nonrefundable:
This reduces the amount of taxes you owe up to the amount of the credit. Any unused portion of the credit will not be refunded to you. So if you qualify for a $1500 credit but only owe $500, the $500 will be applied as a credit but the extra $1,000 will not be returned to you. A foreign tax credit (used to offset income taxes paid abroad) and an adoption tax credit are only two examples of nonrefundable credits.
Refundable:
In this case, any unused portion of the credit will be returned to you. Looking at the example above, if you qualified for a $1500 refundable credit and only owed $500, the remaining $1,000 would be returned to you. An example of this type of credit is the Earned Income Tax Credit, or EITC (tax credit for workers with low to moderate income).
Overview
While this is a simple overview, keep in mind that tax deductions and credits are subject to eligibility requirements and documentation is required. They are also subject to change, so be sure to keep good records (this is not the time to be tossing receipts into a box and stuffing it under the bed), and consider giving us a call and allowing one of our tax experts to help you get the most out of each dollar you earn. Contact us soon, as April 15th is right around the corner and done correctly, you will be able to jump up and down, even though the taxman cometh!
Final thought
In addition to the article on taxes and Covid relief, I have included one on Reverse Mortgages, which may be of interest to you. Please do not think of the Reverse Mortgage of old; for many, this can be a valuable tool in the retirement planning process. There is also one on the costs that come in highest for retirees. Hint: it is NOT healthcare but it IS something we are all currently facing, retiring or not.
Warmly,
Kimberly Wolf and Your Team at Pacific Financial Advisors