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What is Tax Relief?
By Jamela Adam MONEY RESEARCH COLLECTIVE
Millions of taxpayers in the United States struggle with fulfilling their tax obligations. According to recent data from the Internal Revenue Service, in 2020 alone, Americans owed a staggering $141 billion in back taxes, interests, and penalties.
If you’re dreading tax season each year or feeling weighed down by your tax obligations, don’t worry. There is help available. Tax relief options like income tax credits and government debt settlement programs can lighten your load and help you keep more of your hard-earned money in your pocket. Read on to learn more about what tax relief is and how it can help reduce the amount of taxes you owe Uncle Sam.
How does tax relief work?
There are several types of tax relief, each with its own eligibility requirements and benefits. However, all tax relief programs either save you money on taxes or help you get out from under the tax debt you owe. In the following sections, we’ll dive deeper into the various forms of tax relief and help you figure out which best fits your situation.
Understanding tax deductions
A tax deduction is an expense that can be deducted from your income to reduce the amount you pay in taxes. There are two ways to claim a tax deduction: A standard deduction or an itemized deduction.
Simply put, a standard deduction is a preset amount that you can subtract from your taxable income each year with no questions asked. Since there’s no need to provide any documentation to qualify, it’s a simple and rather straightforward way for filers to lower their tax obligations by a fixed amount.
Below are the standard deduction amount set by the IRS for the tax year 2022:
- Singles and married people filing separately: $12,950
- Married couples filing jointly: $25,900
- Heads of households: $19,400
Itemized deductions, on the other hand, require more extensive paperwork since you’ll need to list each specific expense on your Schedule A. However, claiming itemized deductions may make more financial sense for you if the total amount is greater than that of your standard deduction. This option can be beneficial if you’ve incurred large medical expenses, property taxes, etc. during the tax year.
Here are some other examples of itemized deductions you could potentially claim apart from the ones mentioned above:
- Charitable contributions
- Gambling losses
- Home mortgage interest
- Moving expenses
- Real estate tax
- Casualty and theft loss(es) from a federally declared disaster
Keep in mind that you’re only allowed to choose one deduction method. This means if you opt for the standard deduction, you can’t further reduce your taxable income with itemized deductions.
Understanding tax credit
Though tax deductions and tax credit both lower the amount of money you’ll need to shell out during tax season, they do so in different ways. Unlike tax deductions that reduce your taxable income, tax credits directly reduce your final tax bill, dollar-for-dollar. Here’s an example to illustrate the difference: Let’s say Sarah is in the 24% tax bracket and qualifies for $10,000 in itemized deductions; she’ll shave $2,400 ($10,000 x 24%) off her tax bill. Whereas if Sarah qualifies for a $10,000 tax credit, she’ll lower her tax obligations by exactly $10,000 — a considerably larger amount of savings than what she’d realize on $10,000 in tax deductions.
Here are some of the most popular tax credits you could consider taking advantage of this tax year:
Earned income tax credit
Also known as EITC or EIC, this is a special tax break offered to low-income or moderate-income workers to help reduce their tax burden.
Foreign tax credit
This is a dollar-for-dollar credit to help U.S. expats avoid the possibility of double taxation and offset the income tax paid in a foreign country.
American opportunity tax credit
Also known as AOTC, this tax credit helps college students or their parents pay for the costs of postsecondary education.
Child tax credit
This refundable tax credit is for families with qualifying children. If the child is under the age of 6, the parent can potentially receive up to a $3,600 credit. And if the child is between 6 and 17, the parent could receive a $3,000 credit.
Lifetime learning credit
Similar to the AOTC, the Lifetime Learning Credit (LLC) helps offset the cost of education. However, unlike AOTC which only covers the first four years of college, LLC is less restrictive and can apply all the way through grad school.
Saver’s credit
Formerly known as the Retirement Savings Contribution Credit, the Saver’s Credit encourages low-income and moderate-income workers to set aside money for retirement.
Understanding tax exclusions
Tax exclusion, as its name suggests, reduces your taxable income by excluding certain income streams from being taxed altogether. Some examples include life insurance death benefit proceeds, child support, welfare, and academic scholarships.
If you participate in an employer-sponsored health insurance plan, the portion of the premiums you pay can also be exempt from taxation. This prevents you from having to pay taxes on compensation received in the form of health benefits.
Another common example of tax exclusion pertains to home sales. For single taxpayers, you can exclude up to $250,000 of the capital gain from the sale of your main residence — provided that you meet all qualifying conditions.
Other tax exclusions can include revenue streams from:
- Municipal bond income
- Disability pensions
- Payments for natural disaster relief
- Benefits from federal subsidies
Understanding tax debt relief
Falling behind on your taxes? You might want to look into the Fresh Start program by the IRS. Launched in 2011, this program aims to help distressed taxpayers clear up their tax problems and resolve any outstanding tax debt. There are currently four Fresh Start options available:
- Offer in compromise: This option is a settlement between a taxpayer and the IRS that allows the taxpayer to pay less than the full amount of taxes owed. To qualify for an offer in compromise, you must demonstrate financial hardship and meet specific requirements. You can use the offer in compromise pre-qualifier tool to see whether you’re eligible.
- Currently not collectible (CNC): If you qualify for the currently not collectible status, the IRS won’t levy on your assets or garnish your wages. Instead, you’ll defer making tax payments until you’re financially ready to start paying. Keep in mind that under this option, the IRS can keep your tax rebates and apply them to your tax debt.
- Installment agreement: This payment plan allows you to pay your tax debt over a specific and extended timeframe. Just like a mortgage or a car loan, you’ll make monthly payments to the IRS until the tax debt is paid in full. Note that interests and penalties can continue to accrue during the repayment period.
- Penalty abatement: the IRS understands that there are circumstances beyond your control that can prevent you from fulfilling your tax obligation. For this reason, the IRS offers a penalty abatement for taxpayers who can show that their non-compliance was due to reasonable cause. Some examples of reasonable causes include the inability to obtain tax-related records, natural disasters, or the illness/death of the taxpayer. Bear in mind that the lack of funds, in and of itself, is not a reasonable cause for failure to comply with tax laws.
Apart from government tax debt relief programs, you can also seek help from tax professionals who can help negotiate payment options with the IRS. Make sure to do your research to find the best tax relief companies that can solve your tax problems and get your life back on track.
When is tax relief a good idea?
Tax relief can be a good idea if you find yourself struggling to keep up with your tax obligations. For example, if you owe the government back taxes, you may be able to negotiate a payment plan with the IRS to gradually pay it off over time. And if you’re a single parent facing financial difficulties, you can claim certain tax help such as the Child Tax Credit to reduce your tax bill and relieve some weight off your shoulders.
Even if you aren’t having trouble paying your taxes, you can still take advantage of tax deductions, tax credits, or tax exclusions to help lower your tax bill. For example, if you’re self-employed and work from home, claiming the home-office tax deduction can help you free up money to reinvest in your business.
Tax relief requirements
When it comes to tax breaks, there are a lot of different options and programs available. However, each one has different requirements in order to qualify. That’s why you should always check the IRS website or consult with a tax professional beforehand. Otherwise, if you’re audited by the IRS and found to have claimed an incorrect amount of tax relief, you might be required to repay the full amount of taxes owed plus interest. In severe cases, the IRS can also charge you with an accuracy or fraud penalty. So don’t take any chances and always do your research before claiming any type of tax relief. It could save you a lot of money and headaches down the road.
Alternatives to tax relief
If you determine that tax relief programs aren’t right for you, consider exploring these alternative solutions to help resolve your tax debt:
Take out a home equity loan
Taking out a loan to pay off your tax debt might not sound like an attractive solution for homeowners, but the IRS actually advises taxpayers in distress to “consider financing the full payment of tax liability through loans, such as a home equity loan from a financial institution.” A HELOC, or home equity line of credit, is a way to tap into the equity in your home for a variety of purposes, including home improvement projects, college tuition, and in some cases, resolving tax debt. Because home-equity interest rates tend to be quite affordable, you can end up saving money in the long run — instead of incurring hefty penalties and interest charges on your tax bill.
Debt consolidation loans
If you’re not just behind on your taxes, but also drowning in several other types of high-interest debt, you might want to consider taking out a debt consolidation loan. By consolidating multiple debts with different interest rates and monthly payments into a single loan, you can make one monthly payment at a lower interest rate. This can save you a huge chunk of change on interest charges and help you get out of debt faster. Be sure to compare rates from various providers so that you can find the best debt consolidation loan for your particular situation.
Bottom line to tax relief
If you’re looking for ways to resolve your tax debt or just get a bit of extra money back in your pocket, it’s worth taking the time to explore the different tax relief options available. And if you’re ever unsure about the requirements associated with each option, consult with a tax professional beforehand.
Whichever tax relief method you go with, just be sure to address any outstanding tax liabilities as soon as you can. The sooner you do so, the fewer interest charges and penalties you’ll incur, and the more peace of mind you’ll have.
