You may have heard about some of the great money-saving tax deductions allowed by the IRS. The deductions for mortgage interest, charitable contributions, and medical expenses can be especially lucrative if you paid these expenses. However, the reality is that these deductions cannot be used by most Americans. These and most other tax deductions require you to itemize your deductions, which only 29% of Americans choose to do. Fortunately, there are some tax breaks that everyone can use, even if they don't itemize.
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Adjustments to income vs. deductions
When it comes to tax deductions, you have two choices. You could opt for the standard deduction, which is currently $6,200 for singles and $12,400 for married couples. Or you can choose to itemize deductions, which means adding up all of the deductions to which you are entitled and subtracting the total from your taxable income, thereby lowering the taxes you owe. You can use whichever method is more beneficial to you.
However, there are a few deductions you can take regardless of whether you itemize deductions or take the standard deduction. These are known as adjustments to income or "above-the-line" deductions, and they lower your adjusted gross income (AGI) before your other deductions are applied to calculate your taxable income.
7 adjustments to income
As of the 2016 tax year (the tax return you'll file in 2017), here are seven of the most common adjustments to income allowed by the IRS. In no particular order, they are:
1. Traditional IRA contributionsThe deduction for traditional IRA contributions is unique, as it is the only deduction on this list you can still take advantage of for the 2016 tax year. As long as you qualify based on certain income limitations, you can deduct up to $5,500 in contributions (or $6,500 if you're over 50) to a traditional IRA account for the 2016 and 2017 tax years. In addition, there's a tax credit for low- to middle-income taxpayers designed to incentivize retirement savings that you might be able to take advantage of, on top of this deduction. This is a big reason why I've written before that retirement saving is the best tax break of all.
2. Alimony paidIf you pay alimony to a former spouse, or under a separation agreement, then it can be used as an adjustment to your income, and it must be claimed as income by the recipient. It's important to keep in mind that child support and any noncash (property) payments don't qualify.
3. Bad debtsIf you're owed money that you can't collect, then you may be able to write off the amount you're owed as an adjustment to income. There's a method to determine what constitutes a legitimate bad debt for tax purposes, but generally speaking, you must be able to prove that the transaction was intended as a loan and not as a gift, and you must establish that you've made a reasonable effort to collect the debt.
4. Moving expensesIf you move a significant distance and begin a new job shortly thereafter, many of the expenses incurred during the move can be used as an adjustment to income. You don't necessarily need to have a job lined up before you move. Instead, you just need to work full-time for 39 of the 52 weeks immediately following the move, and your new house needs to be at least 50 miles further from your old job than your old house was.
5. Student loan interestIf you're one of the millions of Americans who makes student loan payments, then some or all of the interest you pay could be tax-deductible. As of the 2016 tax year, you can deduct the lesser of $2,500 or the actual amount of interest paid. This deduction is subject to income limitations: Your modified adjusted gross income (MAGI) must be less than $65,000 if you're single, or less than $130,000 if you're married filing jointly, to take the full student loan interest deduction.
6. Tuition and feesIf you don't qualify for either of the two tuition tax credits, you may be able to take advantage of the tuition and fees deduction instead. You can deduct up to $4,000 in qualified education expenses if your MAGI is less than $80,000 (single) or $160,000 (married filing jointly). It's worth mentioning that the credits are usually more beneficial if you qualify, so here's a quick guide to help you determine which is the best tax break for you.
7. Educator expense deductionIf you are a full-time (defined as at least 900 hours per year) K-12 teacher, instructor, counselor, principal, or aide, you can deduct up to $250 in unreimbursed expenses related to your profession. These expenses can include things such as professional development activities, classroom supplies, software you use, and others.
How much could you save?
These tax breaks can be quite lucrative for a couple of reasons. Obviously, the direct tax savings from using these deductions can be nice. As a personal example, I maxed out my traditional IRA last year and was able to deduct the maximum of $2,500 in student loan interest last year, which combined to save me $2,000 on my taxes (more if you include state taxes).
Furthermore, and less obviously, these deductions can help you qualify for other tax breaks. The ability to take many deductions and credits is dependent on your AGI or MAGI. For example, you'll notice that the student loan interest and tuition and fees deductions are both dependent on MAGI limits. Since these adjustments lower your AGI and MAGI, they can help you qualify for other tax breaks as well.
Just because you choose not to itemize your taxes doesn't mean you can't save a bundle on your tax bill, so read up on those above-the-line deductions before you file your return.
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