The word “taxes” makes most people groan. There are good reasons for this response: First of all, the cost of paying your taxes annually can be a financial burden. You may feel taken to the cleaners every time you view your paycheck after withholding for federal income taxes (not to mention state income taxes as well as Social Security and Medicare taxes). And taxes are time consuming—to gather information, meet with a tax professional if you use one, or prepare and submit your own returns.

Second, it can cost you money to get your taxes done. The IRS says that nearly 60% of taxpayers use paid preparers for their returns. Of course, because more than 90% of individual income tax returns are completed by computer (through a paid preparer, with software, or FreeFile), knowing the places where deductions and credits are entered on the return is not critical to you; it's effectively done automatically.

Third, the tax law is very complicated and changing all the time. There have been several major tax acts impacting 2022 returns, including the Consolidated Appropriations Act, 2022, the Inflation Reduction Act of 2022, and earlier laws taking effect in 2022.

Fourth, you have to know what the tax rules are and can't claim ignorance to avoid taxes and penalties. Even if you use a tax professional or tax preparation software to prepare your return, you remain responsible for your taxes. The Tax Court has noted that using software is not an automatic excuse to avoid underpayment penalties.

How can you combat the feeling of dread when it comes to taxes? It helps to know that the tax law is peppered with many, many tax breaks to which you may be entitled. These breaks allow you to not report certain economic benefits you enjoy or to subtract certain expenses from your income or even directly from your tax bill. As the famous jurist Judge Learned Hand once stated (in the 1934 case of Helvering v. Gregory in the Court of Appeals for the Second Circuit):

So get your tax affairs in order and legally reduce what you pay each year to Uncle Sam!

In getting a handle on how to do this by taking advantage of every tax break you may be entitled to without running afoul of the Internal Revenue Service (IRS), there are some simple rules to keep in mind. They include:

• You must report all of your income unless a specific law allows you to exclude or exempt it (so that it is never taxed) or defer it (so that it is taxed at a later time).
• You can claim deductions only when and to the extent the law allows. Deductions are referred to as a “matter of legislative grace”; Congress doesn't have to create them and does so only for some purpose (for example, to encourage economic activity or to balance some perceived inequity in the tax law).
• Tax credits are worth more than tax deductions. A credit reduces your tax payment on a dollar‐for‐dollar basis; a $1,000 credit saves you $1,000 in taxes. A deduction is worth only as much as the top tax bracket you are in. Suppose you are in the 24% tax bracket, which means this is the highest rate you pay on at least some of your income. If you have a $1,000 deduction, it is worth $240 (24% of $1,000) because it saves you $240 in taxes you would otherwise have to pay.
• In a number of cases, different deduction rules apply to the alternative minimum tax (AMT), a shadow tax system that ensures you pay at least some tax if your regular income tax is lower than it would have been without certain deductions.

Whether you prepare your return by hand, use computer software or an online solution, or rely on a professional, this book is designed to tell you how to get every tax edge you're entitled to. Knowing what to look out for will help you plan ahead and organize your activities in such a way that you'll share less of your hard‐earned money with the government.

Tax‐Favored Items

There are 5 types of tax‐advantaged items receiving preferential or favorable treatment under the tax law:

1. Tax‐free income—income you can receive without any current or future tax concerns. Tax‐free income may be in the form of exclusions or exemptions from tax. In many cases, tax‐free items do not even have to be reported in any way on your return.
2. Capital gains—profits on the sale or exchange of property held for more than one year (long‐term). Long‐term capital gains are subject to lower tax rates than the rates on other income, such as salary and interest income, and may even be tax free in some cases. Ordinary dividends on stocks and capital gain distributions from stock mutual funds are taxed at the same low rates as long‐term capital gains.
3. Tax‐deferred income—income that isn't currently taxed. Since the income builds up without any reduction for current tax, you may accumulate more over time. However, at some point the income becomes taxable.
4. Deductions—items you can subtract from your income to reduce the amount of income subject to tax. There are 2 classes of deductions: those “above the line,” which are subtracted directly from gross income, and those “below the line,” which can be claimed only if you itemize deductions instead of claiming the standard deduction (explained later). And there are some deductions subtracted from adjusted gross income that may be claimed whether or not you itemize other personal deductions.
5. Credits—items you can use to offset your tax on a dollar‐for‐dollar basis. There are 2 types of tax credits: one that can be used only to offset tax liability (called a “nonrefundable” credit) and one that can be claimed even if it exceeds tax liability and you receive a refund (called a “refundable” credit). Usually you must complete a special tax form for each credit you claim. Some credits may be claimed in advance of filing the return; they are paid directly to eligible taxpayers or used on behalf of taxpayers. For 2022, the advance premium tax credit is used to reduce health insurance premiums for coverage through a government marketplace. For part of 2021, the advance child tax credit helped parents by giving them a monthly payment, if eligible.

This book focuses on different types of tax‐favored items: exclusions (tax‐free income), above‐the‐line deductions that don't require itemizing, itemized deductions, tax credits, and other benefits, such as subtractions that reduce income. At the end of this Introduction you'll see symbols used to easily identify the type of benefit being explained.

Limits on Qualifying for Tax‐Favored Items

In many cases, eligibility for tax benefits or the extent to which they may be claimed depends on adjusted gross income (AGI) or modified adjusted gross income (MAGI).

Adjusted gross income is gross income (all the income you are required to report) minus certain deductions (called “adjustments to gross income” on Schedule 1 of Form 1040 or 1040‐SR). Adjustments or subtractions you can make to your gross income to arrive at your adjusted gross income are limited in 2022 to the following items:

• Alimony payments for pre‐2019 divorces and separation agreements
• Archer Medical Savings Accounts (MSAs) (for accounts set up prior to 2008)
• Business expenses of self‐employed individuals
• Capital loss deductions of up to $3,000
• Charitable contributions up to $300 ($600 for joint filers) if you don't itemize personal deductions, but only if Congress extends this tax break for 2022; see the Supplement for any update
• Educator expenses up to $300
• Employer‐equivalent portion of self‐employment tax
• Forfeiture‐of‐interest penalties because of early withdrawals from certificates of deposit (CDs)
• Health Savings Account (HSA) contributions
• Individual Retirement Account (IRA) deductions
• Jury duty pay turned over to your employer
• Legal fees for unlawful discrimination claims
• Net disaster loss incurred before February 26, 2021, for which insurance settlements were fixed in 2022, but only if you don't itemize personal deductions (Congress may extend the net disaster loss rule for events after this date; check the Supplement for any update)
• Net operating losses (NOLs)
• Performing artist's qualifying expenses
• Qualified retirement plan contributions for self‐employed individuals
• Rent and royalty expenses
• Repayment of supplemental unemployment benefits required because of the receipt of trade readjustment allowances
• Self‐employed health insurance deduction
• Simplified employee pension (SEP) or savings incentive match plan for employees (SIMPLE) contributions for self‐employed individuals
• Student loan interest deduction up to $2,500
• Travel expenses to attend National Guard or military reserve meetings more than 100 miles from home

Figuring AGI may sound complicated, but in reality it's merely a number taken from a line on your tax return. For example, AGI is the figure you enter on line 11 of the 2022 Form 1040 or 1040‐SR.

Modified adjusted gross income is merely AGI increased by certain items that are excludable from income and/or certain adjustments to gross income. Which items are added back varies for different tax breaks. For example, the MAGI limit on eligibility to claim the student loan interest deduction is AGI (disregarding the student loan interest deduction) increased by the exclusion for foreign earned income and certain other foreign income or expenses. All of these items are explained in this book.

Household income is a term in tax law used to determine eligibility for the premium tax credit to help pay for coverage purchased through a government marketplace. Household income is explained further in this book in connection with these tax rules.

Qualified business income. If you are an owner in a pass‐through entity—a sole proprietorship, limited liability company, partners, or S corporation—you may be eligible for a qualified business income (QBI) deduction. QBI for purposes of this personal deduction is explained further in Chapter 14.

Taxable income. This is the amount of income remaining after subtracting deductions. Taxable income is the amount on which taxes are figured. Taxable income is also the threshold used for determining the QBI deduction explained in Chapter 14.

Standard Deduction versus Itemized Deductions

Every taxpayer, other than a dependent of another taxpayer, is entitled to a standard deduction. This is a subtraction from your income, and the amount you claim is based on your filing status. Table 1.1 shows the standard deduction amounts for 2022. About 87.5% of all filers used the standard deduction.

In addition to the basic standard deduction, certain taxpayers can increase these amounts. An additional standard deduction amount applies to those age 65 and older and for blindness. For 2022, the additional amount is $1,750 for individuals who are not married and are not a surviving spouse and $1,400 for those who are married or a surviving spouse.

You cannot claim any additional standard deduction that applies to those 65 or older and/or blind if you choose to itemize deductions in lieu of claiming the basic standard deduction amount.

Individuals who do not itemize but suffered a net qualified disaster loss in a federally declared disaster area before February 26, 2021, and settled a claim in 2022 can effectively increase their standard deduction amount. Net qualified disaster losses are explained in Chapter 12.

Instead of claiming the standard deduction, you can opt to list certain deductions separately (i.e., itemize them). Itemized deductions include:

• Medical expenses
• Taxes
• Interest payments
• Gifts to charity (non‐itemizers may be able to claim a limited deduction for cash donations if Congress extends the rule that expired at the end of 2021; check the Supplement for any update)
• Casualty and theft losses in federally‐declared disaster areas
• Gambling losses
• Estate tax payments on income in respect of decedents

Generally, claim the standard deduction when it is greater than the total of your itemized deductions. However, it may save overall taxes to itemize, even when total deductions are less than the standard deduction, if you are subject to the alternative minimum tax (AMT). The reason: The standard deduction cannot be used to reduce income subject to the AMT, but certain itemized deductions can.

In the past there was an overall limit on itemized deductions for high‐income taxpayers. This limit does not apply for 2018 through 2025.

If a married couple files separate returns and one spouse itemizes deductions, the other must also itemize and cannot claim a standard deduction.

Impact of Deductions on Your Chances of Being Audited

Did you know that the IRS collects statistics from taxpayers to create profiles of average deductions? If you claim more than the average for your income range, the IRS's computer may select your return for further examination. The Inflation Reduction Act provided funding for the IRS to hire 87,000 new agents, causing concern among taxpayers that audit chances will increase. The Treasury Secretary promised no increased audit rates for those with income under $400,000, but there are no guarantees.

Nonetheless, tax experts agree that you should claim every deduction you are entitled to, even if your write‐offs exceed these statistical ranges for those who itemize. About 12.5% of individuals itemize their deductions. Just make sure to have the necessary proof of your eligibility and other records you are required to keep in case your return is examined.

How to Use This Book

This book is tied to Form 1040, U.S. Income Tax Return for Individuals. It can also be used for Form 1040‐SR, Income Tax Return for Seniors; a form specifically for seniors age 65 and older.

The chapters in this book are organized by subject matter so you can browse through them to find the subjects that apply to you or those in which you have an interest.

Each tax benefit is denoted by an icon to help you spot the type of benefit involved:

•  Exclusion
•  Above‐the‐line deduction
•  Itemized deduction (a deduction taken after figuring adjusted gross income)
•  Credit
•  Other benefit (e.g., a subtraction other than an above‐the‐line or itemized deduction that reduces income)

For each tax benefit you will find an explanation of what it is, starting with the maximum benefit or benefits you can claim if you meet all eligibility requirements. You'll learn the conditions or eligibility requirements for claiming or qualifying for the benefit. You'll find both planning tips to help you make the most of the benefit opportunity as well as pitfalls to help you avoid problems that can prevent your eligibility. You'll see where to claim the benefit (if reporting is required) on your tax return and what records you must retain to support your tax position.

You'll find dozens of examples to show you how other taxpayers have successfully taken advantage of the benefit. Over the years, taxpayers have been able to write off literally thousands of items; not every one is listed here because space does not allow it. And you'll learn what isn't allowed even though you might otherwise think so. There are references to free IRS publications on a variety of tax topics that you can download from the IRS website (www.irs.gov) or obtain free of charge by calling 800‐829‐1040.

You'll also see key dates for various actions, such as filing returns, contributing to retirement plans, and reporting foreign financial accounts to the U.S. Treasury. For example, the deadline for filing 2022 federal income tax returns is April 18, 2023.

In the appendices, you'll find a listing of items that can be adjusted each year to reflect cost‐of‐living changes so you can plan ahead, as well as a checklist of items that are tax free, and a checklist of items that are not deductible.

Throughout the book you will find alerts to possible changes to come. For a free update on tax developments, look for the Supplement to this book in February 2023, by going to www.jklasser.com, as well as to my website, www.BigIdeasForSmallBusiness.com.