The Tax Cuts and Jobs Act was the most sweeping overhaul to the United States tax code in three decades. In addition to lowering the tax bills for the majority of Americans, the tax reform bill also simplified the tax code tremendously.
One of the ways the tax code has been simplified is that there are fewer available deductions. For example, the once-valuable personal exemption doesn't exist anymore, and employees can't deduct job-related expenses. Instead, the standard deduction has become much larger, making itemized deductions a moot point for many Americans.
Having said that, there are still some very lucrative tax deductions you might be able to take advantage of, and here are three of the most valuable.
Before we go any further, consider that taxpayers can choose the standard deduction, or they can itemize, whichever is most beneficial for them on their 2020 tax return. And there are four main itemizable deductions:
- Mortgage interest.
- State and local taxes (SALT).
- Medical expenses.
- Charitable contributions.
The standard deduction is $24,800 in 2020 for married couples filing jointly, and half of that amount for single filers. Most households aren't going to find itemizing worthwhile just with mortgage interest and state and local taxes alone, and since medical expenses can only be deducted to the extent they exceed 10% of adjusted gross income, most people won't be able to use theirs.
However, the fourth main itemizable deduction can be very large. The IRS allows taxpayers to deduct charitable contributions of as much as 60% of their adjusted gross income. And while most people aren't going to give more than half of their income away, it's important to note that these donations can be in the form of money or property, so we're not just talking about cash donations.
Most Americans don't contribute enough to their retirement accounts. Most financial planners suggest a minimum retirement savings rate of 10% of salary, not including any employer contributions. The average 401(k) participant contributes less than 7% of theirs.
As if the prospect of a financially secure retirement wasn't enough motivation to save, there's another good reason – contributing a bunch to your retirement accounts can save you a ton of money on your tax bill.
Contributing to tax-deferred retirement accounts like a traditional IRA, 401(k), 403(b), or 457 is done with pre-tax dollars. In other words, your taxable income will be reduced dollar-for-dollar. For example, if you have taxable income of $70,000 and contribute $5,000 to your traditional IRA, it will reduce your taxable income to $65,000.
While it may not be practical to max out your retirement accounts (the 401(k) contribution limit is $19,000 in elective payroll deferrals for 2020), the point is that this can be not only one of the most effective ways to reduce your tax bill, but it also can help set you up for a secure financial future later in life.
The pass-through deduction
If you're self-employed, the pass-through tax deduction (formally known as the qualified business income deduction) can be your best friend.
The short version is that if you have any income that comes from self-employment that is paid through a pass-through entity such as a sole proprietorship, partnership, LLC, or S-corporation, you may be able to deduct 20% of that income. In other words, $100,000 in self-employment income can become $80,000 in the eyes of the IRS before your other deductions are applied.
The pass-through deduction is restricted for certain high-income taxpayers, as well as for self-employed people in certain service occupations, like doctors, lawyers, and accountants who earn more than a certain amount. Still, if you qualify, the pass-through deduction can save you a ton of money on your 2020 tax bill.
Just a few of the possibilities
These are three of the most lucrative tax deductions Americans can take advantage of, but this is by no means an exhaustive list. There are many more tax deductions available, so be sure to check out our guide to tax deductions and consult a tax professional to make sure you're getting as many valuable tax breaks as possible.
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