Standard Or Itemized Deductions: Which Should You Take?
When it comes to making deductions at tax time, taxpayers have two options: standard or itemized deductions. The standard deduction is a set amount every taxpayer is entitled to take, regardless of actual deductions or expenditures incurred throughout the year. Itemized deductions, on the other hand, are the actual deductions and expenses used for personal or business purposes during the tax year. Itemizing deductions is a more time-consuming process because the taxpayer is required to list expenses line-by-line and provide evidence (receipts or invoices) that the expense was actually incurred. However, itemizing your deductions is worthwhile if it results in significant tax savings.
What Is The Standard Deduction?
The standard deduction, as its name suggests, is a set amount any taxpayer may deduct from his or her taxable income without demonstrating evidence. For 2011 tax returns (to be filed in April 2012), the standard deduction for a single taxpayer is $5,800. For married taxpayers filing jointly, the standard deduction is $11,600.
Taxpayers over the age of 65 and those who are blind are eligible for higher standard deductions. See the IRS website for the additional information on these types of deductions.
The standard deduction tends to fluctuate from year to year, historically rising each year to keep pace with inflation.
What Is An Itemized Deduction?
An itemized deduction is a single expense incurred throughout the tax year that is eligible to be excluded from your total taxable income. The following are examples of deductible items:
- Mortgage loan interest
- Charitable donations (Red Cross, tithing, nonprofit organizations, including clothing, furniture and other items which may be deducted based on value).
- Qualified medical expenses (unreimbursed expenses exceeding 7.5 percent of the taxpayer's Adjustable Gross Income, or AGI, including prescription drugs, medical supplies, glasses or contact lenses, office visit fees, chiropractor visits, lab work and other similar expenses)
- Business travel expenses
- State and local taxes (amounts paid the previous tax year)
- Health insurance premiums not paid by an employer or through a pre-tax program
It's important to note that in previous tax years, no receipt was required for charitable donations of $250 or less. However, the IRS now requires receipts for all charitable contributions of any dollar amount. Taxpayers giving to qualified charitable organizations throughout the year should keep track of donations and obtain receipts whenever possible.
Miscellaneous expenses also qualify as itemized deductions. These items are those that don't fall within the other categories outlined above, including professional association dues, business insurance premiums, supplies required for work, tuition for employment-related continuing education, and other professional expenses.
In order for a taxpayer to utilize miscellaneous deductions, the total of all miscellaneous deductions must be equal to or greater than 2 percent of the tax payer's Adjustable Gross Income. For example, if a taxpayer earns $50,000 per year, miscellaneous deductions must be $1,000 or more. If the total of all miscellaneous items doesn't meet this threshold, the taxpayer is still able to itemize other deductions, excluding miscellaneous expenses.
When The Standard Deduction Makes Sense
The standard deduction is often the simplest and most logical way to complete a tax return. For taxpayers holding traditional employment and who don't make significant contributions to charity or incur out of pocket work-related expenses, the standard deduction is often greater than actual expenditures that they could itemize. In this case, taking the standard deduction will reduce the overall amount of taxes paid, thus saving the taxpayer money.
However, many taxpayers miss additional tax savings by taking the standard deduction. Those with mortgages or home equity loans are eligible to deduct the amount of interest paid on those loans throughout the tax year. Often, this amount alone is enough to exceed the standard deduction, making it worthwhile to itemize.
Individuals or married couples who are self-employed, who make significant charitable contributions or incur significant work-related expenses may also benefit from itemizing deductions.
Itemizing deductions makes sense for individuals who incur expenses greater than the amount of the standard deduction allowed in a given tax year. Filling out Schedule A with a list of possible deductions is the simplest way to determine if itemizing or taking the standard deduction makes sense. Ideally, taxpayers should opt for the method that allows them to take a larger deduction to avoid paying unnecessary taxes.
Itemizing makes sense for most individuals who are self-employed, because those taxpayers are able to deduct business expenses and possibly a portion of a home mortgage payment and utilities if they use their home for business purposes. (the deduction equal to the proportion of the home used solely and exclusively for conducting business, or the percentage of the home's square footage dedicated to business use).
Every taxpayer should evaluate his or her deductions to determine if the standard deduction or itemized deductions make more sense each tax year.
For many taxpayers, taking the standard deduction is the simplest way to file taxes. But with the variety of deductions available, some taxpayers are missing additional savings by not itemizing their deductions. A simple calculation using Schedule A can determine if itemizing deductions will lower an individual's taxes in a given year.