When it comes time to do your taxes, it is always beneficial to take as many tax deductions as you possibly can.  If you can legally make the deduction, it won’t be considered cheating on your taxes.  You just want to be sure that you are paying the least possible amount on your taxes.  Sometimes people miss deductions they have available and end up paying more taxes than they should.  That is never fun.

When figuring out your gross income, you have to include basically any money that comes in to you.  This includes your ordinary wages, extra income, interest, dividends, etc.  The only money coming in to you that is not included is cash that you get in the form of a loan.  If someone lends you ten thousand dollars, you don’t report that as income.  If someone owes you ten grand and pays you back in full without interest, you don’t have to include any of that income in your taxes.  However, if you have ten grand in your savings account and you accrue five hundred bucks worth of interest in the year, you do have to include that in your taxes.

Now what sort of interest payments can you deduct and use to offset your total tax bill?  Well the only sort of of interest a regular working individual may deduct is the interest on their home loan.  Your mortgage interest is deductible up to a million dollars worth of principle.  So for example, say that your mortgage is 500k and you end up paying 30k worth of interest in a given year.  You may deduct that 30k against your income.  However, if your mortgage balance is 2 Million and you end up paying 120k worth of interest that year, only half of it is deductible.  Also, it is only the interest portion of your payments that are deductible.  You are typically paying back some of the principle with each payment, and that part is not deductible.

So what other types of interest are deductible for an individual?  Well, pretty much none.  You can’t deduct the interest on your car loan, the interest on your credit cards or the interest you are paying on that loan for your new big screen TV.  However, if you owned a business and your business took out a loan to buy a car, your business could deduct the interest on that car loan against the profits for that year.

So what is the morale of the story?  Your home loan is probably the best debt you can have.  If you get the opportunity to roll your credit card debt, car loan, etc. into your home mortgage, do it!  Not only are you going to get a lower interest rate, but you are also going to be able to deduct the interest payments from your ordinary income!

Some people think that taking advantage of every single last tax deduction that is available to you is considered cheating on your taxes.  It obviously isn’t considered cheating on your taxes if you are simply following the rules of the IRS.  As long as you are doing everything by the book, there is no limit to how much you can save on your taxes before it becomes illegal.  Just because you have a lot of stuff to write off or tax credits to take advantage of, does not mean that you are cheating on your taxes!

It is in your best interest to get a qualified accountant to sit down with you and help you prepare your taxes so that you can reduce your final tax bill at the end.  Obviously, the more you deduct, the more you save on your taxes.  But the great thing about finding deductions is that they come off the top of your income.  The savings are going to be at the highest tax rate that you would pay.  Let’s use an example:

Say that you made $100k this year, and, just as an example to make things simple, lets pretend that the tax rate on your first $80k is a flat 15%, and 40% on everything above 80k.  So at the end of the year, you owe:

$80k * 15% = $12k

$20k * 40% = $8k

So you owe a total of 20k, and 40% of your total tax bill is on that last 20k that you made this year.  So what if you investigate all your opportunities and you find out that you can deduct a total of 10k, or 10% of your total income for the year.  You want to see what impact this is going to have on your tax bill, so you redo the calculation after you adjusted your income down by 10%.

$80k * 15% = $12k

$10k * 40% = $4k

So now you only owe 16k instead of 20k.  You have reduced your gross taxable income by 10%, but you have reduced your total tax bill by 20%!

You can see the amazing benefit of tax deductions right there.  Your deductions are coming off the top of your income, which is what you are paying the most taxes on.  So it makes sense for you to max out any of your tax deferred accounts like retirement accounts, health savings accounts, etc.  This savings will really help keep your money in your pocket.

Remember to run everything you are doing by a professional accountant.  It is typically not worth doing all your taxes on your own.  There is a lot of deductions you might miss, and a lot of stuff you might try to do that you aren’t supposed to.  It is always good to save money on taxes, but it is never worth it if you are doing something illegal.  Saying “I didn’t know I couldn’t do that” will not get you out of trouble.

If you have a high deductible health plan (HDHP), you may be eligible to create a Health Savings Account. Also known as an HSA, this is basically a special savings account that is used to pay for medical related expenses. The primary benefit of this account is that you can make contributions (or deposits) into your account using pre-tax income. The drawback is that you can only use money in this account for medical-related expenses. The definition of medical related expenses is pretty broad; I have even heard that you can buy diapers with your health savings account.

The tax savings works like this: Say you make $50,000 in one year, and you want to contribute $2,000 to your health savings account (There are yearly contribution limits, make sure you aren’t contributing more than your limit). You deposit the $2,000 in your account and you write the whole $2,000 off on your taxes even if you haven’t spent a dime in medical related expenses that year. Your savings account grows tax free and rolls over from year to year, unlike a flexible spending account. When you need to make medical related expenses (doctor bills, deductible, medicine, etc), just use the money from your health savings account. Piece of cake!

After spending a couple hours reading through my health insurance documentation, I finally figured out how to start my health savings account. The one thing that would have been nice is if my health insurance company told me that I wasn’t setting up the health savings account through them or with them. I could go to any financial institution that I wanted and set the account up there. I did a search on Google for HSA accounts and found plenty of places to sign up. The one credit union I ended up with offered the account with a visa debit card and a 5% interest rate. The only drawback is that they start charging a $1/month fee after the first year. However, all I need in the account is $240 and the interest will cover the monthly fee the entire time.

My health savings account ended up being really easy to get started. I just filled out some forms online, clicked the “I agree” button, sent them a couple bucks to start the account off, and now everything is set up. I didn’t have to do anything through my Health Insurance to get the account set up. After setting up your health savings account, just be sure to get itemized receipts for every single purchase that you make with your account. Save these receipts in case you need to show that all your purchases were health related. I will have to research exactly what expenses are included in “medical related expenses” so that I can take maximum advantage of all the tax savings. It will be great knowing that I can pay for cough drops tax-free!