What Is an Itemized Deduction?
It’s that time of the year again when picking between itemized and standard deduction can give you a headache, won’t it? Instead of doing what everyone else seems to be doing, you should figure out which of these two options can save you more money in the long run. Today we’re going to discuss itemized deductions.
The first thing you need to know about this approach is the fact you should be well prepared to undertake it. If tax season is just a short distance away, we don’t recommend you going through the hassle unless you’ve saved receipts and proof of your yearly expenses. These are required by the IRS as evidence for all the items you’ve added on your tax forms.
Itemized Deduction Vs Standard Deduction
Until recently, many American households have picked itemized deductions over standard ones. So what’s the difference and why the change?
The standard deduction represents the amount of money eligible taxpayers can deduct from their gross income. This number depends on your filing status, age, whether or not you’re legally blind and whether you’ve claimed as a dependent on someone else’s tax return.
Itemized deductions are sometimes subject to thresholds, but nonetheless they can include gambling losses, property tax, medical expenses, eligible charity donations and more.
The Tax Cuts and Jobs Act has recently nearly doubled the standard deduction amounts. If your expenses are much lower than the new measures, you shouldn’t opt for an itemized approach, as you won’t be saving as much money. If the opposite is true for you, make sure all your paperwork is in order before you even start.
Want to know more about standard deduction? Check this article for the latest information so that when the time comes, you’ll know exactly how to file your taxes with an approach that best suits you and your household.
Understanding Itemized Deductions
Right off the bat, you should not confuse tax deductions with tax credits. In the case of credits, taxpayers will simply lower their bills by the credit amount. For example, if you are eligible for a $1,000 tax credit and your due taxes amount to $16,000, you’ll only be required to pay $15,000.
Understanding itemized deductions calls for a little more math! Have you got your pen and paper ready?
Unlike for standard deductions, itemized deductions rely on your tax bracket. Yours will depend on where your income places you, higher or further down the ladder. Say you’re single and that your gross income is $80,000. If your itemized deductions come up to $10,000, your taxable income will be $70,000. Itemized deductions reduce our taxable income, but by how much?
Well, in this example you’ll need your tax rate for that bracket, 22%. Multiplying your $10,000 figure with your tax rate will give you the amount of tax saved- in this case, $2,200.
$80,000 – $10,000 = $70,000
$10,000 × 0,22 = $2,200
Starting from 2018, the doubling of the standard deduction made itemizing tax deductions less advantageous for many taxpayers.
When should you pick itemized deductions?
In order to answer this question, you should first look at the deduction you’re eligible through standard deduction, depending on your filing status as well as other considerations.
For more information on standard deductions, check out this article!
A single taxpayer in 2020 could be better off filing for the standard deduction of $12,400 if his or her itemized deductions are much lower than that. Married couples who file jointly can deduct $24,800. Depending on their yearly expenses, it might be worth it to take advantage of this, not to mention that itemizing involves a lot more time and research.
In some cases, picking isn’t even a choice anyway. Nonresident aliens and married individuals who are filing separately must itemize. In the latter case, a joint decision must be made. Ideally, you should both look for ways in which you can reduce your tax liability. To put it simply, if your spouse decides to itemize, you cannot pick the standard approach even if you’re filing separately.
What Can and Can’t Itemize?
Allowable deductions change every year, so you should always do your research before making a decision between this and standard deductions.
You can add charitable donations (up to 60% of your adjusted gross income), gambling losses, investment interest, $2,500 of student loan interest and $250 for educators who buy classroom supplies, both medical and dental expenses (if they’re over 10% of your adjustable gross income) to the list.
However, you cannot itemize alimony payments, unreimbursed employee expenses or tax- preparation expenses.
As we have explained earlier, there are certain thresholds and caveats when it comes to itemizing. For example, you may itemize your mortgage interest on a loan of $750,000 but not above. The only exception to this rule is if you have had a loan of $1 million and purchased your property before the 15th of December, 2017.
You can also itemize state and local income, personal property and sales taxes but only up to $10,000. Furthermore, only active-duty military moving expenses (due to military order) are acceptable. Natural disaster losses may only be added if the area is officially recognized as a disaster area by the president.
Some of these may surprise you, especially when looking at which of these no longer applies. That’s because the changes are relatively recent, having been introduced in 2018, and many citizens may not have been made aware of the changes to the tax system. As always, ensure that you’re well documented. The last thing you need is to make mistakes on your tax forms.
How Do You Claim Itemized Deductions?
Turn to page two of your 1040 form where you’ll see a question regarding your decision: itemized or standard. If you’re going for the former you’ll also need a Schedule A.
Schedule A is crucial as it’ll run you through all your items and how to calculate your expenses properly. Once finished you’ll have to add your final amount back on your 1040 Form.
The Bottom Line
In order to reduce your tax bill, you can pick between a standard and itemized deduction. The itemized deduction represents the expenditure on yearly eligible expenses, so take careful note of what you can or can’t add to the list as well as other special considerations.
In the end, the amount you’ll save rests on your tax bracket and filing status. While most Americans can pick between these two filing systems, there are some restrictions. Most notably, nonresident aliens, although other exceptions do apply. Married couples must decide how they are going to file in order to avoid any roadblocks.
What do you think, was this article helpful? We hoped you’ve got a better understanding of what you should do come tax season. Remember, if you’re unsure what standard deductions imply, you can always refer back to this article!