You just can’t avoid it—we all have to do our taxes for the 2021 tax year. But if you play your cards right, you can substantially reduce your taxable income. Tax exemptions, tax deductions and tax credits change your adjusted gross income (AGI), lowering your tax bill in the process.
In 2017, the Tax Cuts and Jobs Act (TCJA) changed or eliminated many of the exemptions, deductions and tax credits traditionally available to American taxpayers. Feeling daunted? We’ve got you covered. To get you ready to file your 2021 taxes, we’re here to break down those tax exemptions and deductions. This is general information, you should always consult a tax professional about your individual situation.
In This Piece:
- Tax Breaks in Brief
- Tax Deductions
- Tax Credits
- Is Your Business Tax-Exempt?
- Make Tax Season Simpler
- The Tax Exemption Wrap
Tax Breaks in Brief
Tax deductions, tax credits, tax exemptions—tax break terminology can be confusing. Let’s demystify the lingo with a brief explanation of each type.
Tax Deductions
In a nutshell, tax deductions reduce your AGI. You subtract deductions from your gross income, and sometimes you’ll end up in a lower tax bracket as a result. Popular tax deductions include the student loan interest deduction, the medical expenses deduction, the IRA contributions deduction and the self-employment expenses deduction.
Tax Credits
Tax credits reduce the amount of tax you owe. Simply put, they act like money-off vouchers for your final bill. Common tax credits include the child tax credit, the lifetime learning credit, the earned income tax credit and the residential energy credit.
What Is the Personal Tax Exemption for 2021?
Before tax year 2018, everyone got a $4,050 personal tax exemption. Taxpayers then got a $4,050 exemption for each dependent in their household. When the TCJA passed in 2017, it eliminated this exemption, almost doubled the standard tax deduction and increased child and dependent credits. So, no more personal or dependent tax exemptions until at least 2025, when the TCJA expires.
Tax Deductions
When you file your taxes, you can use the standard deduction or itemized deductions to offset your taxable income. In 2020, the standard deductions were:
- $12,400 for single filers
- $24,800 for joint filers
- $18,650 for head of household
However, for 2021, the deduction amounts were adjusted for inflation to:
- $12,550 for single filers
- $25,100 for joint filers
- $18,800 for head of household
What Can I Deduct on My Taxes?
If you take the standard deduction, you can’t itemize your deductions. Many people go for the standard deduction because it amounts to more than the total value of their itemized deductions. Hefty medical bills, disaster losses and large charitable contributions can make itemization worthwhile, however.
Common Tax Deductions
We’ve briefly covered medical bills, disaster losses and charitable contributions, but let’s go into more detail. Here are a few more common tax deductions.
- Nonrefundable credits: Only provide a refund up to the amount you owe in taxes.
- Refundable credits: Provide a refund no matter how little you owe.
Tax Credits
Tax credits reduce the amount of tax you have to pay. There are lots of different individual tax credits. Let’s talk about a few of the most popular credits in more detail.
- Family and dependent credits: If you have children or take care of aging relatives, disabled adults or other dependent people, you may qualify for specific dependent credits. Examples include child and dependent care credit and adoption credit. For 2021, the child tax credit was expanded from $2,000 to $3,000. However, how much you get on your return depends on if you took the credit in advance with monthly payments for the second half of 2021.
- Homeowner credits: Tax credits for homeowners change often. Credits for 2021 include residential energy credits and one for owning a plug-in electric vehicle.
- Health care credits: The Affordable Care Act is a health care credit. If you paid out of pocket for health insurance, you can offset your premiums via the Health Coverage Tax Credit.
- Education credits: Tax breaks like the lifetime learning credit (LLC) help offset education-related expenses.
- Income and savings credits: If your income is lower, you might qualify for the earned income tax credit. Financial credits include the Saver’s Credit and the foreign-earned income exclusion (FEIE).
Is Your Business Tax-Exempt?
Have you ever considered the tax status of your business? Some organizations are tax-exempt, so they don’t pay any taxes whatsoever at the federal level. It might sound good, but there’s a catch. To achieve tax-exempt status, you can’t be a for-profit business, and you can’t receive a profit-based payout from your business.
Tax-exempt business types include:
- Charitable organizations
- Political organizations
- Veterans organizations
- Social welfare organizations
- Agricultural or horticultural organizations
- Labor organizations
- Social clubs
Tax-exempt businesses are often—but not always—also exempt from state and local taxes once they receive federal tax-exempt status. This rule varies from state to state, however.
Make Tax Season Simpler
Do you find tax season nerve-wracking? You’re not alone. Every year, millions of Americans wait until the last minute to file their taxes. Some of them owe taxes, while others feel intimidated by the filing process.
The Tax Exemption Wrap
Tax breaks traditionally fall into three categories: tax exemptions, tax deductions and tax credits. In 2017, the TCJA put tax exemptions on the back burner until at least 2025, leaving deductions and credits alone on the table for tax year 2021. You can itemize your deductions, or you can choose the standard deduction when you complete your taxes.
