The Facts on Itemized Tax Deductions
The US tax code can be complex and confusing, with numerous rules and regulations that change periodically. Deducting taxes can be a complex subject within the tax code. One popular method is through itemized tax deductions, which lets individuals and businesses reduce their taxable income by claiming expenses incurred during a tax year. However, there are certain rules that govern the process of itemizing to ensure that taxpayers do not unfairly evade taxes. In this article, we will delve into the facts on itemized tax deductions and outline what taxpayers need to know.
What Are Itemized Tax Deductions?
A tax deduction is a reduction in taxable income by the amount of the expense incurred for specific purposes. Taxpayers who choose to itemize expenses on their tax returns list all expenses that are tax-deductible, as allowed by the Internal Revenue Service (IRS), and take the sum of these deductions to reduce their taxable income.
There are two ways to claim deductions on your tax return: you can either take a standard deduction or itemize your deductions. The standard deduction is a specific amount that taxpayers can reduce from their taxable income without having to itemize expenses. The standard deduction amount typically changes annually. Those who don’t have enough expenses to exceed the standard deduction should take the standard deduction, while those who have more than the standard amount of expenses can benefit from itemizing.
Itemized deductions allow taxpayers to deduct expenses they incurred during the tax year for medical expenses, charitable donations, state and local taxes, mortgage interest, and other costs like unreimbursed employee expenses and tax preparation fees. Itemized deductions provide incentives for taxpayers to make charitable donations, pay real estate taxes, and incur expenses that reduce their taxable income.
Furthermore, itemizing deductions is particularly useful for taxpayers who are relatively high-earning or who have significant, ongoing expenses, such as those who own property or self-employed individuals. In contrast, taxpayers with lower-income and fewer expenses than the standard deduction will find little benefit in itemizing.
What Are the Rules?
To qualify for itemized deductions, there are several rules that taxpayers must follow. For starters, a taxpayer must keep track of all transactions and expenses incurred during the tax year. All relevant information such as receipts, bills, and statements should be accurate and properly documented.
One of the most common errors taxpayers make when itemizing tax deductions is forgetting to track tax payments, including state and local income taxes, sales taxes, and property taxes. The IRS provides resources and tables to determine the amounts of these taxes that can be claimed.
Another significant key to claiming itemized deductions is timing. Expenses are typically deductible in the year in which they were paid, regardless of when the service was delivered. For instance, if you paid mortgage interest in December 2021 at the beginning of the 2022 fiscal year, the interest amount cannot be claimed until the 2022 tax year; the same rule applies to medical expenses, charitable donations, and other tax-deductible expenses.
What Can Be Itemized?
The IRS has specific rules for what expenses qualify for itemized deductions. These expenses must be related to the taxpayer’s income and necessary to achieve it. Based on the tax code guidelines, here are some popular categories of itemizable deductions:
Medical Expenses: Expenses for medical care such as prescriptions, copays, surgeries, medical device purchases, and transportation for medical care purposes.
Taxes: State, local, and property taxes, sales taxes, and other deductibles paid for local taxes that meet certain conditions.
Charitable Donations: Cash donations, including charitable contributions of property, travel costs incurred while volunteering for a qualified charity, and gifts to family members in dire situations or emergencies.
Mortgage Interest: Interest from home mortgages and interest paid on second homes or rental property.
Investment Interest: Investment interest paid on brokerage accounts and debts related to investments.
Business Expenses: Business-related expenses incurred in connection with the taxpayer’s job, such as travel and entertainment, equipment, and supplies, are usually deductible when they exceed the threshold percentage of Adjusted Gross Income (AGI).
Casualty and Theft Losses: Casualty or theft losses that arise from theft or destruction of personal property or when a natural disaster destroys the property, such as a home or business. However, certain conditions must be met before claiming the deduction.
There are other categories of deductions that can impact tax liabilities, so it can be useful to consult with a tax professional or work with tax software to determine if you qualify for additional deductions.
How Does the Tax Cuts and Jobs Act of 2017 Affect Itemized Deductions?
In 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law. The act made significant changes to the tax code and affected many taxpayers, including those who itemize deductions. The changes took effect starting on January 1, 2018, and have continued to have an impact on tax returns ever since.
One significant change to itemized deductions was the increase in the standard deduction for individuals, married couples filing jointly, and heads of households. The standard deduction increased to $12,000 for individuals, $24,000 for married couples filing jointly, and $18,000 for heads of households.
In contrast, TCJA eliminated the deduction for personal exemptions, and it limited several itemized deductions that existed before the act. For instance, taxpayers can now only claim a maximum of $10,000 per year in state and local tax deductions, including property, income, and sales taxes. There is no limit before, and this change particularly affects taxpayers living in states with high taxes and high-priced real estate.
Another common deduction for itemizers affected by TCJA is the cap on mortgage interest deductions, which were reduced from $1 million to $750,000 for mortgages taken out after December 1, 2017. Additionally, the limit on home equity loan interest has been removed, and the threshold for deducting medical expense deductions has been decreased from 10% to 7.5% of AGI for tax relief in 2017 and 2018.
What Are the Benefits of Itemizing Deductions?
Itemizing deductions offers several benefits for taxpayers who have high cash outflows. Taxpayers who itemize their deductions, especially those who pay high expenses in areas like real estate and state taxes, are generally able to reduce their taxable income and possibly get a higher tax refund or pay lower taxes. Thus, itemizing is a good option for taxpayers who have significant expenses that they can itemize and whose itemized deductible expenses exceed the standard deduction.
An example of a taxpayer who would benefit from itemizing is someone who owns a home and who pays over $10,000 in property taxes, lives in a high-income tax state and has significant medical costs. Their total deductible expenses could easily exceed the standard deduction. For others, it might depend on the specific tax year.
What Are Some Tips for Maximizing Itemized Tax Deductions?
Maximizing itemized tax deductions can be difficult, especially as the rules and regulations are subject to change. However, some tips can help taxpayers increase their deductions. Here are some tips to consider for itemizing:
– Keep meticulous records: It’s essential to maintain your receipts and statements of expenses as well as to track every expense that might be tax-deductible.
– Make donations and charitable contributions: Donations to charitable organizations are tax-deductible, and they can boost your itemized deductions quickly. You could also consider donating appreciated assets like stock and mutual funds as an alternative for easy tax savings.
– Pay property taxes or other expenses ahead of time: It is best to pay tax expenses ahead of time to qualify for tax deductions, as the deduction applies to the year in which it was paid.
Another way to maximize deductions is to consider seeking the services of tax preparation professionals to help you with your tax filing. Certified professionals can advise you on tax deductions, tax credits, and other financial matters, ensuring you maximize your itemized deductions.
Conclusion
Itemized tax deductions provide an excellent opportunity for taxpayers to reduce their taxable income, minimize tax liability, and receive a larger tax return. However, the rules and regulations surrounding itemizing tax deductions can be complicated, so it is critical to understand what you can claim. Keeping complete and accurate records can be the difference between cost savings and missed deductions. With careful planning and organization, taxpayers can shrink their tax liability and stress lessened come tax time.
An itemized tax deduction is a type of eligible expense that an individual taxpayer has an incurred and may report on their federal income tax returns so that the amount of the individual’s taxable income may be reduced. An itemized tax deduction is an alternative option for a taxpayer to choose, as opposed to the standard deduction. When filing taxes, a taxpayer may compute the adjusted gross income and discover the amount of itemized tax deductions, which can be subtracted from the gross income to calculate the total amount of taxable income. Next, the taxpayer may use the standard deduction method to compute the amount of taxable income. Whichever method yields the greater amount of deductions will generally be the method chosen by the taxpayer when the tax return is filed.
What are Allowed for Itemized Tax Deductions?
There are a number of itemized tax deductions which may be included in a tax return to reduce the amount of taxable income of an individual:
Medical expenses are eligible to be included in itemized tax deductions, up to a certain amount. The amount of eligible medical expenses is calculated by determining 7.5 percent of a taxpayer’s gross adjusted income and subtracting it from the total medical expenses. Medical expenses which are eligible for inclusion are:
Payments to doctors, dentists, physical therapists, psychologists, health care professionals, etc.;
Premiums of medical insurance;
Payments for prescription medication;
Travel expenses for transport to medical facilities for treatment, including mileage;
Non-deductible medical expenses, such as health club memberships;
Taxes, both state and local. These include:
Income taxes;
Property taxes;
Mortgage interest expense on debt which has been incurred on up to two homes;
Investment interest, up to the amount of income returned from such investments;
Charitable Contributions to recipients that are eligible. The deduction is allowable between 30 to 50 percent of the adjusted gross income, depending on the recipient. Though goods and money are accepted for itemized
tax deductions, services are not, except for expenses incurred for performing such services. Charitable contributions eligible for itemized tax deductions generally are given to:
Churches, synagogues and other houses of worship;
Federal, state, or local government organizations;
Fraternal or veteran organizations;
Individuals and political contributions are not included as a tax deductible contribution.
Losses that have been incurred due to theft or casualty to the extent that the losses exceed 10 percent of a taxpayer’s adjusted gross income.
Losses incurred due to gambling to the extent of the amount of total income created due to gambling winnings.
Miscellaneous Itemized Tax Deductions:
Miscellaneous itemized tax deductions differ from typical itemized deductions because miscellaneous deductions have a 2 percent minimum. This means that a taxpayer can only deduct miscellaneous itemized deductions that total at least 2 percent of their adjusted gross income. Any deduction not listed in 26 U.S.C. § 67(b) is considered to be a miscellaneous itemized tax deduction. These usually include:
Clothing and equipment which has been purchased for job-related activities, such as hardhats and uniforms. Suits and tuxedos are not eligible for deduction;
Subscription memberships to newspapers, magazines and other periodicals for purposes relating to a job;
Union dues.
Standard Tax Deduction and Itemized Tax Deduction Comparison:
Not everyone is eligible to choose between itemized tax deduction and standard tax deduction. Only taxpayers who meet certain requirements may choose the standard tax deduction method. The taxpayer must be either a citizen of the United States or a resident alien to be eligible for a standard deduction. If the taxpayer is a nonresident alien, he or she will not be able to choose the standard method. When a married couple files their tax returns, if they are filing separately, if one spouse chooses the itemized tax deduction method, the other spouse will not be eligible to choose the standard method. Instead the spouse should either choose itemized tax deduction or claim a “0” for the calculated total of the standard deduction. In addition, itemized tax deductions require prior records to be maintained to prove their validity.
When a taxpayer has calculated the total amount of taxable income when using both the itemized tax deduction and standard tax deduction methods, the two differing totals should be carefully analyzed. Even if choosing the itemized tax deduction method yields a more beneficial return for the taxpayer, if the difference is negligible between the itemized and standard totals, it may be wiser to choose the standard method. The reason this should be considered is because the Internal Revenue Service (IRS) may disagree with the itemized total, and may make changes that reduce the amount of return. A standard deduction will not be adjusted by the IRS unless a taxpayer’s filing status is changed.
