3.3 Standard deduction vs. itemized deductions

When filing taxes, you've got two main options: the standard deduction or itemizing. The standard deduction is a fixed amount that reduces your taxable income, while itemizing lets you claim specific expenses. Your choice can significantly impact your tax bill.

The Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction, making it more attractive for many. However, itemizing might still be beneficial if you have substantial medical expenses, mortgage interest, or charitable donations. It's crucial to crunch the numbers and see which method saves you more.

Standard Deduction vs Itemized Deductions

Comparison of Deduction Methods

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• Standard deduction reduces taxable income by a fixed amount
  • Varies based on filing status (single, married filing jointly, head of household)
  • Adjusted annually for inflation
  • 2023 amounts: $13,850 (single),$27,700 (married filing jointly), $20,800 (head of household)
• Itemized deductions allow claiming specific expenses to reduce taxable income
  • Potentially exceed standard deduction amount for some taxpayers
  • Requires more detailed record-keeping and documentation
• Taxpayers must choose between standard deduction or itemizing
  • Cannot claim both in the same tax year
  • Decision impacts both federal and state tax returns in some cases

Impact of Tax Cuts and Jobs Act

• Nearly doubled standard deduction in 2017
  • Made standard deduction more advantageous for many taxpayers
  • Simplified tax preparation for those who previously itemized
• Eliminated or limited several itemized deductions
  • Reduced benefits of itemizing for some taxpayers
  • Examples include caps on state and local tax deductions, changes to mortgage interest deductions
• State and local tax considerations may still influence itemizing decision
  • Some states require consistent method on federal and state returns
  • High-tax states may make itemizing more beneficial despite federal changes

Itemized Deduction Expenses

Medical and Tax-Related Expenses

• Medical and dental expenses exceeding 7.5% of adjusted gross income (AGI) deductible
  • Includes costs for doctors, hospitals, prescription medications, medical devices
  • Example: $10,000 medical expenses with$100,000 AGI, deductible amount $2,500 ($10,000 - $7,500)
• State and local taxes (SALT) deductible up to $10,000 ($5,000 if married filing separately)
  • Includes income taxes, sales taxes, property taxes
  • Example: $6,000 state income tax +$5,000 property tax = $10,000 deduction (capped)

Home-Related and Charitable Deductions

• Mortgage interest deductible on first $750,000 of indebtedness ($375,000 if married filing separately)
  • Applies to homes purchased after December 15, 2017
  • Example: $800,000 mortgage at 4$30,000 (4% of $750,000)
• Charitable contributions to qualified organizations generally deductible
  • Includes cash donations, non-cash property (clothing, household items)
  • Example: $5,000 cash donation to local food bank +$2,000 value of donated furniture = $7,000 deduction

Miscellaneous Deductions

• Casualty and theft losses from federally declared disasters claimable
  • Must exceed $100 per incident and 10% of AGI
  • Example: $15,000 flood damage with$100,000 AGI, deductible amount $4,900 ($15,000 - $100 -$10,000)
• Gambling losses deductible up to amount of gambling winnings
  • Example: $5,000 gambling winnings and$7,000 losses, deductible amount $5,000
• Most miscellaneous itemized deductions eliminated by Tax Cuts and Jobs Act
  • Exceptions exist for specific professions (performing artists, reservists, fee-basis government officials)

Itemizing vs Standard Deduction

Calculation and Comparison

• Sum all potential itemized deductions and compare to applicable standard deduction
  • Example: Single filer with $14,500 in itemized deductions vs$13,850 standard deduction
• Evaluate long-term tax planning implications
  • Decision to itemize in one year may affect ability to itemize in future years
  • Example: Bunching charitable donations in alternate years to exceed standard deduction threshold
• Analyze specific financial situation
  • Consider home ownership, charitable giving patterns, medical expenses relative to income
  • Example: New homeowner with large mortgage interest may benefit more from itemizing

Practical Considerations

• Factor in additional time and effort required for itemizing
  • Record-keeping throughout the year
  • More complex tax preparation process
• Assess potential for increased IRS scrutiny
  • Itemized deductions may increase likelihood of tax audits
  • Example: Large charitable deductions or home office expenses may trigger review
• Consider state tax implications
  • Some states require same method (standard or itemized) on both federal and state returns
  • Example: California taxpayer may benefit from itemizing on federal return to maximize state deductions

Itemized Deduction Limitations

Specific Deduction Limits

• Medical expense deductions limited to amounts exceeding 7.5% of AGI
  • Less beneficial for lower-income taxpayers
  • Example: $50,000 AGI with$5,000 medical expenses, deductible amount $1,250 ($5,000 - $3,750)
• State and local tax deductions capped at $10,000 ($5,000 if married filing separately)
  • Significantly impacts taxpayers in high-tax states
  • Example: $15,000 in state income and property taxes, deductible amount limited to$10,000
• Mortgage interest deductions limited to interest on first $750,000 of indebtedness
  • Applies to homes purchased after December 15, 2017
  • Example: $1 million mortgage at 4$30,000 (4% of $750,000)

Additional Limitations and Considerations

• Charitable contribution deductions generally limited to 60% of AGI for cash donations
  • 30% limit for capital gain property
  • Carryover provisions allow excess amounts to be deducted in future years
  • Example: $100,000 AGI with$70,000 cash donation, deductible amount $60,000 with$10,000 carried forward
• Alternative minimum tax (AMT) can effectively limit benefit of certain itemized deductions
  • Particularly affects high-income taxpayers or those with large deductions
  • Example: Taxpayer with significant state tax deductions may lose some benefit under AMT calculation
• Overall limitation on itemized deductions (Pease limitation) suspended through 2025
  • May return in future tax years, potentially reducing itemized deductions for high-income taxpayers