When you file your taxes each year, you have the choice of taking the standard deduction or itemizing your deductions. The standard deduction is a preset amount that you are allowed to deduct from your taxable income each year. This amount will vary according to your tax filing status and is adjusted annually. But often, it is more beneficial to itemize your deductions. To get the biggest bang out of your buck, read on to learn when to itemize your deductions and when to stick with the standard deduction.
In President Trump’s new tax outline, itemized deductions are virtually going away except for a few, such as mortgage payments and charitable donations. In the place of itemized deductions, the standard deduction is proposed to double. The intention is to maximize tax savings and simplify the tax code. Good idea, right? Below is an overview of the current rules for itemized deductions.
The Purpose and Nature of Itemized Deductions
Itemized deductions fall into a different category than “above-the-line” deductions, such as self-employment expenses and student loan interest; they are “below-the-line” deductions, or deductions from adjusted gross income. They are computed on the IRS’s Schedule A, and the total is then carried to your 1040 form. Once itemized deductions have been subtracted from your income, the remainder is your actual taxable income. Itemized deductions were created as a social-engineering tool by the government to provide economic incentives for taxpayers to do certain things, such as buy real estate and make charitable donations.
Which Deductions Can Be Itemized?
Schedule A is broken down into different sections that specify each type of itemized deduction. The following is a brief overview of the scope and limits of each category:
Unreimbursed Medical and Dental Expenses
This deduction is the most difficult to qualify for. Taxpayers who incur qualified out-of-pocket medical and/or dental expenses that are not covered by insurance can deduct expenses that exceed 10% of their adjusted gross income.
Homeowners can deduct the interest that they pay on their mortgages and home equity lines of credit.
Taxpayers who itemize are able to deduct two types of taxes on a Schedule A: Personal property taxes (such as real estate taxes) and state or local taxes that were assessed for the previous year. However, any refund received by the taxpayer from the state in the previous year must be counted as income if the taxpayer itemized deductions that previous year.
Any donation made to a qualified charity is deductible (within certain limitations). Cash contributions that exceed 50% of the taxpayer’s adjusted gross income (AGI) must be carried over to the next year, as well as non-cash contributions that exceed 30% of AGI.
Casualty and Theft Losses
Any loss incurred because of a casualty or theft can be reported on a Schedule A; however, only losses in excess of 10% of the taxpayer’s AGI are actually deductible. Also, if a taxpayer incurs a loss in one year and deducts it on taxes, any reimbursement that is received in later years must be counted as income.
Unreimbursed Job-Related Expenses and Certain Miscellaneous Deductions
W-2 employees who incur work-related expenses can deduct the expenses that exceed 2% of their AGI. Work-related expenses include items such as: equipment and supplies, protective clothing, expenses for maintaining a home office, vehicle expenses, dues to professional organizations and professional subscriptions. Certain other miscellaneous deductions are listed in this section as well, such as income tax preparation and audit fees, and any expenses related to maintaining investments or income-producing property. These fees include such items as IRA or other account-maintenance fees, legal and accounting fees, and margin interest.
Other Miscellaneous Deductions
This category of itemized deductions includes items such as: gambling losses to the extent of gambling winnings, losses from partnerships or subchapter S-corporations, estate taxes on income in respect of a decedent, and certain other expenses.
Income Limitations for Itemized Deductions
Itemized deductions for taxpayers with an AGI above a certain level may be reduced. These levels depend on your filing status. If you’re above this level, you’ll need to complete an Itemized Deductions Worksheet to determine the amount to enter on line 29 of the Schedule A.
Remember to Aggregate
There are times when the additional deduction from excess medical or job-related expenses will allow itemized deductions to exceed the standard deduction. Do not assume that you cannot deduct miscellaneous expenses or that you cannot itemize deductions if your itemizable deductions are insufficient, by themselves, for you to qualify.
The Bottom Line
There are many rules concerning itemized deductions that are beyond the scope of this article. Working with an experienced tax professional can help to ensure those rules are applied to your tax return in your best interest. The Trump Presidency may bring about big changes, but that remains to be seen.