Standard Deduction vs. Itemized Deductions
As tax season approaches, odds are you are seeing in the news and hearing everyone talk about deductions.”Oh you can deduct that,” and “that’s not deductible.”
Many of you may be asking yourself, what exactly is a deduction? and what will result in receiving the largest refund or owing the least?
In the quest of completing your taxes (or having a CPA prepare them), each taxpayer must determine if it is more beneficial for them to take the standard deduction or to itemize their deductions. You must do one or the other.
But first, how do deductions benefit me?
As you can see from the screenshot of the 1040 below, both the standard deduction and itemized deductions effectively reduce your adjusted gross income to arrive at taxable income.
As is evident, the larger this deduction line, the less your taxable income, and the less total taxes you will have owed for the year. There are limited times when a taxpayer does not have an option and must itemize their deductions even if itemizing deductions results in less of a benefit than taking the standard deduction.
When do I have to itemize deductions?
- If you are married, are filing a separate tax return from your spouse, and your spouse itemizes their deductions.
- If you elect to change your annual accounting period and are therefore filing a short year tax return.
- If you were a nonresident alien or a dual-status alien during the year. Dual-status implies you were both a nonresident for part of the year and a resident for the other part of the year. Additional rules apply if you are not a U.S. citizen. We suggest speaking with a tax professional to determine correct treatment.
What is the Standard Deduction?
The standard deduction is a fixed dollar amount, determined by the IRS, that reduces your taxable income. As noted above, by reducing your total taxable income, when your applicable rate is applied, the total tax that was due for the year to the IRS is effectively less. Below is a table summarizing the standard deduction amounts for 2014:
|If your filing status is…||Your standard deduction|
|Single or Married filing separately||$6.200|
|Married filing jointly or Qualifying widow(er) with dependent child||12.400|
|Head of household||9.100|
If you are wiser (born before January 2, 1950) and/or blind, your standard deduction for 2014 is determined below. The first step, is to determine your applicable “number.” Count the boxes below that apply to your situation:
You: Born before January 2, 1950: □ Blind: □
Spouse: Born before January 2, 1950: □ Blind: □
Total applicable boxes _______
In the following table look for your filing status in column 1. Locate your “number” in column 2. Your applicable standard deduction is in column 3:
|If your filing status is…||Number of boxes above||Your standard deduction|
|Married filing jointly or Qualifying widow(er) with dependent child||1||$13.600|
|Married filing separately||1||$7.400|
|Head of household||1||$10.650|
Now that you know what your standard deduction is, let’s determine if it would be more beneficial for you to itemize your deductions.
The IRS has established certain allowable deductions. These are reported on schedule A of the individuals’ tax return.
This section will discuss some of the most common itemized deductions. To determine if other situations may be applicable or if you have any questions you can contact us here.
NOTE: A forewarning. You must keep appropriate supporting documentation for all your itemized deductions. The IRS generally does NOT recognize bank statements or credit card statements as sufficient documentation. You will need to keep receipts of all your documents. There are various softwares and phone apps you can utilize to make this process much easier for yourself.
Deductible Medical and Dental Expenses
Non reimbursed medical and dental expenses are deductible in excess of a 10% floor (all expenses in excess of 10% or 7.5% depending on your age of your adjusted gross income (AGI)).
Deductible medical and dental expenses as described by the IRS include the following:
- Payments for services provided by various medical practitioners
- Nursing home services and in-patient hospital care fess
- Payments for various drug and alcohol rehabilitation programs
- Fees for prescribed weight-loss programs for a specific disease or diseases diagnosed by a physician, including obesity
- Prescription drug and medication costs.
- Payments made for admission and transportation to a medical conference relating to a chronic disease that you, your spouse or your dependents have (if the costs are primarily for and essential to necessitated medical care). However, you may not deduct the costs for meals and lodging while attending the medical conference
- Dental payments for false teeth
- Payments for prescription eyeglasses, contact lenses and reading glasses
- Fees for the blind or deaf relating to hearing aids, crutches, wheelchairs, and guide dogs
- Costs of transportation to access medical care
- Payments for insurance premiums paid.
Taxes You Paid
Taxes you paid are directly deductible. These DO NOT include federal income and most excise taxes nor Social security, Medicare, federal unemployment (FUTA), and railroad retirement (RRTA) taxes.
State and Local Income Tax Deduction
Each individual can elect to deduct either state income taxes or general sales taxes. Deductible state income taxes include:
- State and local income taxes withheld from paycheck
- State and local estimated taxes paid during the year
- Various mandatory state contributions
If you elect to deduct general sales tax, you can either deduct the actual expense or use the optional sales tax tables. There are various rules to the actual sales tax deduction that you will want to consult the prescribed directions for. Of course to take any actual deduction, you will want sufficient appropriate supporting documentation (receipts). The optional sales tax calculator is much easier and makes record keeping much easier. You can find this calculator here.
Property Tax Deduction
The real estate tax deduction (property taxes) is one of the most common deductions. Property taxes paid during the year are deductible for properties you own that are not for business. Property taxes for your business are business expenses, effectively reducing your business net income. For individuals, these are often reported on your mortgage interest statement Form 1098 if you escrow your payments. If not, you can obtain this information easily by searching for your counties’ property tax records or contacting your local county office.
Personal Property Taxes
Here you can deductr the state and local personal property taxes paid during the year. These include county taxes assessed during your annual car registration and more!
If you have additional taxes that were not deducted with the previous lines, you can enter and deduct them here if they are qualifying deductible taxes.
Interest you Paid
Deductible interest is often one of the main factors that push individuals itemized deductions in excess of the standard deduction.
Mortgage Interest and Insurance
Home mortgage interest and points are deductible as long as is for any loan that is secured by your main home or second home. This includes both first and second home mortgages, home equity loans, and re-fi mortgages. The points you paid on completing your mortgage paperwork will be included on your settlement statement. It will be important to provide this statement to your accountant for your tax return processing. The mortgage interest will either be reported on a 1098, which you will receive after year end from the mortgage provider, or you will have to determine by utilizing an amortization schedule for private mortgages.
In this section you can also deduct your mortgage insurance premiums paid during the year.
Investment interest, not including interest related to passive activities or to securities creating tax-exempt income, is interest paid on money you borrowed that is related to investment property.
Gifts to Charities
The ability to deduct charitable contributions provides an incentive for individuals to donate as well as provide charities with the extra funding they need to provide the services they do.
In order to take this deduction, your donation must be made to a qualified tax exempt charity. This means money donated to individuals can not be deducted. The following apply to charitable donations:
- Can only deduct amount given in current year (not pledges)
- You can donate property but generally need to have the following records to substantiate:
- Less than $250 – receipt from the Organization
- $250-500 – a written acknowledgement of the donation with item description of estimated value
- $500 – 5,000 – the same above information along with description of how and when you got the property and the basis
- $5,000+ – a qualified appraisal must be completed and presented
- Can NOT deduct your time spent helping a charity
- Can deduct the cost of gas and oil to get to a volunteer spot (actual cost or 14 cents per mile)
Casualty and Theft Losses
Losses derived from theft, vandalism, fire, storm, or similar causes; car, boat, and other accidents; and corrosive drywall may be partially or fully deductible. The deductible portion are those not reimbursed by insurance or the amount of loss that is in excess of your insurance coverage.
In order to properly determine the amount of loss you can deduct here, complete and attach Form 4684 to your return.
Job Expenses and Certain Miscellaneous Deductions
This section is one of both the most abused and underused deductions on the tax return.
Unreimbursed Employee Expenses
In order for these expenses to be deductible, they must be both ordinary and necessary expenses for your job that you were not reimbursed by your employer for. The issue that a lot of individuals run in to is what defines ordinary and necessary. The IRS defines ordinary as one that is both common and accepted in your industry and profession. They define necessary as expenses that are helpful and appropriate for your business. A defined distinction exists in that the expense does not have to be required in order to be considered necessary.
If you are able to claim any travel, transportation, or meal/entertainment deductions, you will need to be sure to complete and include form 2106.
Some examples of additional deductible unreimbursed business expenses:
- Safety equipment, small tools, and supplies
- Uniforms not suitable for ordinary wear but required by your employer (scrubs, specialized uniforms, etc.)
- Protective clothing including hard hats, safety shoes (steel toed boots), and glasses
- Dues paid for local chambers and professional organizations
- Subscriptions paid for professional journals.
- Certain business use of part of your home
- Certain educational expenses.
Tax Preparation Fees
These are the fees you paid to have your prior year tax return prepared. Whether it be by an accountant or a fee to file through TurboTax, you can deduct it here.
Other expenses differ from Other Miscellaneous Deductions reported in the next section below. These expenses are related to amounts you paid to produce reported taxable income and for managing property for income. A sample of common other expenses follows:
- Certain legal and accounting fees
- Clerical help and office rent
- Custodial fees.
Other Miscellaneous Deductions
Reference the IRS schedule A instructions or your accountant for additional expenses you may possibly qualify for!
As you can see from the above, there is a definite potential benefit to itemizing your deductions, if you are able to. Yes itemizing will provide more of a benefit, but it also requires you to maintain adequate records for multiple years. Creating a system of organization and record management is key to your success if an audit were to arise of your tax return. Overall, as you begin itemizing your deductions, there are numerous opportunities for you to rightfully save. This is where hiring a CPA to help you understand all the potential deductions you could qualify for would be beneficial.