We're still a ways out from tax season (unless you're an entrepreneur or business owner who pays quarterly taxes). Careful planning when it comes to taxes can make a huge difference in how much you end up needing to pay. There are some tax breaks you should know about so you can take advantage of them.
Tax deductions reduce the amount of taxable income you are liable for. When preparing your taxes you can choose either the standard deduction or to itemize your deductions. Which one works best will depend on your personal situation. Choosing to itemize your deductions will require more paperwork. How much you can get from a standard deduction will depend on your filing status. Some common deductions include retirement contributions, interest on student loans, certain business expenses, medical expenses, charitable donations, and contributions to health savings accounts.
Unlike a tax deduction that reduces your tax liability, a tax credit reduces your actual tax bill. Tax credits have the potential to significantly reduce the amount of taxes you owe, even more so than tax deductions. The American Opportunity Tax Credit is great for students at colleges and universities. Parents can qualify for the child tax credit and potentially the child and dependent care tax credit. Then there's the earned income tax credit and residential energy credit. You can receive a 26 percent tax credit by installing solar panels on your home.
Tax exemptions are exactly what they sound like. It's income or other transactions that are exempt from being taxed. Some types of capital gains can be exempt from being taxed, which can be useful if you're involved in the purchase and sale of assets. This is great for homeowners who want to avoid paying capital gains taxes. Interest earned on municipal bonds is also considered exempt from taxation at both the federal and state level. Certain organizations that are organized as 501(c)(3) nonprofit corporations are considered to be tax exempt. These organizations are charitable organizations and you may be able to reduce your tax liability by donating to them.
Tax breaks can do a lot for reducing your tax liability. The more you know, the more you are likely able to save. Become familiar with the tax deductions, credits, and exemptions you qualify for and how to take advantage of them. You may be surprised by how much you are able to save on your taxes.