Can you really claim that deduction? Some of the tax deductions you hear about most often are actually quite difficult to qualify for. It's important to understand how these deductions work, so you don't anticipate tax savings that you won't receive. Here are the rules and limitations you should be aware of for five common deductions.

Medical and Dental Expenses
Medical and dental expenses are tax deductible, but the qualifications you must meet to benefit from this deduction are so high that most people won't meet them. That's because you can only deduct medical and dental expenses that exceed 7.5% of your adjusted gross income (AGI). Starting in 2013, that threshold will rise to 10%.

Let's look at an example of how this deduction works. Let's say your AGI, which is your gross income minus above-the-line adjustments like student loan interest, moving expenses and contributions to self-employed retirement plans, is $60,000. Your AGI is higher than your taxable income because it doesn't take into account your standard or itemized deductions or exemptions for you, your spouse or dependents.

With a $60,000 AGI, to take any deduction for medical and dental expenses you'd need to have more than $4,500 of qualifying expenses in this category. Then, only those expenses in excess of $4,500 would be deductible.

Remember, the value of a deduction is equal to your marginal tax rate, so if you had $5,500 in qualifying medical and dental expenses, you could take a $1,000 deduction. With a marginal tax rate of 25%, this deduction would save you $250 on your federal return. It would not, as some people think, save you $5,500. For more information about this deduction, consult IRS publication 502.

Tax Preparation Expenses
Similar to medical and dental expenses, tax preparation expenses are only deductible to the extent that they exceed 2% of your AGI. Assuming the same $60,000 AGI as in the previous example, your tax prep costs would have to exceed $1,200 before you could deduct anything.

If you do your taxes yourself with the assistance of tax software, you're probably spending less than $100 to prepare your taxes, and you won't get any deduction. If you hire a tax professional who charges you $2,000, you could deduct $800 ($2,000 - $1,200). Again, assuming you're in the 25% tax bracket, this deduction would save you $200. That's a mere 10% of what you paid to have your taxes prepared, and a far cry from the $2,000 savings you might have anticipated.

Job-Hunting Expenses
Like tax prep fees, job hunting expenses are only deductible when they exceed 2% of your AGI. But job-hunting expenses have another catch - you can only deduct them when you're looking for a new job in your present occupation. If you need to change occupations because your old job is no longer in demand, you can't deduct your job hunting expenses. The only good news about this deduction is that you can deduct your expenses even if you don't land a new position.

Charitable Donations
Gifts and donations to qualified charities can help you reduce your tax bill, but only if you itemize your deductions. If you take the standard deduction, you won't see any tax benefit from your charitable donations.

There are some further limits on what you can deduct in this category. If you receive any type of benefit in exchange for your donation, you must subtract the value of the benefit from your deduction. This means that, for example, if you donate $100 to a nonprofit and receive a $10 magazine subscription as a benefit, you can only deduct $90, not $100, on your tax return.

If you make a gift of $250 or more, whether it's in cash or goods, the nonprofit must supply you with a receipt stating the amount of any financial donation or a description of any donated property and whether you received anything in return. You don't have to file this statement with the IRS, but if you're later audited and you don't have it, your deduction may be disallowed and cost you money in taxes, penalties and interest.

If you donate property worth more than $500, you have to fill out IRS form 8283 providing details about your donation. The $500 limit applies to all donated property for the year, not to each donation. It's not hard to hit this threshold even if you're only donating household items like clothing and furniture.

Student Loan Interest
Student loan interest is more valuable than many other deductions in the sense that it's an above-the-line deduction. This means you can claim it even if you don't itemize. It also reduces your adjusted gross income, making it easier to qualify for deductions on medical and dental expenses, tax preparation fees and job-hunting expenses.

However, the student loan interest deduction is limited to $2,500 no matter how much you actually paid in interest that year. If you pay $1,000 in student loan interest, you can deduct all $1,000, but if you pay $3,500, you can only deduct $2,500.

But that's not all. If you make too much money, you lose this deduction. The deduction phases out when your modified adjusted gross income (MAGI) reaches $60,000 if you're a single filer and $120,000 if you're married filing jointly. Single filers lose the deduction once MAGI reaches $75,000 and married couples lose it at $150,000.

Finally, if your filing status is "married filing separately," you can't claim the deduction at all. See IRS publication 970 for full details on the student loan interest deduction.

The Bottom Line
Some tax deductions aren't as valuable as they appear to be at first glance. If you don't understand how they work, you might end up with an ugly surprise at tax time in the form of a tax bill that's higher than you expected. Read the fine print about any deduction or credit you're considering before you plan to claim it.

Related Articles
  1. Professionals

    Holding Out for Capital Gains Could Be a Mistake

    Holding stocks for the sole purpose of avoiding short-term capital gains taxes may be a mistake, especially if all the signs say get out.
  2. Credit & Loans

    Four Ways to Improve Education In America

    U.S. students place 27th in math and 20th in science out of 34 countries. The United States must reform its education system or harm future economic productivity and global trade competitiveness.
  3. Savings

    A Look at the Cost and Tax Treatment of College

    Is there more we can do to improve the affordability of post-secondary education? We take a look at how students and colleges are taxed today.
  4. Professionals

    Advisors: Warn Clients About These Audit Triggers

    There are several factors that may increase the risk of an audit, especially with high-net-worth clients.
  5. Professionals

    3 States Where Taxes Can Hammer Retirees

    Knowing which states ding retirees with the highest tax implications should be part of your retirement research.
  6. Professionals

    Best Ways to Avoid RMD Tax Hits on IRAs

    If you want to avoid hefty tax penalties, read this cheat sheet on IRA required minimum distributions.
  7. Retirement

    Top Tips for Minimizing Taxes on Social Security

    Social Security benefits are taxable under certain circumstances. Here are some ways retirees can lessen the tax burden.
  8. Professionals

    How to Help Retirees Manage Taxes on Distributions

    There are many variables when it comes to helping retirees manage taxes on distributions. Here's what advisors need to consider.
  9. Taxes

    Employers: Don't Forget IRS Form 941

    Your obligations as an employer include various employment taxes. Use this form to report them.
  10. Entrepreneurship

    What's the Purpose of IRS Form 1065?

    Business partners need the information on this form to complete their own tax returns. Here are the details.
RELATED TERMS
  1. Duty Free

    Goods that international travelers can purchase without paying ...
  2. Wealth Management

    A high-level professional service that combines financial/investment ...
  3. Directors And Officers Liability ...

    Directors and officers liability insurance covers you if you're ...
  4. Tax Deductible Interest

    A borrowing expense that a taxpayer can claim on a federal or ...
  5. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  6. Proof of Charitable Contributions

    Substantiation required by the Internal Revenue Service for a ...
RELATED FAQS
  1. What are the best free online calculators for calculating my taxable income?

    Free online calculators for determining your taxable income are located at Bankrate.com, TaxACT.com and Moneychimp.com. Determining ... Read Full Answer >>
  2. In what instances does overhead qualify for certain tax allowances?

    Businesses are just as keen as anyone else to keep their tax burdens low by any means possible. Overhead expenses often qualify ... Read Full Answer >>
  3. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  4. How are write-offs recorded on my tax return?

    The way your write-offs are recorded on your tax return varies depending on whether you are filing a personal or business ... Read Full Answer >>
  5. How is the deductible I paid for my insurance claim treated for tax purposes?

    The deductible you pay on your health insurance policy may be tax-deductible if you meet certain conditions. However, whether ... Read Full Answer >>
  6. What is the difference between comprehensive income and gross income?

    Comprehensive income and gross income are similar, but comprehensive income is a specific term used on a company's financial ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!