Politicians are always taking corporations and the super-rich to task for exploiting loopholes in the tax code. Don't you wish someone was yelling at you for paying too little in taxes? Where are the loopholes for the average American taxpayer? The best we can hope for is to take as many deductions as humanly (and legally) possible.
It's tax time again, which means it's time to get creative with those deductions. Can you convince the Internal Revenue Service (IRS) that your pet iguana is a service animal? Can you deduct toilet paper as a business expense because you come up with some of your greatest ideas in the bathroom? Can you deduct your bar tab as a form of stress reduction therapy? No, but you'll give your auditor a good story to tell around the IRS water cooler.
Keep reading for our list of 10 creative tax deductions that won't land you in jail. Think of them as loopholes for the little guy.
If you move to another town for a new job, the Internal Revenue Service (IRS) will let you deduct a portion of those expenses from your taxable income. But did you know that you can even deduct moving expenses if you're self-employed? Or if you get fired from the job that you moved for in the first place? Yup, the IRS is uncharacteristically generous with this one, so take full advantage!
The IRS applies two basic "tests" to determine if you can deduct moving expenses: distance and time. First, the distance test: If you move for a new job -- or even to find a new job -- the new location must be at least 50 miles (80 kilometers) farther than the distance of your old commute [source: IRS]. So if you used to drive 30 miles (48 kilometers) to work, the new location must be at least 80 miles (129 kilometers) from your old home. If you're self-employed and work from home, then you only have to move 50 miles away, which can be as close as the neighboring city or town.
Now the time test: Once you move into your new location, you must be employed full time for at least 39 weeks of the next 12 months. What's great about this is that you don't have to work for the same company that brought you out to the new location. Even if you quit that job or get canned, you can still deduct the moving expenses if you get another job in the same geographical area that keeps you employed for the minimum 39 weeks. Note that if you're self-employed, the time rule is more strict; you must remain employed full time for at least 78 weeks of the next 24 months after the move [source: IRS].
What exactly does the IRS let you deduct as moving expenses?
- Packing and shipping costs (moving company, for example)
- Up to 30 days of storage
- Travel to the new home including gas at $0.17 a mile
- Hotel rooms, but not meals
- Disconnecting utilities at the old home and connecting new ones [source: Turbotax].
The cool thing about moving expense deductions is that they're an "above the line" deduction, meaning you don't have to itemize deductions to claim them [source: Bischoff]. Now let's look at some ways to get creative with education expenses.
Student Loan Interest
The U.S. tax code is designed to encourage certain purchases and activities that strengthen society. Home ownership is one of those, and so is higher education. That's why the Internal Revenue Service (IRS) lets you deduct the interest you pay on both home mortgage loans and student loans. But did you know that you can deduct the interest paid on student loans -- even if you aren't the person that's paying it? If you qualify, you can deduct up to $2,500 in student loan interest every year.
As the IRS sees it, the person who is legally obligated to pay back a student loan has the right to deduct the interest [source: TurboTax]. In most cases, that person is the student. So even if your parents are the ones writing the check each month, you can still deduct that interest on your tax return.
With the IRS being the IRS, nothing is straightforward, so there are a few conditions that could potentially disqualify you from claiming the interest deduction on your tax return:
- If you're claimed as a dependent on someone else's tax return (your parents', for example), then you cannot claim the deduction.
- If your modified adjusted gross income is greater than $80,000 for a single filer or $160,000 for a married couple filing jointly, then you can't claim student loan interest as a deduction [source: Perez].
- If the loan is a Direct PLUS loan for parents or a similar loan in which your parents are legally obligated to repay it, then you can't deduct the interest from that loan [source: TurboTax].
Now let's look at some creative deductions you can take from contributing to a good cause.
If you donate money to your church or another tax-exempt organization, you are allowed to deduct those cash donations from your taxable income. The same is true for non-cash donations like used items donated to Goodwill. But did you also know that you can deduct expenses incurred from volunteer work or other charitable activities? Thanks again, IRS!
Let's say you mentor a kid across town as part of the Big Brothers, Big Sisters program. You drive 20 miles (32 kilometers) every week to meet him at his apartment. You buy reading and math workbooks to complete together. Every month, you take him to the museum or the zoo or a children's music concert. You have kids of your own, and sometimes you pay a baby sitter to watch your own children while you mentor.
All of these out-of-pocket expenses support a volunteer activity with a tax-exempt charitable organization. So all of these expenses are deductible, including:
- Mileage to and from the mentoring appointments
- Books and other tutoring materials
- Tickets to museums, zoos and educational events
- Childcare expenses while you volunteer [source: Williams Accounting & Consulting].
Don't let your charitable nature cheat you out of well-deserved tax deductions. If you really want to get creative, you can even deduct the expenses of the flour and sugar you buy to make cookies for the school or church bake sale fundraiser.
Next, we'll look at the creative (but dangerous) world of home office deductions.
Home Office Expenses
Before we get too deep into this one, heed this warning: Home office deductions are a huge red flag for the Internal Revenue Service (IRS). The IRS has established a strict set of rules on home office deductions and too many taxpayers try to flaunt them. So unless you have a perverse love of audits, rein in your creativity on this one.
According to the IRS, a portion of following expenses may be deducted for a qualifying home office:
Instead of itemizing, you can opt for taking a standard deduction of $5 per square foot of home office space, up to 300 square feet.
Again, the IRS is a stickler on this one. A qualifying home office is a part of the home that is used "exclusively and regularly" as the principle place of business [source: IRS]. Ideally, it's a separate structure from the living quarters of the house. If not, then it needs to be a place set aside exclusively for business purposes. People get into trouble when their bedroom doubles as their graphic design studio, or they work from home a couple days a week because the commute is too long [source: Turbotax].
But if you already have a portion of your home set aside exclusively for business purpose, then you have the right to take as many deductions as you deserve. For example, if you regularly meet clients or customers in your home office, you can deduct the cost of repairs and maintenance -- even landscaping -- to the home that make it more presentable [source: TurboTax].
Now let's see how you can save tax dollars by turning your hobby into a small business.
Hobby or Business?
You love growing vegetables. You love growing vegetables so much that you sell your extra produce at the local farmers market. But when you add up the money you invest each year in seeds and fertilizer and equipment repairs, you realize that this is becoming an expensive hobby. The problem is that the Internal Revenue Service (IRS) doesn't allow you to deduct expenses related to hobbies. Instead of scaling back your garden, however, why not turn your passion into a small business?
You don't have to jump through a bunch of legal hoops to start a small business. If you're a sole proprietor, you simply report your business income and expenses on Schedule C of your normal 1040 tax return. The perk is that you can deduct all of the "ordinary and necessary" expenses related to your business, even if you don't make a profit. Seeds, fertilizer and farmer's market signs are all ordinary and necessary expenses for a market gardener.
But here's where things get tricky. Whether or not your small business is profitable, the IRS insists that there be a "reasonable expectation of earning a profit" [source: Turbotax]. If you claim business losses year after year, the IRS might question whether this hobby-turned-business is really just a tax shelter. The best way to prove your legitimacy is to pass something called the "three of five" test [source: Nolo]. If your business was profitable in at least three out of the past five years, the IRS should leave you alone.
For the next creative deduction, we look at that morning commute.
Cost of Commuting
First, the bad news: If you drive miles to work every day in gridlock traffic, and then suffer through the same living hell on the way back home, the IRS won't give you a dime for your troubles. For some strange reason, you can deduct all sorts of expenses when traveling for business, but not when traveling to and from your regular place of business. But now the good news: There's a loophole.
A growing number of employers in America are participating in commuter benefit programs like the one operated by TransitChek. If your employer enrolls with TransitChek, you can opt to make pretax deductions from your monthly paycheck to cover commuter expenses. Those include everything from parking costs to bus passes to bicycle repairs. Since the money is withheld from your paycheck before taxes, it functions as a deduction from total taxable income.
For tax year 2017 (2018), the maximum monthly deduction is $260 for qualified parking and transportation [source: TransitChek]; However, the new tax legislation has removed this incentive so you can't take it next year [source: Miller].
For the next creative deduction, we'll look at unconventional medical expenses.
The IRS allows you to deduct medical expenses as itemized deductions, but only if the expenses are greater than 7.5 percent of your adjusted gross income [source: IRS]. Even if you consider yourself a relatively healthy person, you might want to read the fine print on Schedule A.
For starters, you can deduct medical expenses for yourself, your spouse and any dependents. Not only are you allowed to claim out-of-pocket expenses from doctor's office visits and medications, but also unconventional practitioners like chiropractors, acupuncturists, Christian Science practitioners, and pretty much anyone who can write a note saying that the treatment is medically necessary [source: IRS]. There are even taxpayers who have successfully deducted the expense of installing a backyard swimming pool because a doctor said it would help treat their emphysema [source: TurboTax].
And don't forget about travel expenses. You can deduct up to 17 cents a mile for driving back and forth from medical treatments, including meetings for programs like Alcoholics Anonymous [source: IRS]. You can even deduct the cost of traveling to a conference about your specific medical condition, although the costs of meals and lodging are on you.
If you have a child with a diagnosed learning disability, you can also deduct the cost of any special education programs and therapies, the mileage traveled to those therapies, and even the tuition costs for higher education programs specifically for people with learning disabilities [source: IRS].
Service animals are another deductible medical expense, but we'll talk more about service dogs and other animal-related deductions on the next page.
Dog food is a serious expense, especially if you own a fat dog. So pet owners can be excused for looking for any possible deduction come tax time. But even though our pets perform many important services for us -- chasing squirrels off the lawn, eating the leftovers under the baby's high chair -- few of them qualify as professional service animals. If you do have a medical condition that can be helped by a service animal, though, then all pet expenses above 7.5 percent of your adjusted gross income are deductible [source: IRS].
Under certain conditions, your pet might qualify as a business expense. Let's say you own a farm and your cats perform a critical service as rat and mouse hunters that protect your stored grain. Or you own a junkyard and your dog is the best alarm system money can buy. In both of those cases, you may be able to deduct at least a portion of your pets' "maintenance" costs as a business expense [source: Bird].
And then there's the case of the California "cat lady" who successfully wrote off her cat food as a charitable expense. No, she wasn't making charitable contributions to the cats. She argued in tax court that she was taking care of the cats for a nonprofit organization that found foster homes for feral animals. Even though the IRS denied the deductions, the tax court judge ruled in her favor [source: Saunders].
There are new changes to the next tax deduction that impact residents from Florida to Washington state.
The Internal Revenue Service (IRS) allows you to deduct state and local income taxes from your adjusted gross income during the same tax year. So, if you pay $1,000 in state and local taxes in April 2017 for income earned in 2016, you can deduct $1,000 from your 2017 federal income taxes. But what if you live in a state like Florida, Texas or Washington that don't collect state or local income taxes? The IRS gives these taxpayers -- all taxpayers, really -- the option of deducting state sales taxes instead. The IRS offers a handy sales tax calculator for estimating your deduction, but you can take even larger deductions if you buy a boat, plane or an airplane [source: McCormally].
You can also deduct certain vehicle-related taxes. For example, many states charge an annual registration fee for your car, truck, motorcycle, motor home or boat. This registration fee is really an extension of a sales tax, which is deductible as a personal property tax [sources: Barton, IRS].
However, starting in tax year 2018 (2019) there is an cap. Your total claim for state, sales and property taxes cannot exceed $10,000, or $5,000 for married couples filing separately. Unfortunately, it's not possible to pre-pay next-year's taxes to avoid the cap because they'll be considered paid in 2018. State, local and foreign property taxes that are deductible under Schedules C, E, and F are not capped [source: Erbs].
Tax Preparation and Appraisals
Even though it's hard to see it at 11:38 on the night of April 15, there is a silver lining to filing taxes: You can deduct all expenses related to the preparing and filing of taxes! Sort of... Tax preparation deductions fall under "miscellaneous itemized deductions" that are subject to the 2-percent limit. That means you can only deduct tax preparation expenses and fees that exceed 2 percent of your adjusted gross income [source: IRS]. Fine, it's more of a bronze lining.
Deductible expenses and fees include your accountant's fee, any software you purchased to help you prepare your taxes (Web-based services like TurboTax count), and even "how-to" books about taxes [source: IRS]. If we charged you for reading this article, you could deduct that, too.
Another deduction that falls under the 2-percent limit has to do with appraisals. If you are donating a particularly expensive item to a charity or tax-exempt institution, the IRS requires a professional appraisal to determine its fair market value. You can't include the cost of the appraisal as a charitable contribution, but you can deduct the appraisal fee as a miscellaneous itemized deduction [source: IRS]. The same is true for property that is damaged in a storm. The IRS requires an appraisal to assess the extent of the "casualty loss" for tax purposes. Again, the appraisal fee is deductible.
Many Americans don't think about their tax bills until the new year. But there are things you need to do before Dec. 31 if you want to pay less later.
Author's Note: 10 Creative (But Legal) Tax Deductions
As I write this article, I'm e-mailing back and forth with my accountant about home office deductions, local wage taxes, and other baffling tax issues that make you question the existence of a just God. I am well aware that income tax revenue is used to do all sorts of awesome things like educate children and repair bridges and educate children on how to repair bridges, but does it really have to be my tax revenue? Can't they just tax the mean people? Is there no loophole for quirkiness? Apparently not. The bright side is that researching and writing about creative tax deductions has given me hope that next year I can game the system in my favor. Do you think I can convince the IRS that my three children are service animals?
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