With tax season upon us, it is time to tackle the age-old question: should I to itemize my taxes when filing?
Itemizing’s relevance has increased since the Tax Cuts and Jobs Act nearly doubled the standard deduction for individuals as well as couples. So, should you itemize your deductions? If so, what is the right way to do it?
Should You Itemize or Use the Standard Deduction?
One of the reasons people choose the standard deduction is because of the effect it has on the tax-prep process. This makes it relatively easier and faster. This is, however, a somewhat flawed approach. By choosing not to itemize your deductions, you might be paying more in taxes than you ought to.
There are a large number of deductions and tax credits that are available to taxpaying individuals as well as couples. You can find the list of itemized deductions on the IRS website.
Depending on your income level, the assets you own, and the debts you have, you might qualify for many of these deductions. By claiming them, you can reduce your tax bill significantly and save money.
For example, if you happen to have a mortgage or a home equity loan, the interest amount you pay is entirely deductible. Similarly, if you spend a substantial amount of money on medical expenses, you can deduct a portion of the expenses as well.
The same rule applies to a number of other expenses like local and state income taxes, property taxes, donations made to charities, and many more. Put it all together and the amount is likely to exceed the standard deduction you are allowed to claim, certainly if you live in a high tax state like California or New York.
Currently, the rate of standard deduction is set at $12,000 for individual taxpayers, $18,000 for heads of households, and $24,000 for couples who file their returns jointly. If the total amount of your itemized deductions exceeds the standard deduction amount, you should definitely itemize your deductions.
How to Itemize Deductions
Now that you’ve decided whether itemizing is for you, let’s look at the logistics of the process:
Obtaining the Necessary Forms
The first thing you need to do when itemizing is to obtain the necessary forms to file your tax returns; these are Form 1040 and Schedule A. You can either download the forms directly from the IRS website or get them from the local IRS office, post office, or local library.
Proof of Income and Expenses
Your eligibility for certain deductions depends on your adjusted gross income. So, to confirm this, you need to submit a proof of income.
Depending on your occupational status (full-time worker, independent contractor, or self-employed), you might need one or more of the following documents, including a pay stub, bank statement, W-2, 1099, 1099-MISC, and more.
The IRS generally does not require you to submit proof of expenses while filing your returns. However, in the event of an audit, you will have to submit the documentation for every deduction you claimed in your returns.
It’s a prudent idea to collect all the required documents beforehand and keep them safely filed away.
Itemizing Your Deductions
You can use Schedule A for the purpose of itemizing your deductions. The instructions for Schedule A can be downloaded from the IRS website. Included in the instructions is a list of all the expenses that you are allowed to itemize, depending on your eligibility.
This is the most important step in the whole process – one which can reduce your tax burden considerably. You should take as much time as you want and do a thorough job of itemizing all the possible deductions that you can qualify for. Even in the age of lower taxes and a strong economy, this is just logical.
Check out the video below to get some visual learning about how you can itemize your deductions:
Most Common Tax Deductions
Here is a list of the most common tax deductions that you can take advantage of.
You are allowed to deduct the interest paid on your mortgage, as long as the total loan amount does not exceed $750,000. Similarly, you are also allowed to deduct the amount you paid towards mortgage points while purchasing or building your house.
Local and State Taxes
You are allowed to deduct the local and state taxes you paid from your adjusted gross income, – up to $10,000. – from your adjusted gross income. You can choose to deduce local and state income taxes or sales taxes, whichever allows you to claim a bigger deduction.
Medical and Dental Expenses
If the amount you spent on medical and dental expenses is equal to or less than 7.5% of your adjusted gross income, you do not qualify for the deduction. If it is more than 7.5% of your income, you can deduct the difference from your income.
For example, if you make $100,000 per year and your total medical and dental expenses amount to $7,500 or less, you cannot claim any deduction. If, on the other hand, you spend $12,000 on medical and dental expenses, you are allowed to deduct $4,500 ($12,000 – $7,500) from your income.
Some of the qualifying medical expenses include:
- Diagnostic procedures like x-rays and scans
- Prescription medications
- Ambulance services and in-hospital care
- Fees charged by general physicians, dentists, psychiatrists, ophthalmologists, podiatrists, and physical therapists
You can even deduct the amount you spend on home renovation, as long as it is done for medical purposes like constructing a wheelchair ramp.
If you donate to tax-exempt charitable organizations, you can deduct the amount from your adjusted gross income.
If you donate physical items like clothes, books, furniture, electrical appliances, or vehicles, you can deduct the value of the items from your income. The same rule applies to real estate properties as well.
The amount you contribute to your 401(k) and traditional IRA accounts are deductible. Similarly, the amount you contribute to your health savings account is also deductible.
If you borrow money to make a taxable investment and if you pay interest on the borrowed amount, you can deduct the interest from your adjusted gross income.
Apart from this, there are a number of other deductions that you might qualify for, which include student loan interest, educational expenses, home office expenses, residential energy credits, gambling losses, and alimony.
Calculating Your Taxable Income
Once you have made a complete list of all your deductions, add them and subtract the amount from your adjusted gross income. The resulting number is your taxable income.
Now, you can calculate the amount of tax you have to pay, depending on the income tax bracket you belong to. You can reduce your taxes further by claiming tax credits that you qualify for.
Itemizing your deductions gives you an opportunity to reduce your tax bill considerably. Though the process can be more complicated than standard deductions, the time and effort you put into it could be well worth the dollars you will save at the end of the day.