Tax Deductions and Credits Guide

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. Come tax season, though, if you haven't researched how to minimize your income taxes, you may end up paying more than the Internal Revenue Service (IRS) requires.

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 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. This means that if you are entitled to a credit worth $4,000 and owe $3,000 in taxes, you won't owe any taxes and you'll get a $1,000 tax refund.

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.

On the other hand, if your marginal tax rate is higher than the credit percentage, a deduction would benefit you more. 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 when you determine your 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. You cannot deduct expenses for your job that are not reimbursed unless you are:

• An armed forces reservist
• A qualified performing artist
• A fee-basis state or local government official
• An employee with impairment-related work expenses

Also, elementary and secondary school educators can deduct up to $300 per year of qualified expenses.

Charitable Donations

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. A taxpayer filing a return as single could deduct up to $300 of charitable contributions made in cash to qualifying charitable organizations and still claim the standard deduction in 2021. However, this deduction is no longer available for tax years 2022 and later. You'll have to itemize deductions if you want to include charitable donations.

Since 2021, taxpayers who itemize their deductions also enjoy a special allowance for cash charitable contributions. Generally, itemizers could deduct cash contributions up to an amount that typically was equal to 60% of their adjusted gross income (AGI) before 2020.

Itemizers can also 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.

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 ($145,000 and $175,000 if you file a joint return). You can’t claim the deduction if your AGI is $85,000 or more if single ($175,000 or more if you file a joint return).

For 2022, the expected AGI phaseout for single taxpayers is between $70,000 and $85,000 and between $145,000 and $175,000 for joint returns. 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.

Tax Treatment

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. At the end of 2022, the White House announced that this pause was extended in response to a federal court blocking a student loan forgiveness program. The new deadline is either:

1. 60 days after the forgiveness program is allowed to go forward or the litigation is resolved; or
2. 60 days after June 30, 2023

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.

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, are 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.

There 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.

Earned Income Tax Credit

The earned-income tax credit (EITC) is a refundable tax credit available to low-income workers. For 2022, 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. If you are claimed as a dependent on another taxpayer's return, you are not eligible to claim the EITC.

The credit percentage, earnings cap, and credit amount vary depending on your filing status, your number of dependent children, and your level of earned income. For instance, the maximum Earned Income Tax Credit amount for tax year 2023 is $7,430 for qualifying taxpayers who have three or more qualifying children, up from $6,935 for tax year 2022.

To be eligible, you must have earnings but cannot have investment income in excess of $10,300. 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 you owe, you may be eligible for a refund.

Child Tax Credit

The American Rescue Plan Act (ARPA) increased the amount of the Child Tax Credit, made it fully refundable, and provided for its distribution in advance payments to taxpayers for 2021. The Child Tax Credit changes, however, expired at the end of 2021 and weren't extended by the U.S. Congress. As a result, the Child Tax Credit for 2022 and 2023 reverted back to $2,000 per child under age 17 unless it is extended by new legislation.

The maximum refundable portion of the credit in 2023 is $1,600, up from $1,500 in 2022.

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.

In 2021, 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 at 20%. Above an AGI of $400,000, the CDCTC phases out by one percentage point per $2000 (or a fraction thereof) until it reaches 0% at an AGI of $438,000.

The 2021 enhancements to the CDCTC applied only for one year. Unless extended by Congress, the CDCTC for 2022 and 2023 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 the age of 18 or a disabled individual are entitled to tax benefits for qualified, reasonable, and necessary expenses incurred for the adoption. The maximum tax credit for such expenses is $15,950 per child for 2023. If a taxpayer receives employer-provided benefits for such expenses, up to $15,950 of benefits per child can be excluded from income. Benefits over that amount are taxable income.

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, tax benefits are allowed even if the taxpayer has no qualified expenses.

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.

In order to claim the full credit, your modified adjusted gross income (MAGI) for the tax year 2023 must be $80,000 or less if you file as an individual. Your income must be $160,000 or less if you file jointly. Individual taxpayers with MAGIs of at least $90,000 or couples filing a joint return with MAGI of at least $180,000 do not qualify for the credit.

The credit is phased out if your modified adjusted gross income exceeds those amounts. This means you cannot claim the $2,000 credit at all.

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 on 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 2022 and 2023 are:

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.
  

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.