Every American citizen who makes money has a civic duty to pay taxes to help finance essential public services. While most are generally willing to contribute, it’s only reasonable that no one wants to give more than what they owe. This is where tax deductions come into play.
Many of your daily expenses may qualify as deductions on your income tax return, saving you a significant amount. Depending on how your expenditures are categorized, you may either claim the standard deduction or itemize your allowable deductions.
Accordingly, whatever your employment status is, it’s crucial to learn how to make the most of your tax return. Below, we’ll discuss several ways you can maximize your deductions and credits, but before we dive deeply, let’s touch on which types of expenses are deductible.
Deductions reduce your tax liability by lowering your taxable income. These are usually expensed you incur during the year that can be subtracted from your gross income to determine the exact amount you need to pay.
Common tax deductions include interests on mortgage and student loans, medical and dental bills, local, state, and property taxes, and charitable donations.
Tax credits, on the other hand, are a lump sum dollar amount given to eligible taxpayers, directly reducing their tax bill. A few credits are refundable, which means that if you owe the IRS $300 in taxes but are provided an $800 credit, you’ll be paid the difference of $500 in a check. However, remember that tax credits are mostly non-refundable.
Examples of tax credits include Earned Income Tax Credit, which is intended for low- to moderate-income earners; Child and Dependent Care Credit, which reimburses working parents for child care expenses; credits for energy-saving renovations, which are available to homeowners; and American Opportunity Credit and Lifetime Learning Credit, which help cover college fees.
Maximizing Tax Deductions
1. Write a checklist
Make it a habit to create a checklist of all tax deductions and credits you’re eligible for. Knowing what’s available to you not only ensures that you’re not overlooking anything but also helps you determine which documents to keep during the year. This will make it easier to organize and prepare paperwork when it comes to submitting tax returns.
Be sure to include both daily and one-time expenses in your list. If you regularly donate to charity, you may be allowed to deduct your mileage and other expenses incurred from traveling to and from the charitable institution, so be sure to look into the specifics.
2. Assess your finances
Finance experts suggest conducting a quarterly or mid-year evaluation of your overall financial situation. This way, you can build a more accurate estimate of your tax liability. Plus, you will be able to shift and adjust your spending to take advantage of deductions, breaks, and credits you’re qualified for.
For example, if you have been holding off on certain purchases that belong in deductible categories, it’s wise to make those during a year in which you plan to itemize. You can achieve the maximum effect while spending on something you actually need. Pay extra attention to categories where it’s required to cross a minimum threshold, such as medical and dental bills so that they can qualify as deductions.
3. Leverage your Roth individual retirement account (IRA)
Having a Roth IRA can reduce your tax burden later in life. In Roth IRAs, the contributions are taxed instead of the withdrawals. Thus, qualified withdrawals will be tax-free since you have already paid income tax for your contributions.
Moreover, account owners who are at least 59½ years old and have held their accounts for five years can take distributions and investment earnings without paying federal taxes. Since taxes are likely to increase in the future, opening a Roth IRA can save you a hefty sum.
4. Segregate business and personal records
If you own a business, it’s advisable that you keep business income and expenditures separate from personal income and expenses. You will not only comply with the IRS; you will also be able to check every expense thoroughly. This helps avoid missing any cost that could be deducted from your tax return—a likely situation if you mix personal and business money.
5. Stay up-to-date on revisions
It’s critical to be educated on revisions following the Tax Cuts and Jobs Act (TCJA). This bill has significantly altered the tax code for both institutions and the average American citizen, focusing on reducing corporate, estate, and individual tax rates. How this tax law affects you will depend highly on your personal circumstances, so it’s essential to read up on it before tax preparation and filing.
Specific miscellaneous fees and unreimbursed employee business expenses, such as business use of a vehicle, uniform and safety equipment costs, or travel expenses, have been eliminated. If these are expenses you incur frequently, their removal can substantially impact your tax return.
Moreover, the standard deduction has almost doubled, so it might make sense to take it instead. This will also simplify your tax planning, reduce preparation time, and save you the trouble of record-keeping. However, this is a case-to-case basis, so assess your situation properly.
6. Avoid acquiring debt
Failure to comply with tax filing and payments requirements can lead to penalties and interest. Over time, these can accumulate, and the amount you owe can grow dramatically. The IRS can also use harsh tactics to collect the debt, including wage garnishment, tax liens, bank account seizures, and more.
For this reason, it’s crucial to make prompt payments when you get any tax debt, even if you can’t cover the debt in full at the moment. However, if the unexpected happens and your debts pile up, the IRS Fresh Start Program can help relieve you of large tax bills that you cannot immediately pay. Make it a priority to address tax debt problems, and be sure to inquire about all of your options.
Minimize the Chances of Being Audited
In a tax audit, the IRS closely examines your tax return to verify the accuracy of your income and deductions. Tax returns are typically chosen for audit when the amounts entered are unusual and suspicious. If the IRS decides to audit yours, there isn’t much you can do about it.
You may lessen the likelihood of being singled out for special attention in the first place by steering clear of common tax audit mistakes. Below are some tips you can follow to avoid an audit from the IRS:
1. Stay honest
It may seem obvious, but being completely truthful on your tax return is an absolute must. Reporting income, deductions, credits, and other data as precisely as possible can help lower your chances of being audited.
You should be prepared to back up any numbers you state on your tax return with the necessary documents. Self-employed individuals, for example, should save receipts for any business deductions claimed.
2. Evaluate your figures
Incomplete or inaccurate entry is one of the most typical red flags for auditors, but it is also preventable. It may appear straightforward to follow the suggestion to double-check your tax return before submitting it, but people can sometimes be too reckless with their taxes.
In certain circumstances, taxpayers make avoidable mistakes when filing by forgetting about income or related paperwork they’ve received. It’s a good idea to wait for all of your income reports, bank and investment statements, and other relevant financial papers to arrive before beginning your tax prep.
It is also critical to correctly declare dependents and exemptions and ensure that all numbers match. The IRS’s automated system can detect disparities very quickly, and it will be difficult to determine whether a discrepancy is unintentional or intentional.
3. Be realistic when itemizing deductions
Auditors can also get suspicious if itemized deductions are unreasonable or out of the ordinary, whether the taxpayers are individuals or business owners. For example, taking a charitable tax deduction for 40% of your total income may cause the IRS to raise an eyebrow.
4. Opt for online filing
Taxpayers across the country who expected a refund had the option to file electronically by 1990. In 2020, the IRS received approximately 195 million individual tax returns that were e-filed. According to the IRS, filing returns online can help reduce errors and the likelihood of an audit.
5. Hire an experienced CPA
If you are busy with work and worried about overlooking important details, hiring a professional tax accountant may be best. Leaving your tax prep and filing to a CPA is not only convenient and efficient; it can also mitigate any filing errors and misinformation, improve your record-keeping, and maximize the value of your deductions. Plus, having peace of mind during the often stressful tax season is priceless.
Frequently Asked Questions
1. How long does a tax audit usually take?
Mail and office audits are quite straightforward and move more quickly than field audits. The IRS notifies a taxpayer within seven months of filing their tax return with mail audits. These can end in three to six months, depending on how responsive the taxpayer is.
As for office audits, the IRS typically starts within 12 months of filing and lasts between three and six months. However, if the information provided by the taxpayer is incomplete or other issues arise, the audit can be extended for years.
Field audits start within a year after filing the return and can take up to a year. However, field audits are usually saved for more complicated situations involving businesses and include a thorough financial records review.
2. What are the needed documents?
For the audit, the taxpayer will be asked to submit electronic records with a hard-copy backup. The requirements will differ depending on the taxes being evaluated and may include supporting documentation like financial statements, loss statements, certificates of exemptions for non-taxed sales, trial balances, invoices, general ledgers, and receipts.
3. Do I need to consult a tax professional?
That is all up to you. However, outsourcing an audit to an experienced tax professional can help immensely, especially if you’re not keen on representing yourself. An enrolled agent, an attorney, or a licensed CPA can handle your case properly, as they are knowledgeable in the field of taxation and familiar with IRS procedures. They can also defend your position effectively and wrap up the audit more quickly.
4. What should I do if I disagree with the adjustments?
If you do not agree with the auditor, the best option is to go to IRS appeals or the court, depending on the situation and the details of your contention. This will prolong the audit period by six months to a year.
Honesty is always the best policy when it comes to tax filing. While getting the maximum value of your tax deductions is important, it’s vital to keep the figures sensible and logical. Moreover, it’s critical to respond comprehensively and promptly for a faster resolution when dealing with audits.