Some FAQs from our tax clients:
- What is the difference between a credit and a deduction?
- To itemize or not to itemize?
- How long should I keep tax returns?
- What should I keep track of during the year?
1. Credit vs. Deduction
- A deduction reduces your taxable income.
- A credit reduces your tax bill, dollar for dollar For example; energy credits, child tax credit, foreign tax credit, etc.
- This should make more sense after we briefly walk through an example.
- First, we have our INCOME.
- Then we DEDUCT the larger of either the STANDARD AMOUNT or ITEMIZED DEDUCTIONS. Your tax professionals will let you know which deduction to take.
- This equals our taxable income and thus the total tax we owe to Uncle Sam.
- SUBTRACT CREDITS, ESTIMATED PAYMENTS, AND WITHHOLDINGS to come to…
- *DRUMROLL* The AMOUNT either REFUNDED OR OWED.
As you can see, both credits and deductions lower your tax bill, but in different ways.
2. Itemized vs. Standard Deduction
- The choice comes down to whichever is bigger.
- Standard deductions for 2023:
- Single - $13,850.
- Married Filed Jointly - $27,700.
- You receive an additional $1,500 if you are over 65 years old.
- This means that if you are married and both you and your spouse are over 65, your standard deduction for 2023 is $30,700!
- We compare the standard deduction to itemized deductions to see which is bigger.
- Common itemized deductions include:
- Medical or dental expenses that exceed 7.5% of your Adjusted Gross Income.
- Interest paid on a home mortgage.
- State and local taxes. The max we can use is $10,000.
- Charitable contributions to qualified organizations.
- Be sure to get a receipt letter from the organization.
If the total of itemized deductions exceeds the standard deduction, itemizing will result in a lower taxable income, thus reducing the amount you owe to Uncle Sam.
3. How Long Should I Keep Tax Returns?
- Although the IRS recommends keeping the past 7 years of returns, we err on the side of caution and recommend keeping all tax returns. If at any time you are in need of your return or any information within it, having it on hand is better than requesting a copy from the IRS. Also, the IRS will provide a transcript of your return if the return is older than 7 years, this is a “watered-down” version of your return. Having the full return on hand is the best option.
- The good news is that you can destroy tax return supporting documents 7 years and older. These are usually what take up the most room anyway.
4. What Should I Keep Track of During the Year?
One of the most frequently asked questions is, “Do I need to keep track of my itemized deductions during the year?” The Tax Cuts and Jobs Act (TJCA), signed into law in 2017, nearly doubled the standard deduction. We now see most clients take the standard deduction. With that being said, we suggest keeping track of the itemized deductions for the year. We will add up itemized deductions to compare with the standard to determine the larger of the two.
- The biggest issue we see is tax documents missing due to being delivered electronically. Ensure you have your tax documents set to be delivered via mail to ensure you have all that you need when tax time rolls around.
- W-2s, 1099s, Health Insurance, and Investment tax forms should all be mailed. If you have your investments with us here at TimeWise, we have your tax forms on hand.
Keep a file handy throughout the year to be used exclusively for tax documents. Keep a notepad in there as well if there are questions or items you think of throughout the year that you would like to cover during tax season.