With tax season quickly approaching, it’s a great time to take a look at your projected tax return and decide on a tax strategy that fits your personal situation. Choosing the right deductions is one way taxpayers can plan for their federal income tax liability to reduce taxable income and, potentially, achieve a larger return.
When it comes to deductions, you have two overarching options: to select the standard deduction or to itemize deductions. While there are reasons why you would benefit from either strategy in a given tax year, there are significant benefits to both options depending on your income and personal circumstances.
Let’s explore the differences between standard and itemized deductions and the associated strategies that lead taxpayers to choose one over the other.
The Difference Between Standard and Itemized Deductions
The choice between standard and itemized deductions is sometimes made for you based on your eligibility to claim either type. While there are some restrictions on claiming deductions, these are usually based on a taxpayer’s filing status, filing period, and citizenship status.
Assuming you have the option to claim either type deduction, there are some major differences between the two.
Standard Deduction
The standard deduction amount is based on the taxpayer’s income, age, and filing status. For the tax year 2019, the standard deduction amounts are as follows:
Single Taxpayers - $12,200
Married Taxpayers Filing Jointly - $24,400
Head of Household - $18,350
There are additional amounts applicable to those 65 or older. You can use the IRS’s How Much is My Standard Deduction tool to determine a more accurate amount.
Regardless of the amount, the standard deduction is applied to your gross income in order to adjust your taxable income. Ideally, the amount of your standard deduction will be less than the amount you would be able to deduct by itemizing.
Itemized Deductions
Itemized deductions are pre-defined expenses that the IRS identifies as legitimate factors that decrease your taxable income. Unlike the standard deduction, itemizing can lead to a variety of deductible amounts once you go through your yearly expenses and applicable deductions. If this number is more than your standard deduction, it’s usually in your best interest to itemize.
If your itemized deductions do equal more than the standard deduction, you’ll have a lower adjusted income, resulting in lower taxes and a potentially higher return. There are also many potential deductions you can browse, some of which we’ll review later.
There are strict rules that apply to taxpayers who itemize their deductions, which are a deterrent for some. Ensuring that all rules are adhered to and going through the extensive list of deductions also takes a considerable amount of time. While that makes planning in advance more important, the extra time to itemize deductions isn’t always available to taxpayers.
Changes by the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) was passed in December of 2017 brought about the largest changes to U.S. tax code since 1986. Among the many changes in the TCJA, one was an increase in the standard deduction for all taxpayer categories, reduced tax rates for individuals and businesses, and various limitations to available itemized deductions.
The major changes to itemized deductions included a reduction in the allowed deduction for medical and dental expenses, lower allowable deduction for state local taxes, restrictions to mortgage interest deductions, and the elimination of miscellaneous deductions higher than 2% of your adjusted gross income.
Overall, the TCJA makes itemizing your deductions less advantageous than in previous tax years. However, it can still be worthwhile to itemize depending on your situation, and it’s still possible that your itemized deductions might exceed the standard deduction.
List of Itemized Deductions
While there are many potential itemized deductions, here are the most popular and often the most advantageous:
Medical and Dental Expenses - This deduction pertains to qualified medical expenses that exceed 10% of your adjusted gross income. There are many qualified expenses under this deduction, including hospital care and ambulance service.
State and Local Taxes - This deduction is limited to $10,000 and requires that you choose whether to deduct state and local sales tax or state and local income tax. For both options, the IRS provides tables and a calculator function to help you determine how much you can deduct without tracking every receipt. This deduction also includes property taxes.
Interest - Generally, this deduction is for home mortgage interest and investment interest. Special attention must be paid to the separation between business and personal use of loans, as the reporting method will change based on the usage. There are also, of course, limits on the amount you can deduct for home mortgages and investment interest.
Charitable Contributions - With this deduction, you can list monetary gifts (and their equivalent) given to organizations of a religious, charitable, educational, scientific, literary, or humanitarian nature. There are limits to the amount the IRS will allow you to deduct, so make sure to plan accordingly when donating and tracking your contributions.
For a full list of available itemized deductions, check out the draft of the 2019 Instructions for Schedule A.
Strategies for Increasing Itemized Deductions
With changes from TCJA affecting itemized deductions, it’s even more important to have a strategy in place to ensure that you’re maximizing deductions.
Multiple strategies are available. One might be making charitable donations out of your IRA. If you’re in a position to donate to charitable organizations and are over the age of 70, consider utilizing this option. It essentially involves replacing taxable minimum distributions with tax-free donations to approved organizations. The amount you donate is completely tax-free, meaning you avoid paying taxes on the distribution while gaining the ability to write-off the donation.
If making tax-free charitable donations isn’t an option, you can still strategize by timing out your spending to fit into a single tax year. This strategy can be used for medical bills by planning payments based on the tax year. For example, you can pay minimum amounts due until you’ve entered the tax year in which you plan to itemize deductions. At this point, begin paying bills aggressively until you reach the threshold for claiming the medical deduction.
A more permanent tax strategy for increasing itemized deductions is to move to a low-tax state. While this last one might seem a little drastic, it’s an option worth examining, especially if you have an option to work remotely or participate in the gig economy. Taking up residence in a low-tax state is a long-term strategy that can impact your deductions year after year.
For more tips on itemizing deductions or tax planning in general, contact Adams Consulting. We take pride in our ability to help individuals and businesses alike with their tax prep needs.