WHILE YOU DON’T HAVE much choice when it comes to paying taxes, you can benefit from significant deductions that reduce the amount you owe Uncle Sam.
“We’re allowed to take deductions against income,” explains Traci Kratish Pumo, the managing director with the tax and financial advisory firm BDO. Those deductions reduce the amount of income subject to tax, and taxpayers have two main options: the standard deduction or itemized deductions.
Deductions are especially important this year now that personal exemptions have been eliminated, says Bill Smith, the managing director for the National Tax Office at the financial firm CBIZ MHM LLC. For the 2017 tax year, taxpayers could claim an exemption of $4,050 for themselves and each of their dependents. However, those exemptions were eliminated for the 2018 tax year under the Tax Cuts and Jobs Act, making deductions now the prime way to reduce taxable income.
While the standard deduction is the government’s built-in subtraction that you can take while preparing your taxes, itemizing is composed of individual deductions that, together, can help lower the amount of taxable income you pay.
With the April 15 tax-filing deadline around the corner, now is the time to seize upon beneficial tax breaks. Read on to discover the pros and cons of each deduction method to decide which approach is best for you.
Standard Deduction
To compensate for the loss of personal exemptions, the standard deduction nearly doubled for the 2018 tax year. Depending on your tax-filing status, you are entitled to take one of the following standard deductions:
- Single or married filing separately: $12,000
- Head of household: $18,000
- Married filing jointly or qualified widow(er): $24,000
“More taxpayers are taking the standard deduction this year,” says Tracie Miller-Nobles, a certified public accountant and member of the American Institute of CPA’s National CPA Financial Literacy Commission. That’s largely because many people don’t have enough itemized deductions to exceed the amount of the standard deduction.
Here are the key benefits of the standard deduction:
- It’s easy, convenient and saves time.
- Some taxpayers qualify for a bigger deduction.
- Anyone can claim it.
It’s easy, convenient and saves time. If you like to keep your taxes as simple as possible, opting for the standard deduction might be the wise way to go. The standard deduction is essentially an automatic process that doesn’t require you to devote time or energy to tracking expenses. As a result, it saves you the trouble of providing documentation, filling out a Schedule A form or needing to understand nuances of tax law.
Some taxpayers qualify for a bigger deduction. Some individuals might be eligible for an increase in their deduction based on age or disability. Taxpayers who are age 65 and older or blind are entitled to an additional deduction of $1,300 to $1,600, depending on their tax-filing status.
Anyone can claim it. You’ll be allowed to take a standard tax deduction even if you don’t have expenses that qualify you to make itemized deductions.
Though the standard deduction is a simple method, it might not be the best option based on your financial situation. Here are the drawbacks of taking the standard deduction:
- Standard deductions have filing limitations.
- You might end up with a smaller deduction.
Standard deductions have filing limitations. You won’t be able to take a standard deduction in a few scenarios. If you’re married and filing separately, you can’t claim a standard deduction if your spouse itemizes his or her deductions. Though not as common, if you’re a nonresident alien, a dual-status alien or someone who is filing a tax return for a period of less than a year, then you won’t be eligible for the standard deduction. Your deduction can also be limited if you’ve been claimed as a dependent on someone else’s taxes.
You might end up with a smaller deduction. The standard deduction amount might be lower than the amount you could deduct if you itemize. For example, the standard deduction might be less than the total amount of mortgage interest, real estate taxes and charitable contributions you’ve paid and could deduct.
Itemized Deductions
Unlike the standard deduction, any taxpayer’s itemized deductions can result in different amounts. Itemized deductions are claimed on a Schedule A form and are broken down into five main categories:
- Medical and dental expenses.
- Taxes you paid.
- Interest you paid.
- Gifts to charity.
- Casualty and theft losses.
There is also a line for other itemized deductions, which covers less common situations such as gambling losses and certain unrecovered investments in a pension. “The three areas people should really focus on are the taxes, interest expense and gifts to charity,” Miller-Nobles says. For most taxpayers, those are the ones that are most likely to add up to more than a standard deduction.
Here are the benefits of Itemized deductions:
- You can claim more expenses.
- You can save more money in taxes.
You can claim more expenses. Mortgage interest, property taxes and medical bills are just a few of the expenses allowed with itemization. While some of these categories have caps or limitations, taxpayers with large mortgages who give generously to charity may find they get a larger deduction by itemizing.
You can save more money. Because you can include more deductions when itemizing, you might stand to earn a larger tax refund. The amount itemizing saves you will depend on your tax bracket. For instance, income taxed in the 25% tax bracket will see a 25 cent tax savings for every dollar itemized above the standard deduction.
Itemizing deductions does come with some drawbacks, however. Here are the disadvantages of itemized deductions:
- It takes more paperwork and effort to itemize.
- There are restrictions on some itemized deductions.
It takes more paperwork and effort to itemize. Unlike standard deductions, itemizing is a manual process. “For itemized deductions, you have to keep excellent records,” Kratish Pumo says. Depending on how good your records are and the amount of your deductions, this time-consuming process might not reduce your taxable income enough to make it worth the effort.
There are restrictions on some itemized deductions. The Tax Cuts and Jobs Act caps the itemized deduction for state and local taxes, including property taxes, at $10,000. What’s more, interest on home equity loans taken out for purposes other than a renovation are no longer deductible, and only interest on the first $750,000 of a new mortgage can be included. If you want to deduct medical and dental expenses, only those in excess of 7.5% of a person’s adjusted gross income are eligible to be itemized.
“(Married couples) have to have $24,001 in itemized deductions to get any benefit,” Smith says. This is a high hurdle for taxpayers to overcome. “A lot of people will suffer from the $10,000 limit on state and local taxes,” according to Smith. Unless someone has at least $14,000 in mortgage interest, significant charitable gifts or a major medical event, it may difficult to find enough deductions to itemize.
Keep good records and document your expenses throughout the year. That way, at tax time, you’ll have a better idea of whether standard or itemized deductions will give you the biggest tax break. Whether you’re filing with the help of a professional or on your own, maintaining solid records is essential.