04 Mar Five Most Common Ways to Reduce Your U.S. Taxes
“Don’t you just take the information I give you and plug it into some software?”
This is one of my least favorite questions I am asked because it is everything that a good CPA should not be. A good accountant should not just take the information provided by the taxpayer and “plug it in”. They should think about the situation and analyze which filing techniques are best for you. Should you file jointly or separately? Should you file with an exclusion or with a foreign tax credit? Were there any children born during the year that can help reduce your taxes? You should have a CPA who is proactive and an advocate for you!
At the same time, no one is ever going to be a better advocate for yourself than you are. It is more important in this ever-changing tax world that you know what is going on with your tax return and know what to ask your accountant. It is also important to know what available tools are best to reduce your U.S. taxes. With that in mind, here are the top five ways to reduce your U.S. taxes. Make sure to go over these with your CPA to ensure you are getting the best results possible:
- Child Tax Credit refund
- Child & Dependent Care Credit
- Filing jointly with your Non-US spouse
- Tuition credits
- Foreign Tax Credits
Child Tax Credit Refund:
For tax years 2019 onwards, your U.S. citizen children aged 17 and younger can net you a $2,000 per child U.S. tax credit. $1,400 of that can be refundable. Meaning if you have five children under the age of 17, and a high enough salary, you can get up to $7,000 back when filing your U.S. tax return. Often people are hesitant to file a return and claim the credit based on two misconceptions. The first being that it is a big audit flag. While this used to be the case a few years back, there is no longer the same bias at the IRS, and as long as you are filing correctly, your chances of being audited are no higher because of your children. The second reason people are hesitant is that they feel like if they don’t request a refund then the IRS will treat them more favorably in future years. This is also, unfortunately, not true and while you will be missing out on a potential refund, the IRS will not feel any differently about you in the years you owe tax.
You have 3 years to file back returns and claim the refund, so if you haven’t made a claim and think you should have, please contact your CPA.
Child and Dependent Care Credit:
Not as well-known as the Child Tax Credit refund, the Child Care Credit is often missed. As long as you qualify, you can get a tax credit for expenses such as daycare costs for children under the age of 12. The Child Care Credit can be used for multiple children in the same year. While education expenses overseas aren’t as high as they are in the U.S., daycare can still be very costly.
The restrictions for the Child and Dependent Care Credit can be limiting though. If you are married and don’t file jointly, you will not be eligible to claim the child dependent care credit. This ties into our next point nicely, which covers filing jointly with your non-U.S. spouse.
Joint filing with a non-U.S. spouse:
Often people do not realize that while their non-U.S. spouse does not have a filing requirement, it may help reduce taxes if they file jointly. Their partner would need to file for an ITIN (Individual Tax Identification Number), and include their own income. However, if your spouse’s sole income is a salary, there may be multiple benefits to adding them on to your tax return. For one, you can claim the taxes they pay overseas which may help reduce your taxes. Another benefit is that you may now be eligible for the Child Care Credit mentioned above. The third is that if you did not have enough income to claim the full Child Tax Credit refund, you may get more by adding your spouse. Finally, while adding them onto your return may also include other income they have, it will not subject them to social security tax or Net Investment Income Tax (NIIT), both of which can be tax traps for U.S. citizens. If you are unfamiliar with social security tax issues and the NIIT, I suggest you read here.
While there can be big benefits to adding your non-U.S. spouse to your U.S. tax return, it is something that should be handled delicately to avoid unwanted taxes. Please make sure to bring this up with your accountant when filing.
The American Opportunity Credit or AOTC is another partially refundable credit. This means that if you qualify, you can get $1,000 from the IRS without having paid them anything in advance. If you are enrolled in a school that is accredited by FAFSA, many of which we have in Israel, the first $4,000 of tuition can help reduce your U.S. taxes by up to $2,500 or get you a refund of $1,000.
In order for the tuition to qualify it needs to be to a FAFSA accredited school, must be the first four years of post-high school level education, and you must be enrolled at least half-time for at least one academic period at the beginning of the tax year. Some additional requirements may also limit your refund, so speak to your CPA if you are currently or were in college.
There is also the lifetime learning credit, which is not refundable but can be used for all post-secondary education and for an unlimited amount of years. Make sure to mention to your tax preparer that you were in school during the tax year to maximize your tax benefits.
Foreign Tax Credits:
You may ask, “I live and work overseas. I pay tax in the country I live in. Why should I have to pay the U.S. also?” This is a great question, and in most situations, you are allowed a credit on your U.S. taxes for the taxes you pay to your home country. While the concept of taking foreign taxes to offset your U.S. taxes may seem like something basic and that should be thought through in every scenario, you may be surprised by how many times it is missed. Often taxpayers will not get the full benefits allowed to them by offsetting their U.S. taxes with the foreign taxes they pay. The reason may be that it is easier for the accountant to prepare the return using a different method like the foreign earned income exclusion.
Not to bog you down with too much tax jargon, but there are basically two ways to make sure you don’t pay U.S. tax on foreign salary income while living overseas. The first is to exclude up to $107,600 (for 2020) of foreign earned income. This is by far the more common way of dealing with foreign salaries, and while easier to file, may lack a better understanding of the taxpayer’s needs.
The second way to negate U.S. taxes is to take into account the foreign taxes paid and calculate a tax credit on the U.S. tax. While this can be more complex and time-consuming the benefits may be well worth it. For one, you will still be eligible for the Child Tax Credit refund mentioned above. For another, it may help to build up a foreign tax credit carryover cushion. As an example, say that you make $100,000 of salary and file single. Your U.S. tax will come out to around $15,000, but your foreign taxes may come to about $20,000. If you claim the exclusion you won’t owe any tax for the current year, but you also won’t have any benefit in a future year, and you won’t be able to get a Child Tax refund.
If you choose instead to use the foreign tax credit, you can end up not owing any U.S. tax, receiving a refund of $1,400 per child, and carrying over the remaining $5K ($20,000-15,000) forward to a future year for up to ten years. Say you decide next year to pull out a foreign pension, while it will be tax-exempt in Israel, it will create $4,000 of tax in the U.S. If you excluded your income last year, you will owe tax this year. However, if you carried over your tax credits from last year, you can use them to offset the current tax and come out with more cash in your pocket.
While this seems like something your accountant should calculate for you, it is important to be aware of the difference so that you make sure to bring it up and confirm that it was considered. As with most things, there can be unforeseen consequences when switching back and forth, so make sure to discuss both approaches with your tax preparer to make sure you are doing what is right for you.
In summary, your accountant should be your advocate, and you should feel comfortable talking to them about how they went about preparing your return. It very well may be that they are unaware of your full situation and if given more information, they may be able to help reduce your taxes further. Make sure that if you owe tax, you go over your situation with your tax preparer to ensure that you know why tax is due. This will not only help save you from potential tax pitfalls but will also help you plan for the future by optimizing your tax situation going forward.