Top Tax Deductions

by Diana Fitzpatrick, J.D.

Don't overlook any of these personal tax deductions -- they make itemizing your deductions well worth it.

1. Mortgage interest and property taxes.
You can deduct the mortgage interest (not the principal) that you pay on a loan secured by your primary residence or a second home. To claim the deduction, you must be obligated to pay the debt and you must actually make the payments. You can also deduct any taxes you pay on real estate you own that is not used for business. If you have a mortgage on the property, the annual mortgage statement (Form 1098) you receive from the bank should include both the amount you paid in real estate taxes for the year and the interest and points you paid for the year (your mortgage interest deduction). 

2. Charitable donations.
You can deduct any cash or noncash contributions you make to a qualified nonprofit organization. While you are supposed to save receipts for any contribution, deductions for noncash contributions under $250 are rarely questioned. For noncash contributions over $250, you must have a receipt or acknowledgement from the nonprofit organization. For noncash contributions over $500, you have to file an extra form with your tax return, Form 8283, Noncash Charitable Contributions.

3. Medical expenses and health savings accounts.
You can deduct the amount of your medical and dental expenses that exceeds 7.5% of your adjusted gross income. Eligible expenses include both health insurance premiums and out-of-pocket expenses not covered by insurance for both you and your dependents. Unless your medical expenses are substantial, however, your medical expenses will probably fit within the 7.5% limitation, meaning you won't be able to deduct anything.

If you have a qualified Health Savings Account (HSA), you can deduct your contributions to the account, and you don’t have to pay tax on any interest you earn from the account. To establish an HSA account, you must have a high-deductible health plan that qualifies under the HSA rules. You can use money in your HSA account to pay almost any kind of health-related expense.

4. Child and dependent care.
If you have to pay someone to care for your child (under 13) or a dependent needing care so that you can work or look for work, you may be able to claim a tax credit for those expenses. The credit is a percentage of your eligible work-related child or dependent care expenses, ranging from 20% to 35%, depending on your income. There is a dollar limit on the amount of expenses for which you can claim the credit. The limit is $3,000 of the expenses paid in a year for one person, or $6,000 for two or more. You must reduce these dollar limits by the amount of any dependent care benefits provided by your employer that you exclude from your income.

5. State and local taxes.
Under the American Jobs Creation Act (AJCA) of 2004, taxpayers have been given a choice when it comes to deducting state and local taxes. For the tax year 2005, you can choose to deduct either your state and local income taxes or your state and local general sales and use taxes, but not both. You can decide whether it’s more beneficial to deduct your income tax or your sales tax. This is good news for taxpayers who live in states with no (or a low) state income tax like Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. In 2006, taxpayers will no longer have the choice to deduct state and local general sales taxes, unless pending legislation extends this option to future years.