Most taxpayers either hope to pay as little income tax as is legally possible or try to receive the most money back as a refund after filing their income tax return; however, come tax season, taxpayers who have not researched how to minimize their income taxes may end up paying more in taxes than the Internal Revenue Service (IRS) requires of them.
To reduce your taxable income or receive a larger refund, it's important to consider if you're eligible for tax deductions and tax credits and whether you should itemize when you file your income tax return. We look at each of these ways to reduce your tax bill in detail below.
- Tax credits, tax deductions, and itemized income tax returns are ways you may be able to reduce your taxable income or increase your income tax refund.
- Tax credits offset your tax liability on a dollar-for-dollar basis, but deductions are offset against your income
- You should itemize deductions if they would exceed the standard deduction and result in a lower total taxable income than if you claim the standard deduction.
Tax Deductions vs. Tax Credits
Tax credits offset your tax liability on a dollar-for-dollar basis. If a tax credit is refundable, you will receive a tax refund for all or part of the amount of the credit that exceeds your tax liability.
By contrast, deductions are offsets against your income. The tax savings from a deduction is determined by applying your top marginal tax bracket percentage to the amount of the deduction. If your marginal tax rate is lower than the percentage credit allowance, the credit will be worth more to you in tax savings than a deduction.
Conversely, if your marginal tax rate is higher than the credit percentage, a deduction would be more beneficial. Thus, the higher your income and top marginal tax bracket, the greater the tax savings provided by a deduction.
Research All Your Potential Tax Deductions
Tax deductions are qualified expenditures that can reduce your taxable income. For example, some losses and expenditures, student loan interest, and up to $3,000 of capital losses are deducted from your gross income when determining your adjusted gross income (AGI). Other expenditures, such as state and local taxes and charitable contributions, can be claimed as itemized deductions from AGI in determining taxable income. Most taxpayers tend to focus on the most well-known deductions; however, there are a number of lesser-known tax deductions that you may qualify to take.
Business Travel Expenses
If you are self-employed and have to travel away from home temporarily for your work, you may be able to deduct related travel expenses. The IRS considers travel expenses to be the ordinary and necessary expenses of traveling away from home for your business, profession, or job.
If you are an employee and must travel for your job, you can exclude your employer's reimbursement for business travel expenses from your income; however, you cannot deduct expenses for your job that are not reimbursed unless you are an armed forces reservist, qualified performing artist, fee-basis state or local government official, or an employee with impairment-related work expenses. Also, elementary and secondary school educators can deduct up to $250 per year of qualified expenses.
If you made donations to any qualified charitable organizations, the value of the items donated might be deductible. It's important that you keep all the receipts or other records as evidence of the cost or value of the donated property. Before 2020, taxpayers were entitled to deduct charitable contributions only if they itemized their deductions. In 2021, a taxpayer filing a return as single can deduct up to $300 of charitable contributions made in cash to qualifying charitable organizations and still claim the standard deduction.
A married couple filing jointly can claim the standard deduction and also deduct up to $600 of non-itemized charitable contributions made in cash in 2021. This special deduction for non-itemizers is not available for gifts to private, non-operating foundations; supporting organizations; donor-advised funds; and other organizations that do not qualify as public charities.
For 2021, taxpayers who itemize their deductions also enjoy a special allowance for cash charitable contributions. Generally, prior to 2020, itemizers could deduct cash contributions up to an amount that typically was equal to 60% of their adjusted gross income (AGI).
For 2020 and again for 2021, itemizers can deduct cash contributions to qualifying organizations for up to 100% of their AGI as itemized deductions. Non-cash contributions—and contributions to non-qualifying organizations, the same entities that are ineligible for the non-itemizer deduction—are not entitled to the increased ceiling for itemizers' cash contributions.
The IRS requires that you have written confirmation for all charitable donations. For each contribution of $250 or more, a charitable donee must provide—and you must retain—a contemporaneous, written confirmation of the contribution and its amount and value. Also, the confirmation must acknowledge whether or not you received any goods or services in exchange for the contribution.
Student Loan Interest
There are two different scenarios that may make it possible for you to deduct interest on student loans taken out to pay for tuition, room and board, books, and other qualified educational expenses. In both cases, you must be a student enrolled at least half-time in a program leading to a degree or recognized educational credential at an eligible institution.
If your parents are paying the interest on student loans in your name, you can claim this as a deduction because the IRS views this as a gift from your parents. As long as your parents do not claim you as a dependent when filing their income taxes, you may qualify to deduct up to $2,500 of student loan interest that your parents paid for you.
In addition, you may be able to deduct some or all of the student loan interest that you paid on a loan to pay educational expenses for yourself, your dependents, or your spouse. Taxpayers are eligible to deduct up to $2,500 of student loan interest. Qualified student loan interest is deducted from gross income in determining adjusted gross income (AGI).
Therefore, non-itemizers can deduct these expenses and still claim the standard deduction; however, this deduction cannot be claimed if you are married but file separately or if you or your spouse are claimed as a dependent on someone else’s return.
For 2021, the amount of your student loan interest deduction is gradually reduced (phased out) if your AGI, modified for certain foreign and other income circumstances, is between $70,000 and $85,000 for single taxpayers ($140,000 and $170,000 if you file a joint return). You can’t claim the deduction if your AGI is $85,000 or more if single ($170,000 or more if you file a joint return).
For 2022, the expected AGI phaseout for single taxpayers is between $70,000 and $85,000, for joint returns, between $145,000 and $175,000. You cannot deduct as interest on a student loan any interest paid by your employer after March 27, 2020, and before Jan. 1, 2026, and not included in your income under an educational assistance program.
Student Loan Cancellations and Repayment Assistance
There have been several changes implemented to help borrowers of student loan debt, which include favorable tax treatment, temporary suspension of payments, and loan forgiveness, depending on the type of loan.
Under the American Rescue Plan Act of 2021, the exclusion from income for the forgiveness of student loan debt for postsecondary education is significantly expanded for debt discharges after Dec. 31, 2020, and before Jan. 1, 2026. To qualify for this tax-free treatment, the loan must have been made by a qualified lender to assist your attendance at an eligible educational institution (i.e., one that has a regular faculty, curriculum, and enrolled body of students).
Loans generally are eligible for this tax treatment if made, insured, or guaranteed by federal, state, or local governments or their agencies, as well as educational institutions and certain nonprofit organizations qualifying under section 501(c)(3) of the tax code. Also, loan cancellation pursuant to governmental programs that forgive student loan debt for service in certain professions and certain employers is tax-free; however, loan cancellation in return for services rendered to an educational institution or lender does not qualify for tax-free treatment.
In addition, the CARES Act extended the tax code exclusion for up to $5,250 of educational assistance provided to an employee under a nondiscriminatory employer plan to include payments of principal or interest on an employee’s qualified education loan for the employee’s education. The exclusion applies to payments made after March 27, 2020, and before Jan. 1, 2026.
Loan Payment Suspension and Forgiveness Programs
Due to the COVID-19 emergency, the Department of Education announced that loan payments and collections on federal student loans have been suspended, with interest rates set at zero through Dec. 31, 2022.
In August of 2021, the U.S. Department of Education announced that more than 323,000 borrowers with a total and permanent disability (TPD) would receive more than $5.8 billion in automatic student loan discharges.
Teachers who have worked full-time for five consecutive and complete academic years in a low-income secondary school, elementary school, or educational service agency might be eligible for up to $17,500 in loan forgiveness on a Federal Direct Loan or Federal Family Education Loan (FFEL).
Those employed by a government or not-for-profit organization might be eligible to receive loan forgiveness under the Public Service Loan Forgiveness (PSLF) Program. PSLF forgives the remaining debt owed on Federal Direct Loans after the borrower has made 120 qualifying monthly payments under a qualifying repayment plan while working full-time for a qualifying employer.
The PSLF applies to borrowers with Direct Loans and those who have consolidated other student loans into the Direct Loan Program. Also, borrowers who have yet to consolidate can submit a consolidation application to the Direct Loan Program but must do so by the Oct. 31, 2022 deadline.
Casualty, Disaster, or Theft Losses
You may be eligible to deduct casualty losses relating to your home, household items, and vehicles if the damage is due to a disaster declared by the president of the U.S. For example, residents of Kentucky and Ohio counties who suffered losses due to severe storms, straight-line winds, flooding, and tornadoes that hit their areas beginning Dec. 10, 2021, will be eligible for tax relief. The Internal Revenue Service posts information about specific federally declared disasters whose victims may receive tax relief on its website.
You can also claim deductions for personal and business theft losses. To qualify as a theft loss, the taking of your money or property must have been illegal under state law. Special rules apply for determining the deductible amount. Generally, the deduction must be adjusted for any insurance recovery or other reimbursements.
These are many other items for which taxpayers may claim a deduction if eligible. The IRS provides special requirements for some deductions. As a taxpayer, it's in your best interest to refer to IRS publications to ensure you are eligible before claiming any of these items on your tax return.
Claim All Available Tax Credits
Credits are another way to reduce your taxable income. Check whether you qualify for any of the tax credits listed below.
Recovery Rebate Credit
In March 2021, the distribution of a third Economic Impact Payment (EIP3) to eligible individuals began. These amounts were advance payments of the 2021 recovery rebate credit. Eligible taxpayers who did not receive their EIP3 in 2021 or did not receive the full amount to which they were entitled should claim their outstanding recovery rebate credits on their 2021 tax returns.
Even if a taxpayer is not required to file a return for 2021, they must file a Form 1040 for 2021 to obtain the credit. The 2021 recovery rebate credit will reduce your tax liability for 2021 or be included in your tax refund.
As part of the crisis relief programs for the pandemic, a system of EIPs distributed as advance payments of the recovery tax rebate credit was initiated in 2020. Two EIPs were made to eligible taxpayers in 2020 and early 2021.
The first was $1,200 for single individuals ($2,400 for joint returns) plus $500 per eligible child under age 17; the second, $600 for single returns ($1,200 for joint returns) plus $600 per eligible child under age 17. All payments for 2020 have been made; any outstanding shortfall in a taxpayer’s payment should be claimed on a 2020 tax return, which may require filing an amended 2020 return.
The 2021 EIP3 differs from the earlier ones. The payment amount increased to $1,400 per person, including $1,400 for each dependent. For 2021, the category of eligible dependents broadened to include all qualifying dependents who are U.S. citizens, nationals, or residents with Social Security numbers, or, if adopted, Adoption Taxpayer Identification Numbers.
Thus, eligible dependents include college students, disabled adults, and dependent parents and grandparents in 2021. The income phaseout amounts also changed so that the 2021 credit phases out completely between an AGI of $75,000 and $80,000 for single taxpayers and between $150,000 and $160,000 for married persons filing joint returns.
In early 2022, the IRS will send recipients of EIP3 amounts a document called Letter 6475 to confirm the total amount paid during the year. Individuals can check on the status of their EIP3 for 2021 by linking to the IRS Get My Payment online tool.
Earned Income Tax Credit
The earned-income tax credit (EITC) is a refundable tax credit available to low-income workers. For 2021, the EITC can be claimed by any low-income worker with a dependent child. It is also available to childless, low-income workers who have a principal residence in the U.S. for more than half the year and who are 19 or older, specified students age 24 or older, or former foster youth and homeless youth age 18 or older. An individual who is claimed as a dependent on another taxpayer's return is not eligible to claim the EITC.
The credit percentage, earnings cap, and credit amount vary depending on a taxpayer's filing status, the number of dependent children, and their level of earned income. To be eligible, a taxpayer must have earnings but cannot have investment income in excess of $10,000 for 2021. The credit reduces the amount of tax owed on a dollar-for-dollar basis. If the amount of this credit is greater than the amount of tax that a taxpayer owes, the taxpayer may be eligible for a refund.
The maximum credits for 2021 are $1,502 for workers with no qualifying children; $3,618 for one qualifying child; $5,980 for two qualifying children; and $6,728 for three or more qualifying children. AGI ceilings apply to the EITC. For single returns, heads of household, and widowed and married persons filing separately, the maximum AGI levels per child/dependent for the EITC are $21,430 for none; $42,158 for one; $47,915 for two; and $51,464 for three or more.
For joint returns, the maximum AGI levels per child/dependent are: $27,380 for none; $48,108 for one; $53,865 for two; and $57,414 for three or more. The IRS has provided an online tool to help taxpayers calculate their EITC; the tool is expected to be updated to determine EITC amounts for 2021.
Because of the economic downturn caused by the economic crisis and lockdown, some taxpayers' incomes were lower in 2021 than in 2019 or 2020. To address this issue, the tax law permits taxpayers to elect to determine their EITC for 2021 on the basis of their 2019 or 2020 earned income if one of those years is more beneficial.
Child Tax Credit
The Child Tax Credit changes expired at the end of 2021 and weren't extended by the U.S. Congress. As a result, the Child Tax Credit for 2022 will revert to $2,000 per child under age 17 unless extended by legislation.
For 2021, the credit had been $3,000 per qualifying child and $3,600 per child under age 6. The ARPA had increased the age limit for qualifying children from 16 in 2020 to 17 in 2021. Eligible dependents were broadened to include all qualifying dependents who are U.S. citizens, nationals, or residents with work-authorized Social Security numbers.
In addition, beginning in July 2021, the Internal Revenue Service (IRS) distributed the Child Tax Credit to eligible taxpayers in advance payments on a monthly basis. Because it was fully refundable, parents didn't have to owe taxes to receive it. A nonrefundable $500 credit was allowed for certain other dependents who didn't qualify for the Child Tax Credit.
The Department of the Treasury began making advance payments of either $300 or $250 per qualifying child, depending on the child's age, on a monthly basis beginning in July 2021. Taxpayers will claim the balance of their credits on their 2021 tax returns.
The amount of the 2021 credit was reduced by $50 for every $1,000 in modified adjusted gross income (MAGI)—i.e., AGI plus certain non-U.S.-income exclusions—in excess of $150,000 for joint returns, $112,500 for heads of household, and $75,000 for other filers.
This phaseout didn't reduce the credit below its 2020 level of $2,000; however, the remaining $2,000 per child credit phased out at the rate of $50 per $1,000 of modified AGI in excess of $400,000 for joint filers or $200,000 for all other filers.
Child and Dependent Care Tax Credit
The Child and Dependent Care Tax Credit (CDCTC) is a credit that helps taxpayers cover the expenses of caring for a child who is age 12 or under as of the year's end, a disabled spouse, or a qualified dependent (collectively, child care expenses) while working or looking for work. The credit is a percentage of a taxpayer's earned income and phases out for taxpayers with AGIs above $400,000. No credit is allowed at an AGI of $438,000 and higher.
For 2021, the ARPA generally increased the amount of the CDCTC and made it fully refundable.
The rate of the credit increased for low- and moderate-income workers but decreased for higher-income ones. The changes are the same for all taxpayers regardless of filing status. For workers with AGIs below $125,000, the percentage is 50%; for AGIs between $125,000 and $183,000, the CDCTC phases out by one percentage point per $2000 (or fraction thereof) above $125,000, until it reaches 20 % at AGI of $183,000. Between AGIs of $183,000 and $400,000, the percentage remains 20%. Above an AGI of $400,000, the CDCTC phases out by one percentage point per $2000 (or fraction thereof) until it reaches 0% at an AGI of $438,000.
ARPA increased the amount of child care expenses eligible for the credit from $3,000 to $8,000 for one qualifying child or dependent and from $6,000 to $16,000 for two or more qualifying children or dependents. The amount of child care expenses that contributes to determining the credit cannot exceed the taxpayer's earned income. For married couples, the amount of expenses taken into account cannot exceed the earnings of the lower-earning spouse. Married couples must file a joint return to claim the credit.
Expenses qualifying for the credit can include the costs incurred inside or outside the home for nannies, daycare, preschool, and day camp. Expenses for a child's schooling from kindergarten onward and for overnight camp do not qualify. The credit can generally apply to payments to relatives who provide care, so long as the relatives are not dependents of the taxpayer; however, payments are not qualifying expenses if made to a spouse or dependent; a parent of a child being cared for, if the child is the taxpayer's child; or a child of the taxpayer who is 18 or younger, whether or not a dependent.
The 2021 enhancements to the CDCTC apply for one year only. Unless extended by Congress, the CDCTC for 2022 will be nonrefundable and revert to its prior rules: lower expense ceilings, a 35% rate for AGIs under $15,000, and a phaseout to 20% at an AGI of $43,000.
Adoption Credit or Exclusion
Taxpayers who adopt a child under age 18 or a disabled individual are entitled to tax benefits for qualified reasonable and necessary expenses incurred for the adoption. For 2021, the maximum tax credit for such expenses is $14,440 per child. If a taxpayer receives employer-provided benefits for such expenses, up to $14,440 of benefits per child can be excluded from income. Benefits over that amount are taxable income. For 2022, these amounts increase to $14,890. The adoption tax credit is nonrefundable.
Taxpayers can claim both the credit and exclusion for adoption expenses but cannot claim the same expenses for both benefits. Special rules apply depending on whether or not the adoptee is a U.S. resident. For some adoptions of special-needs children, the tax benefits are allowed even if the taxpayer has no qualified expenses.
For 2021, the credit and exclusion generally phase out for MAGI between $216,661 and $256,659, with no amount of either benefit allowed at higher levels. For 2022, the credit and exclusion generally phase out between MAGI of $223,411 and $263,410, with neither permitted at higher levels.
Tax Credits for Education Expenses
Two types of tax credits, the Lifetime Learning Credit and the American Opportunity Tax Credit, provide tax benefits for qualified educational expenses for postsecondary education. The rules for these credits differ. The IRS provides a comparison chart online. It also provides an extensive list of FAQs to help you determine which credit to claim.
Lifetime Learning Credit
The Lifetime Learning Credit is available to taxpayers in the United States who have incurred qualified educational expenses, including tuition, fees, and required books for postsecondary education at a qualified institution within a given tax year. The educational program must lead to a degree or other recognized education credential.
The maximum credit is 20% of eligible expenses up to $10,000 (i.e., $2,000 per tax return). It is intended to help offset the cost of education. For this credit to be claimed by a taxpayer, the student must attend school at least half-time for one academic period (e.g., semester, quarter, summer school). The amount of the credit must be reduced by any tax-free educational assistance, for example, Pell Grants or scholarships received for the same period. The credit is nonrefundable and is available to a taxpayer for only four tax years.
This income phaseout level for this credit was increased in 2021 to compensate for the repeal of the deduction for tuition and fees available in prior years. For 2021, the amount of your lifetime learning credit is phased out if your MAGI exceeds $80,000 ($160,000 for joint returns). No credit is allowed if your MAGI exceeds $90,000 if single or $180,000 for a joint return.
American Opportunity Tax Credit
The American Opportunity Tax Credit is a credit for qualified education expenses paid by an eligible student who is the taxpayer, the taxpayer's spouse, or the taxpayer's dependent. The maximum annual credit is $2,500 per eligible student. To qualify, the student must be enrolled at an eligible educational institution at least half time for at least one academic term for the given tax year. In some cases, this credit may be partially refundable. If the credit reduces the tax liability to zero, an additional 40% of the unused otherwise allowable credit, up to $1000, is refundable to the taxpayer.
The amount of the American Opportunity Tax Credit is phased out if your MAGI exceeds $80,000 if single ($160,000 if you file a joint return). You can't claim an American Opportunity Tax Credit if your MAGI is $90,000 or more if single ($180,000 or more if you file a joint return).
If you are eligible for any of these tax credits, they can substantially reduce or even eliminate the amount of taxes that you owe. They may also increase the amount of your tax refund. In some cases, taxpayers may be eligible for a refund even if there were no taxes withheld from their income for the year due to these tax provisions.
Decide If You Should Itemize Your Tax Return
Every taxpayer should evaluate whether or not they should itemize deductions. Generally, you should itemize your deductions if your itemized deductions exceed the standard deduction and they result in a lower total taxable income than if you claim the standard deduction. Even if you claim the standard deduction, you are still entitled to claim tax credits. The standard deduction amounts for individuals in each filing status for tax years 2021 and 2022 are:
|Single and Married Filing Separately||$12,550||$12,950|
|Married Filing Joint Return and Surviving Spouses||$25,100||$25,900|
|Head of Household||$18,800||$19,400|
However, there are certain cases in which you will have no choice between the standard deduction and itemizing. For example, if you file a joint return with your spouse and you itemize your deductions, your spouse must do so as well.
In deciding whether to itemize or claim the standard deduction for a tax year, you should consider whether you had large or unusual expenses or losses. You should determine which expenses are deductible and calculate the total deductible amount to compare with the standard deduction. Deductible expenses include but are not limited to the following:
- Substantial unreimbursed medical and dental expenses
- Interest for your home mortgage
- Unreimbursed casualty or theft losses
- Contributions of cash or property to a charitable organization
- Major life events: marriage, the birth of a child, retirement, etc.
Consult Information for 2021
When consulting tax publications to prepare your tax return for 2021, you should place close attention to the publication's date and the applicable year referenced for specific rules. Some publications, including the IRS website, may not incorporate all 2021 tax law changes until 2022. The Build Back Better Act (BBB), which passed the House in November 2021, is pending in the Senate. Although its prospects for enactment are uncertain, some or all of the BBB provisions—which include such 2021 changes as an extension of the increased, temporary Child Tax Credit and higher taxes at very high income levels—could yet become law.
Can I Claim the EITC, Child Tax Credit, and Child and Dependent Care Tax Credit?
Provided you meet the qualifications for these tax credits, you can claim all three to the extent that you meet the requirements. Even if you don't owe taxes for 2021, you should nevertheless file a tax return if you qualify for any of these tax credits because all three are refundable—any credit amount that exceeds your tax liability is paid to you if claimed on your tax return.
Do I Have to Itemize Deductions to Deduct Student Loan Interest Paid in 2021?
No. You can deduct interest paid on a student loan in 2021 without itemizing your deductions. You can deduct such interest and still claim the standard deduction. Remember that this deduction is limited to necessary educational expenses for tuition and fees, room and board, and required books; it is subject to a maximum of $2,500 per student and phases out at higher income levels. If you are married, you must file a joint return to claim the credit, and you and/or your spouse cannot be claimed as a dependent on someone else’s return.
Can I Deduct $300 of Charitable Contributions in 2021 Without Itemizing Like Last Year?
Yes. If you are single, you can deduct up to $300 of cash contributions to qualified charities and still take the standard deduction. If you are married and filing a joint return for 2021, you can claim the standard deduction and also deduct up to $600 of cash contributions to qualified charities. Remember that gifts to some charitable organizations—for example, those to private, non-operating foundations and donor-advised funds—are deductible only as itemized deductions. In addition, if you made substantial cash contributions in 2021, you may claim itemized deductions for cash contributions in an amount equal to 100% of your AGI.
May I Claim the Child Tax Credit for a Child Who Has an Individual Taxpayer Identification Number (ITIN) Rather Than a Social Security Number (SSN)?
No, you may not claim the Child Tax Credit for a child with an ITIN. The child must have an SSN to be a qualifying child eligible for the Child Tax Credit (CTC) or the additional child tax credit (ACTC).
The Bottom Line
It is important to follow the instructions for tax forms and tax preparation programs carefully. Some deductions and credits are reduced (i.e., phased out to zero) as income levels increase. Other deductions, for example, the medical expense deduction, only allow you to deduct expenditures above a percentage threshold.
The IRS provides extensive information and publications about filing requirements and eligibility for and limitations on tax benefits on its website. Or, you can consult a tax professional about return preparation and maximizing your eligibility for tax credits and deductions.
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