For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.
When looking for a professional to answer your tax questions, you want to search for certified public accountants (CPAs). These individuals specialize in accounting and have experience dealing with taxes on a regular basis.
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Tap into the knowledge and expertise of these tax professionals by reviewing some of the most commonly asked questions they receive below.
1. How can I reduce my tax bill?
The tax code provides several ways to control your tax bill through deductions and credits. Tax deductions allow you to reduce your taxable income, and tax credits allow you to directly reduce your tax liability.
When you make income from a job, you can often reduce your taxable income by contributing to an employer-sponsored retirement plan or your own individual retirement account (IRA). You may also have a high deductible health plan through your employer with access to a health savings account (HSA) or flexible spending account (FSA).
All of these accounts allow you to contribute pretax dollars to invest or hold in cash for saving or for certain expenses. As a result, these contributions lower your taxable income and save you money on your tax bill.
If you have dependents, you may qualify for the child tax credit, a partially refundable credit in 2020 meant to lower the cost of raising a child. This credit, worth up to $2,000 for 2020, lowers your tax bill dollar for dollar.
For your 2021 tax return that you will prepare in 2022, the Child Tax Credit is expanded by the American Rescue Plan raising the per-child credit to $3,600 or $3,000 depending on the age of your child. The credit is also fully refundable for 2021. To get money into the hands of families faster, the IRS will be sending out advance payments of the 2021 Child Tax Credit beginning in July of 2021. For updates and more information, please visit our 2021 Child Tax Credit blog post.
2. What kind of deductions do I qualify for?
Almost everyone qualifies for the standard deduction or itemized deductions that reduce your taxable income. These are often the largest deductions available to you. Refer to item 6 below for information on which one might be best for you.
Self-employed workers and business owners may have more opportunities to save on their tax bills, but employees still have plenty of savings opportunities available. As an employee, you can deduct contributions made to IRAs, HSAs, and FSAs when preparing your Form 1040.
For employees, contributions made to your 401(k) or other employer-sponsored retirement plans during the year will not need to be deducted from your tax return. Instead, these dollars have already been taken out of your wages as shown on your Form W-2.
Further, you can deduct student loan interest if you meet certain income criteria as well as home mortgage interest, state and local taxes, and more.
If you have a side hustle, work as an independent contractor, or own a small business, you can deduct a lot of the costs related to running and maintaining your business. You have access to deductions for your home office, self-employment taxes, supplies, equipment, depreciation, health and business insurance, utilities, and much more.
3. What is the difference between marginal and effective tax rates?
The United States uses a progressive tax system, meaning as you earn more income, your income falls into a higher marginal tax bracket. For 2020 and 2021, the U.S. has seven marginal tax brackets with the lowest beginning at 10% on taxable income above $1 and the highest at 37% on taxable income above $518,401 ($523,601 in 2021) for single filers and $622,051 ($628,301 in 2021) for married couples who file jointly. Your marginal tax rate is the tax rate of the tax bracket that your last taxed dollar falls in. For example, if in 2021 your taxable income was $525,000 then your marginal tax rate would be 37% because this amount falls in the 37% bracket.
Your effective tax rate represents the total percentage of your taxable income that goes toward income taxes. the most straightforward way to calculate your effective tax rate is to determine your taxable income and then calculate your total tax bill. From there, you divide the total tax by your taxable income to get your effective tax rate.
4. Which is better: a tax credit or a tax deduction?
All things being equal, a tax credit is often preferable to a tax deduction. Tax credits reduce your tax liability dollar for dollar while tax deductions lower your taxable income. For example, if you prepare your taxes and have a total tax bill of $10,000, a $1,000 tax credit would reduce your bill by that amount.
If you had a $1,000 tax deduction and earned $50,000 in taxable income, your income tax liability wouldn't decrease by $1,000. Instead, your taxable income would now be $49,000. Depending on your tax bracket, that means you would save anywhere from $0 to $370 as compared to $1,000 from a tax credit.
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5. Can I deduct medical expenses?
Each year, the IRS allows you to deduct unreimbursed expenses for qualifying medical expenses if they exceed 7.5% of your adjusted gross income (AGI). These expenses can come from:
- Preventative care
- Medical treatments
- Surgeries
- Dental and vision care
- Psychologist and psychiatrist visits
- Prescription medications
- Prescription appliances (glasses or contacts, false teeth, hearing aids, etc.)
- Travel expenses paid to receive this medical care (mileage, bus fare, and parking fees)
How much you can deduct depends on your income and whether you itemize your deductions. For example, if your AGI is $100,000 and you itemize your deductions, you can deduct any unreimbursed medical expenses in excess of 7.5% of your AGI, or $7,500 (7.5% of $100,000). If you had $10,000 in unreimbursed qualifying expenses, you can deduct $2,500 ($10,000 - $7,500).
6. Should I itemize or claim the standard deduction?
Before the tax reform in 2018, you may have wondered whether you should itemize your deductions or simply claim the standard deduction. That decision got a lot easier after the 2017 Tax Cuts and Jobs Act was passed. You typically don't itemize if the standard deduction saves you more on your tax bill.
The standard deduction nearly doubled from 2017 to 2018, making it harder to justify itemizing your deductions. In 2020, the standard deduction comes to $12,400 for single taxpayers and $24,800 for married taxpayers filing jointly. In 2021, these amounts increase to $12,550 and $25,100 respectively. Even so, you should calculate your itemized deductions and compare them to the standard deduction each year to get the most out of the tax savings available to you.
7. How can I stay up to date with tax laws and changes?
Tax years 2020 and 2021 were anything but quiet in terms of tax law changes. You might feel challenged to keep up with the flurry of updates, but you shouldn’t worry. TurboTax has the pulse on the latest changes to tax laws each year and will keep tax tips updated for new tax year so you can feel confident in filing.
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