Deduction versus credit
A $1,000 deduction saves a person in a 12 percent bracket $120, and a $1,000 credit saves $1,000. A refundable credit is paid out even when the tax owed is zero. Most young adults take the standard deduction instead of itemizing, and that is usually correct. Several deductions, called adjustments to income, are nonetheless available on top of the standard deduction, and so is every credit.
Deductions that need no itemizing
- Student loan interest is deductible up to $2,500 a year, a cap that has not moved in decades, subject to an income phaseout that does move. You qualify if you are legally obligated on the loan and nobody claims you as a dependent, even when a parent made the payments.
- Contributions to a traditional IRA may be deductible, and they can be made for the previous year right up to the April filing deadline.
- HSA contributions made outside of payroll are deductible.
- The self-employed deduct half of their self-employment tax and their health insurance premiums, along with business costs such as mileage, software and equipment.
- Congress has created temporary deductions for tip and overtime income, and the current rules are worth checking if you earn either.
Credits worth knowing
The American Opportunity Tax Credit is worth up to $2,500 per student for each of the first four years of college, and 40 percent of it is refundable. The Lifetime Learning Credit returns 20 percent of up to $10,000 in tuition, including graduate school or a single course. Both rely on Form 1098-T from the school. The saver's credit repays 10 to 50 percent of the first $2,000 that a lower-income worker puts into a 401(k) or an IRA, although full-time students and dependents are excluded, and Congress has scheduled changes to it. The Earned Income Tax Credit is refundable, and workers without children generally must be between 25 and 64 to claim it. Income ceilings for all of these adjust annually, and the IRS lists them.
The dependency question
Around graduation, settle with your parents who is claiming whom. Parents may generally claim a full-time student under 24 who does not provide more than half of their own support, and in that case the education credit belongs on the parents' return. When both returns claim the same person, the second one filed is rejected.
Tip Keep the 1098-E, the 1098-T and the year-end statements from retirement and health savings accounts in one folder. Tax software finds these breaks only when you have the numbers to enter.
