The world of personal taxation and tax deductions can often be puzzling. While these elements aid in reducing one's tax burden, they may also come with unexpected limitations. These limitations can take taxpayers by surprise, reducing the potential tax reduction they envisioned when filing taxes.
This article explains some of the more common tax deductions, their unexpected limitations, and their potential implications.
The nuances of deductions
One of the primary limitations is 'itemized deductions.' When filing, taxpayers can choose between taking a standard deduction or itemizing their deductions. It's essential to remember that deductions are claimed against your income, not your tax liability. Therefore, the value of your deductions depends on your marginal tax rate. The higher your tax bracket, the more valuable each deduction dollar becomes. However, deductions may save you less money if your income drops into a lower bracket.
Common tax deductions
While some of these deductions may apply to one's situation, these tax deductions are also not unlimited.
Mortgage interest—Tax deductions related to home ownership also come with unexpected limitations. While mortgage interest is generally deductible, the amount you can deduct is limited to interest on up to $750,000 of mortgage debt incurred after December 15, 2017.
Also, the interest on home equity loans is no longer deductible unless the funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan.
State and local taxes (SALT)—Starting in 2018, under the Tax Cuts and Jobs Act, taxpayers may deduct up to $10,000 ($5,000 if married filing separately) for a combination of property and state and local income taxes or sales taxes. This limitation can be considerably restrictive, especially for residents of high-tax states.
Medical expenses—Another critical area where limitations pop up is medical deductions. Taxpayers can only deduct the portion of unreimbursed medical expenses that exceed 7.5 percent of their adjusted gross income (AGI).
Charitable donations— Charitable donations, another popular deduction category, are not spared from limitations. Generally, you can deduct up to 60% of your AGI for contributions to public charities. However, there are tighter limits for gifts to certain types of nonprofits and donations of appreciated assets.
This list of deductions is limited; many others may apply to one's situation. Therefore, it's vital to research this year's deductions and visit with financial and tax professionals for clarification before filing.
Understanding the Alternative Minimum Tax (AMT)
Some deductions could trigger the AMT, a separate tax system limiting certain deductions and not permitting others. Without a clear understanding of AMT, taxpayers claiming large amounts of certain itemized deductions may owe AMT, potentially increasing their tax liability.
In conclusion, while personal tax deductions can help mitigate one's tax bill, they have several unexpected limitations. Understanding and factoring the ever-changing tax deductions into a broader tax planning strategy is crucial.
Financial and tax professionals can help taxpayers navigate the complexities of personal taxation by optimizing their tax-saving efforts while staying compliant with the law. Contact them today to get started in preparing for this year's tax season.
Important Disclosures:
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
LPL Financial does not provide legal advice or tax services. Please consult your legal advisor or tax advisor regarding your specific situation.
This article was prepared by Fresh Finance.
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Sources:
https://www.nerdwallet.com/article/taxes/tax-deductions-tax-breaks