Standard Deduction vs. Itemized

What Is a Standard Deduction?

The standard deduction is a fixed dollar amount that can be subtracted from your Adjustable Gross Income (AGI) to reduce the amount of taxes you owe. The specific amount is set every year by the IRS and is usually adjusted for inflation. Which of the standard deductions you can take is determined by your filing status, such as Single or Married Filing Jointly. Taking the standard deduction precludes you from itemizing any of your deductions.

What Is an Itemized Deduction?

Itemized deductions are expenses that fall under a long list of IRS allowable categories. Some of these categories are dental and medical expenses, home mortgage interest, charitable contributions, business use of a home or car and deductible taxes. You must have paid these expenses for yourself or for one of your dependents, such as your spouse or child. Additionally, you must be able to document these expenses with receipts.  You don’t need to know what these deductions are.  TurboTax will easily guide you through itemized deductions.

How Do I Choose?

Itemizing will usually be the way to go if you had large non-reimbursed dental and medical expenses or if you had interest expense on a mortgage, paid property taxes, had large employee business expenses that were not reimbursed by your employer, had major uninsured casualty losses or made large contributions to charities, but TurboTax will make the appropriate choice for you based on your entries for these expenses.

When You Don’t Have a Choice

There are times the choice will be made for you. You cannot use the standard deduction if you are a non-resident alien. If you are married filing separately, and your spouse chooses the standard deduction, you cannot itemize. If you do not have the necessary records for itemizing, then you have use the standard deduction. If you qualify to file Form 1040EZ or 1040A, you cannot itemize, though you may be able to claim certain exemptions and credits.

Both types of deductions are very important because they are a way to reduce your taxable income. While it is may take some time to gather receipts for itemized deductions, you might find it a worthwhile effort as you try to make your taxable income as low as you legally can.

State Sales Tax

This year, those who itemize their deductions have a choice to deduct, either the amount of state income tax paid or state and local general sales taxes paid. It’s either/or, you cannot take both. For those with a state income tax, that tax will often be far higher than the sales tax paid over the year, which is why I highlighted those states with no income tax at all.

Even if you do have a state income tax, it’s still possible that in a high spending year, perhaps including a car purchase or major remodeling along with all the high priced appliances, that the sales tax will total more than your state income tax. Either way, it’s worth taking a bit of time to see if this deduction can benefit you.

Hopefully, if you are going to use the sales tax deduction, you’ve been saving your receipts to document your total claimed sales tax. If you haven’t, or perhaps you only have the bill of sale for that new car or boat, there’s still an option for you.

You can enter your combined state and local sales tax rate and TurboTax will make the behind the scenes calculations for you, per IRS guidelines, to determine the accurate state and local sales tax deduction for you.  If you don’t know your state and local sales tax rates, TurboTax will also calculate your deduction based on just your home state sales tax rate.

One thing to note, taxpayers often think that they will be able to deduct more, because they think the deduction is their gross income times their sales tax rate, however per IRS guidelines, the sales tax deduction is a result of the sales tax rate times an amount based on your income from the IRS State and Certain Local Sales Tax Table and not your entire income.

Tax Tip:  You have the option to deduct sales tax instead of state income tax, even if you live in a state without a state income tax.

Don’t miss out!  Unless Congress extends the rule allowing the deduction of sales tax, 2011 is the last year to add it to your itemized tax deductions.

Medical Expenses

Whose Medical Expenses Can You Deduct?

Generally speaking you can deduct your medical expenses, your spouse’s expenses, or your dependent’s (such as a qualifying child or relative) if you itemize your tax deductions.

What Medical Expenses Can I Deduct?

Please keep in mind that you can only claim the amount of your medical expenses that exceeds 7.5% of your adjusted gross income. Let’s say your AGI is $35,000. If your medical expenses for the year were $2,700 then you can deduct your expenses that were greater than 7.5% of your adjusted gross income. However, if your medical and dental expenses were only $1,750 then you could not claim any, as they didn’t meet the requirement.

The IRS has a huge list of medical expenses that you can deduct. Some common ones I think many people use include:

• Ambulance/Transportation
• Annual Physical Exam
• Breastpump
• Chiropractor
• Dental Treatment
• Insurance Premiums
• Medicine
• Psychologist

For the entire list and detailed explanations, please check out our Medical Expense Checklist. I think most people will be able to find qualifying medical expenses they’ve had this past year. Please note that you can only deduct expenses that you’ve paid to treat, alleviate, or prevent a physical or mental illness.

My Family’s Medical Expenses This Year

After reviewing the IRS list of eligible expenses, I saw that my family has some medical expenses we can deduct. They include:

• Breastpump: We just had our baby girl this year and I’m breastfeeding so the pump has become handy.
• Contact Lens/Eyeglasses: I have both contacts and eyeglasses for my nearsightedness. Glad to see I can get a tax deduction for them.
• Some Medical Insurance Premiums:  Only the ones that are not a pre-tax deduction from my income.
  
• Laboratory Expenses: The blood-work I had done while I was pregnant is an eligible medical expense.
• Medicines: The medicine my doctors prescribed are included.
• Physical Examinations: I get my checkups annually to make sure everything is in check.

I’m really happy to see that we have medical expenses that are on the tax deductible list. Maybe we’ll get a good size tax refund; we’ll see.

Thoughts on Medical Expenses

What medical expenses are you going to deduct when you file your taxes? What has been the biggest expense? What expense surprised you?

Don’t assume because these numbers seem so high that you may not exceed them. Better to take the time to review the things you can deduct and start the old adding machine. Let’s go through the items you may be able to take on your Schedule A:

• Mortgage points - Points are considered prepaid interest as their purpose is to buy down the rate charged on your loan. You can deduct these in full on the purchase of a home if the mortgage is a million dollars or less. If greater than a million, it must be scaled back as will the interest deducted. Note: Points paid for a refinance are not deducted all at once but are taken over the term of the loan, a fraction each year.
• Mortgage interest - Interest on your mortgage is deductible up to the first million dollars of debt owed. Further, interest on up to $100,000 of a Home Equity Liner of Credit (HELOC) is also deductible.
• Property tax - The real estate tax you pay on your home, car, and boat are all deductible.
• For those who live in a co-op, a building in which you own your apartment, but there’s a common area and perhaps, an underlying mortgage, the association should give you a statement each year documenting how much of your monthly fee was for property tax and mortgage interest. Don’t miss these.
• Investment interest - Is deductible limited to your net investment income.
• Student loan interest - is not subject to itemizing, you may take this deduction right on form 1040.
• State income taxes/State sales tax - you may deduct one or the other, which ever is greater for you. If you are in a state with a low income tax, it may be easy for your sales tax to be higher than your local income tax especially in a year when you are furnishing a home or buying a new car.
• Charitable contributions - Cash contributions are the simplest to document. You cut a check or charge the donation, and the charity acknowledges it in writing. If you benefit in any way (book, CD, T-Shirt, tote bag, etc) the charity should tell you the value of the item and it comes off the amount you may deduct. If you donate non-cash property valued over $500, you must fill out a form 8283 to document the donation. If you have long term stock gains, those shares are a candidate for donation. You get to deduct the value on the day the donation is made, and avoid the capital gain on the profit if you were to sell.
• Medical and dental expenses - You can deduct medical and dental expenses as part of your itemized deductions, but only the amount that exceeds 7.5% of your adjusted gross income. Doctors include chiropractors, psychiatrists, psychologists, as well as the traditional MDs and surgeons. Prescription drugs, weight loss programs prescribed by a doctor, and items such as false teeth, eye glasses, and contact lenses are included. Note that you can only deduct the cost of expenses for which you weren’t reimbursed.
• Casualty losses - I discussed this at length last year with all the flooding in the news. You are allowed to take a deduction for losses due to flood, fire, or theft, subject to a $100 deduction, and then only to the extend it exceeds 10% of your adjusted gross income.
• Business expenses - There are a number of items that fall into this category. Use of your home – you must maintain an area exclusive to your business and nothing else. It must be your principal place of business (i.e. your employer, if any, does not have a office for your use. The home office can’t just be for your convenience.) Form 8829 is used to determine the deduction you are allowed. Similarly, the use of your car for business purposes may be deducted. If the car is not used exclusively for business you must keep a contemporaneous accounting of your business miles and deduct only the business portion. If you are reimbursed by your employer for the business use, you don’t report the reimbursement, nor do you take a deduction. Costs incurred while traveling on business are deductible. These include Cost of airfare, meals, lodging, tips, dry cleaning, laundry, and cost of calls made. These expenses are all reported on for 2106 which calculates the amount that flows on to the schedule A.

A long list, I know, but whatever tax bracket you are in, the taxes you save by itemizing can add up fast. If this article helped you uncover some hidden deductions, please let me know by commenting below.