Itemized deductions and the standard deduction reduce the amount of income on which you must pay taxes. Which is worth more, though? Taking itemized deductions can be quite a bit of work when filing your tax return, especially when doing this on your own, for the first time.
Unfortunately, you can only take one; you can either itemize your deductions on Schedule A or take the standard deduction. Most people find it more financially prudent and easier to take the standard deduction, but for others, itemizing their deductions is worth it.
In this article, we will look at what it means to itemize deductions and what exactly the standard deduction is. We’ll also examine when you should itemize and when you are required to itemize.
We’ll take a look at some of the more popular itemized deductions that taxpayers take, looking more closely at a few of them, along with examples on how they affect your adjusted gross income. Finally, we will go over what kind of documentation you need to have organized if you decide to itemize as the IRS will expect you to have specific information ready in the event of an audit.
What is an itemized deduction?
An itemized deduction is an expense on eligible services, products, or contributions that can be subtracted from the AGI (adjusted gross income) to reduce one’s tax bill. Available itemized deductions range from mortgage interest to charitable contributions. Those are just a couple of the ones that are available for you to choose from.
It’s smart to itemize when you have many deductions and when the total of those deductions is more than the amount of the annual standard deduction as established by the IRS. Itemizing can be an overwhelming task, especially if you have not organized your documents and receipts for the tax year.
What is the standard deduction?
The standard deduction is an amount set by Congress. It’s usually increased each year due to inflation. The amount given each year is different; it is based on your filing status. Your filing status is based on your marital status and whether or not you claim any dependents.
If you are married but are not sure whether you should file jointly or separately, you would benefit from this article. For more information about filing statuses and how they affect your tax bill, check out this article.
Claiming the standard deduction reduces your adjusted gross income (AGI) and allows you to fill out IRS Form 1040EZ or IRS Form 1040A, which is shorter and easier than IRS Form 1040, which is used for itemized deductions, such as charitable donations.
The standard deduction for the 2019 and 2020 tax years are as follows:
Filing Status | 2019 Tax Year | 2020 Tax Year |
|---|---|---|
Single | $12,200 | $12,400 |
Married Filing Jointly (MFJ) | $24,400 | $24,800 |
Married Filing Separately (MFS) | $12,200 | $12,400 |
Head of Household (HOH) | $18,350 | $18,650 |
The Medical Expense Deduction
The expenses that you may include in this deduction include the cost of insurance premiums and certain qualifying medical and dental expenses. For 2019, the deduction rate was 7.5% of your adjusted gross income (AGI).
Example: In 2019, your adjusted gross income was $40,000, and your qualifying medical and dental expenses were $5,000. This means your deduction would be limited to $2,000 – the amount that exceeds $3,000 (7.5% of your AGI of $40,000).
The Mortgage Interest Deduction
The interest that you incur on your mortgage can be deducted if you itemize, but certain limitations apply. The Tax Cuts and Jobs Act (TCJA) limits the deduction to $750,000 ($375,000 if you are married filing separate tax returns). Additionally, you can only deduct acquisition debt, not equity debt (funds used to buy, build, or substantially improve your home). This can be a great deduction for you if you incur substantial mortgage interest.
The State and Local Tax Deduction
The Tax Cuts and Jobs Act (TCJA) limits this deduction to $10,000 collectively, meaning you must choose which tax type you will use this deduction for. If you are married filing separately, you are limited to $5,000.
Charitable Contributions Deduction
Tithing and gifts are rewarded and can be deducted as an itemized deduction on Schedule A of IRS Form 1040. The limit put in place by the Tax Cuts and Jobs Act (TCJA) is up to 60% of your adjusted gross income for some gifts. Limitations are 20%, 30%, or 50% for other gifts.
For more information on how to maximize your charitable contributions deduction, check out this article.
Casualty and Theft Loss Deduction
This deduction can be very beneficial if you have experienced a tragedy in a disaster. The limitations placed on this deduction make it such that you must have experienced loss in the event of a disaster area as declared by the government.
Investment Interest Deduction
This deduction applies to broker or advisor fees. This can be a great deduction for you if you are a heavy investor. You are limited in this deduction by how much you earn. That means if you did not earn anything in the tax year, you could not take this deduction because you have nothing to deduct.
What kind of documentation do I need if I itemize my deductions?
If you plan to itemize your deductions, it’s imperative that you maintain organized records – proof that you deserve the deductions you plan to use in case of an audit. Examples of the type of records you may need in the event of an audit include receipts and statements showing you incurred the expenses you are claiming. For more information about the kinds of documents, you may need to have ready in the event of an audit, see this page on the IRS’s website.
For more information on the anticipation of an audit and what you should do to prepare yourself, check out this article. To prepare your records for a possible audit, check out this article. It will guide you as you determine which documentation you should keep in the event of an audit.
Worried about being audited? Check out this article for the best way to reduce your chances of being audited. Expecting an audit? This article will walk you through what is involved in an audit.
To Sum Things Up…
If you are having trouble deciding between the standard deduction and itemizing your deductions on Schedule A of IRS Form 1040, consider getting the help of a tax professional. A tax expert can advise you on the best way to take deductions on your annual tax return, can help you file your tax return, and can counsel you on the right documentation to hold on to during the tax year in the event of an audit.
Are you struggling to understand deductions and whether you should itemize or not? Does the thought of filing your taxes or preparing documentation make your stomach turn? Are you expecting or fearing an audit?
If you are expecting or worrying about getting an audit, please seek the advice of a tax professional. He or she can help you determine what you need to have ready for an audit and can even represent you in the event of an audit.
Keep in mind that some tax professionals do not have the credentials to represent you in an audit. If you need a qualified tax accountant, contact us. We are qualified to help you in the event of an audit.
If you need help with your tax return or a consultation with a tax professional, please contact us. We can help you with your business needs and taxes throughout the year (not just during tax season). You can trust Indiana’s tax expert to steer you in the right direction.
