Posted by Fred Lake

How To Lower Your Tax Bill With Itemized Deductions

How To Lower Your Tax Bill With Itemized Deductions

What are itemized deductions?

Itemized deductions are a list of expenses that you can use to reduce taxable income on your federal income tax return. These include medical bills, taxes, interest paid on the home loan, and donations to charities. The breakdown of taxpayers corresponds to all deductible expenses and decreases the total gross income adjusted to meet taxable income.

When you file your federal income tax return with Form 1040, you have the option of taking the standard or itemized deductions, an amount predetermined by the IRS, depending on your filing status. 

Usually, if the total itemized deductions are greater than the standard deduction available for your filing status, you will choose to itemize.

However, it is important to note that there are certain circumstances in which taxpayers do not have the option of making standard deductions or itemize their deductions. Non-resident aliens must itemize their deductions, and couples who file separately must also choose the same method: one cannot itemize, while the other takes the standard deduction.

Some common itemized tax deductions include:

  • Gift or cash vouchers

  • Injuries and Losses Due to Theft in a Federal Declared Disaster

  • Interest on mortgage loans

  • Medical and dental expenses

  • State and local taxes

Assuming you can itemize, to do this, you will need to keep track of what you spent during the tax year and keep records such as receipts, bank statements, medical bills, and letters of recognition from charities.

You should also take into account the following rules and limitations:

  • Charitable donations: You can claim a free deduction in cash or on the property donated to a qualified organization.

  • Medical and dental expenses: You are permitted to deduct medical expenses that exceed 7.5% of adjusted gross income in 2020.

  • Mortgage interest: If you bought your home before December 16, 2017, you could deduct interest paid on mortgage debt up to a maximum of $1,000,000. If you bought it after December 16, 2017, you can deduct the interest paid for the first $750,000. The mortgage must have been used to "build, buy or significantly improve" your home to be eligible. In other words, real estate debt that was not used to renovate and remodel your home is not eligible.

  • State and local income and property taxes: TCJA has limited the national and local tax deductions to $10,000. According to the previous rules, the deduction for national and local taxes was unlimited.


Personal injury and loss due to theft

Losses suffered as a result of damage to or destruction of personal property and losses due to theft can be deducted. However, losses must exceed 10% of adjusted gross income, less than $100 per event.

The victims must be the result of sudden, unexpected, and unusual events. These include earthquakes, fires, floods, mine collapses, explosions, hurricanes and tornadoes, terrorist attacks, vandalism, and volcanic eruptions. Losses caused by certain traffic accidents may also be deductible.

Losses due to theft include embezzlement, extortion theft, fraud theft, blackmail, and kidnapping for ransom. Any losses should be reduced by any insurance reimbursements received.

If you've been itemizing, you might notice some deductions that aren't on this list. The recent tax reform eliminated several miscellaneous deductions, including capital costs, labor costs, and tax preparation fees. The good news is that these expenses are still tax deductible for businesses. The change only affected individual returns.


What is the standard deduction?

This is a fixed amount that the IRS allows you to deduct, regardless of how many deductible business expenses you have. The standard deduction available depends on your filing status.

The standard deduction for 2017 tax returns was only $6,350 for singles and $12,700 for couples filing jointly. The new TCJA has nearly doubled the standard deductions for all tax states, so several people will see a reduced tax bill with the standard deduction than they would when they itemize.

With higher standard deductions, taking steps to lower your tax bill can be a little more complicated than before. Paying state and local taxes upfront or donating to charity may not be enough to overcome the higher standard deduction difficulty. If you live in a state that has high-tax, your combined income and property tax may already be within the $10,000 limit.


Itemized vs. standard deductions

If your filing status for a standard deduction amount is greater than the itemized amount you are eligible to claim, you should take the standard deduction, and vice versa.

To decide whether it is worth going with the itemized deductions instead of the standard deduction, you will need to know your filing status and have a rough estimate of your income and any itemized deductions you want to claim for that year. A good place to start is to look at your old tax return.

To illustrate, let's say John and Jane are a couple trying to decide to itemize in 2021. Their income and deductions for 2021 should be very similar to 2020, so they pull out their Form 1040 for 2020 and look at line 7 to see their adjusted gross income for 2020 was $100,000.

Let's look at this list of itemized deductions to see if John and Jane can benefit from itemizing in 2021.


Medical and dental expenses

To be eligible for the itemized medical expense claim, the total medical and dental expenses you have to bear must exceed 7.5% of the AGI in 2021.

For John and Jane, that means they would need more than $7,500 in expenses to qualify for a medical expense deduction. John and Jane have health insurance, are generally in good health, and have no major dental or medical procedures scheduled for 2021. With that in mind they estimate that they probably won't have more than $7,500 in medical bills for the year. This leaves their itemized medical expenses at $0


State and local taxes

John makes quarterly tax payments estimated at $5,000 per year for state income taxes. Jane stays at home with their children, so she doesn't make estimated tax payments and does not have any state withheld income tax from her salary.

John and Jane pay about $5,000 a year in property taxes on their homes, and $200 in individual property taxes are paid with vehicle records. Of the $10,200 they pay in state and local taxes, John and Jane can claim $10,000. The additional deduction of $200 is lost because the national and local tax deduction is limited to $10,000. This leaves their itemized taxes at $10,000


Mortgage interest

John and Jane pay about $8,000 a year in mortgage interest on their home. The mortgage balance is well below $750,000, and they have used 100% of the proceeds to purchase the house, so John and Jane don't have to worry about limiting their mortgage interest deduction. This leaves their itemized mortgage interest at $8,000.


Charity gifts

John and Jane donate about $500 in cash per year and an additional $400 in used clothing and housewares to a cheap charity store. Their itemized charitable donation is at $900


The total amount of itemized deductions

The total estimated itemized deductions for John and Jane for 2021 are $18,900 ($8,000 in mortgage interest, $10,000 in taxes, and $900 in charitable donations). If their filing status is married filing together, the standard deduction available to them in 2021 is $25,100, so their itemized deduction is $6,200 lower than the standard deduction. Unless John and Jane end up paying their medical bills in 2021 or don't want to increase their charitable giving dramatically, it's best to claim the standard deduction for 2021.


Bottom Line

Suppose you run the numbers as John and Jane did above, and your calculated itemized deductions are very close to the standard deduction available for your filing status. In that case, you will probably want to keep track of the itemized deductions available just in case. At tax time, your tax advisor can calculate numbers back and forth to see which method produces the lowest tax bill.


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Fred Lake
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