When to File a Nonresident State Tax Return

The federal government requires you to report all income, calculate your total tax liability, and subtract the standard deduction (or any qualifying itemized deductions). However, most states also require you to pay additional state income taxes, which can be complicated. If you live in one state but work in another, you’ll need to fill out a nonresident state tax return.

Working in neighboring states is nothing new and familiar for residents living in regions bordering neighboring states. Thankfully, you don’t have to pay taxes twice on the same income if you live in one state but work in another. However, you must keep track of your income across state lines and fill out a nonresident state tax return to avoid owing the IRS money. How you fill out those tax returns and what you put into them depends on where you are. Let’s get into it.

What Is a Nonresident State Tax Return?

A nonresident state tax return is a unique state income tax return that nonresidents must file if they earn income in that state but are not residents. If you live in Colorado but work in New Mexico, you will need to file a nonresident state tax return in New Mexico and your tax return in Colorado. The tricky thing is that this applies to all forms of compensation. So if you aren’t working in New Mexico, you must report any income earned across state lines in a nonresident state tax return and your income tax return for your home state.

The exceptions to this rule are states with reciprocity agreements. Seventeen states currently have reciprocity agreements with certain neighboring states exempting you from filing a nonresident tax return if you’re working in one of those states and living in one of the conditional neighboring states. But not to worry – you can’t get taxed twice on the same income even if you don’t live in a state with a reciprocity agreement, thanks to a relatively recent ruling by the Supreme Court in 2015.

Meanwhile, on your home state’s income tax return, you can write off any taxes paid to the states you work in but aren’t a resident of as a tax credit. This, again, is somewhat complicated. The agreement explicitly worded that states that tax nonresidents cannot tax their residents on income earned out of state. Meaning that if your home state taxes your income – even if you made that income in a neighboring state – the neighboring state could not tax it. Meanwhile, states that taxed their residents for income earned out of state could not tax nonresidents on income earned in their state.

What this boils down to, however, is simple: You must file a nonresident income tax return if you do not live and work in states with a reciprocity agreement. If the state you work in requires you to pay those taxes, your home state must offer a tax credit. Otherwise, you might pay your home state but not need to pay in your jobs state. Depending on where you live, you will need to file a nonresident state tax return, whether you do or don’t owe any income taxes.

Do I Need to File a Nonresident State Tax Return?

The answer is maybe. It depends on where you live and where you work. So far, seventeen states have signed a reciprocity agreement that allows employees who work in their state but live in a neighboring state to get away with just one tax return based in their home state. Furthermore, nine states don’t have state income taxes (with a rule of exception in New Hampshire). The seventeen (working) states that have reciprocity agreements include:

  • Arizona
  • DC
  • Illinois
  • Indiana
  • Iowa
  • Kentucky
  • Maryland
  • Michigan
  • Minnesota
  • Montana
  • New Jersey
  • North Dakota
  • Ohio
  • Pennsylvania
  • Virginia
  • West Virginia
  • Wisconsin

Remember that New Jersey temporarily ended its reciprocity agreement with Pennsylvania in 2016 and reinstated it in 2021. For any tax years, you need to file retroactively between those years; you may need to file two returns. Furthermore, the nine states that do not impose any income tax include:

  • Alaska
  • Florida
  • Nevada
  • New Hampshire (still taxes investment income)
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

In other words, working in any of these states will not require you to file an additional state income tax return. You will still need to report that income in your home state tax return; however, if your home state charges income taxes.

Where Do I Start?

Is a reciprocity agreement in place between the state you work in and your home state? Start by determining where you live and where you work. Then decide whether you’ve used that agreement by submitting a state-specific form to your employer. This is crucial to ensure that your employer properly withholds your state taxes. If you haven’t, you must file a nonresident state income tax return or risk a hefty and unexpected tax bill.

Assuming you did, you could continue filing a single state tax return for your income at home. If you did not file that form yet, or if you do not live and work in states with reciprocity agreements, you will need to acquire a nonresident tax return from the state you work in. The next step involves determining your income in that state. Figure out exactly how much you earned working in your work state. In addition to salaries and paychecks, other types of taxable income include:

  • Gambling and lotto winnings.
  • Income from selling property.
  • Income as a partner in a corporation, LLC, or partnership.
  • Compensation and income for carrying out a trade in a different state.

To make things easier on you, consider having your prepared federal tax return at hand. Many nonresident tax return templates refer to the figures calculated on your federal tax return to simplify things. Calculate the percentage of your nonresident income versus your total income. This percentage will be your nonresident percentage. You can use this percentage to determine your tax liability, state-specific tax deductions, etc. Your nonresident tax return will have a column for your total income (as per your federal return) and a total for your state-specific earnings as a nonresident.

The process differs from state to state, so it’s essential to refer to your work state’s tax authority and download the respective tax forms for an accurate estimate of your total tax liability in that state. Due to the complexity, many people opt to hire a tax professional to assist in the process. Once you’ve determined your tax liability in your work state, you can file your nonresident tax return. You will need to report all income in your home state tax return – but you are eligible for a tax credit on income already taxed in your work state, as mentioned previously.

What If I Just Moved to a New State?

If you’ve moved to your work state or simply moved from one state to another, your income is still split between two states. However, instead of using a nonresident form – if you began working in your new shape after moving there – you will need to complete a part-year return. This is another type of tax return that calculates your tax liability in your new state after a move.

Guide to Choosing and Hiring the Right Tax Relief Specialist

Seeking tax relief is no easy task, given the degree to which tax law can seem deliberately obtuse. Every step of the process, from tax preparation to filing the paperwork to filing an appeal, can be mired in red tape and feel overwhelming. Having an experienced professional at your side to cut through it all – and help you save money by reducing your tax liability in the process – can mean the difference between dreading Tax Day and treating it like any other. Before you can choose the right tax relief specialist for your circumstances, it pays to know what federal tax relief looks like – and what your options might be.

Understanding Tax Relief

Tax relief is a catch-all term for reducing your existing or future tax liability and may even be applied to ongoing tax problems, such as an outstanding tax debt. Seeking tax relief may involve:

  • Optimizing your deductions;
  • Using tax credits, you unknowingly qualify for;
  • Attempting to rectify an error and eliminate your debt before your penalty grows, or better yet;
  • Seeking penalty abatement.

Tax professionals who may help you with tax relief include tax attorneys, enrolled agentsCPAs specializing in taxes, and credentialed tax preparers. In addition to providing solutions for your immediate tax needs, the main advantages of seeking professional tax relief help include a better understanding of the tax code (and how it might benefit you) and saving you both time and money in the long term.

Navigating IRS Deductions, Exemptions, Credits, and Refunds

There’s a fine line between tax avoidance and tax evasion. The first step of tax relief is preparation. Professional tax preparers help your tax account minimize liability without evading your taxes. You can avoid tax liabilities that do not apply to your tax account or be more efficient with how you itemize your deductions. Tax evasion, however, means illegally skirting your responsibilities as a taxpayer and may be met with felony charges. A tax preparer’s job is to ensure you are always on the right side of the tax code while keeping you from overpaying taxes. In general, you can do this by:

  • Switching from itemized deductions to a standard deduction, or vice versa;
  • Applying for tax credits you might not know you had;
  • Making use of your tax refunds;
  • Optimizing your estimated tax payments to the IRS (avoiding a hefty bill at the end of the year while keeping more money in your pocket);
  • Refreshing your estate plan and looking at how certain financial decisions may help you minimize your tax liability;
  • Restructuring your business or corporation;
  • And finally, learning how to navigate the IRS’s payment plans and options for penalty abatement in the event of unexpected tax debt.

First, deductions. The Tax Cuts and Jobs Act of 2017 made numerous changes to our taxes, including significant changes to deductions, exemptions, and tax credits. For many taxpayers, the most significant change is a massively increased standard deduction and the personal exemption elimination. In 2022, the standard deduction is $12,950 for individual filers – contrasted to the standard deduction of 2015, which was $6,300. Meanwhile, the Tax Cuts and Jobs Act eliminated several key itemized deductions. As many as 87 percent of filers chose the standard deduction over itemizing in 2018. This means that many taxpayers who were better off itemizing before 2017 may be better served picking the standard deduction instead.

Many taxpayers who default to the standard deduction, to begin with, receive a more significant tax cut. Tax exemptions are tax deductions in limiting the amount of taxable income claimed on your tax returns. However, taxpayers cannot claim a personal exemption in the tax years between 2018 and 2025. Certain tax credits, to compensate, were also increased. The child tax credit was doubled from a base of $1,000 to $2,000 and again to $3,000 in 2021 for qualifying parents (with children under 17). Income thresholds for the child tax credit were $200,000 in 2021 and $400,000 for couples filing jointly. Other noteworthy tax credits to keep in mind include:

Keeping an eye out for significant tax changes, such as those introduced by the Tax Cuts and Jobs Act, can help you avoid being sidelined when Tax Day rolls around. Professional tax relief can help you make the most of these changes and minimize your annual tax bill.

Avoiding Penalties and Other Costs

If you find yourself in a situation where the IRS is making calls and sending you notices about your outstanding debt to the government, a little professional help can go a long way. Tax debt is a serious issue, and on top of being a powerful creditor, the federal government also charges hefty interest rates and stacking penalties. A tax relief specialist can help:

Specific agreements with the IRS, such as a partial payment plan, or an offer in compromise, reduce the total debt owed in cases where a taxpayer’s financial circumstances do not allow for full payment within a reasonable timeframe. However, most of these applications for reduced debt are rejected. You may need an experienced professional’s help to draft an offer with a higher likelihood of acceptance.

Choosing the Right Tax Relief Specialist

Choosing the right tax relief specialist is as much a matter of professionalism and reputation as it is a matter of trust. Your go-to tax person will be someone you will need to trust with every detail of your finances and someone you can count on to help you navigate and understand your yearly tax obligations. Take time to meet with several professionals before settling on your final choice.

Standard vs Itemized Deductions: Which Is Right for You?

When preparing a federal tax return, you can choose between a standard deduction or several itemized deductions. In either case, a tax deduction is designed to reduce a taxpayer’s tax liability. This is primarily to reimburse losses, incentivize investment, and reduce the tax liability for low-income households.

Your standard deduction depends on your filing status, while your itemized deductions depend on which deductions you qualify for, with most of them having their qualification requirements. For example, if you owe $42,400 in taxes in 2022 and are single, your standard deduction would be $12,950 – meaning you would only owe $29,450 before tax credits.

If you are married filing jointly, you can double that deduction ($25,900), with the caveat that a joint tax return takes both your income and your spouse’s income into consideration. Whether the standard or itemized deductions are suitable for you depends entirely on how much you earn, your filing status, and whether you have any qualifying itemized deductions.

Standard Deductions

It’s important to mention that the standard deduction is much higher now than just a few years ago, following the Tax Cuts and Jobs Act of 2017. The TCJA doubled the standard deduction for 2018 through 2025 while eliminating several itemized deductions. This change will last until 2025, at which point Congress might make the change permanent or introduce a new tax act. For 2022, the standard deduction for taxpayers under age 65 is:

    • Single or married filing separately: $12,950
    • Head of household: $19,400
    • Married filing jointly/surviving spouse: $25,900

Being older than 65 or blind qualifies you for an additional standard deduction amount. In 2022, that additional standard deduction is $1,400 for each qualifying circumstance. That meant it was wiser to claim the standard deduction instead of itemizing your deductions for many Americans.

Itemized Deductions

However, that doesn’t mean it’s no longer worth itemizing your deductions. If you’re willing to do the math or pay for a professional tax preparation service, you can determine whether itemized deductions make sense, given your current expenses this year. Even the IRS encourages this. Pick the deduction method that nets you the lowest tax liability. Itemized deductions are usually available for costs such as:

    • State and local taxes (up to $10,000).
    • Mortgage interest (on the first $750,000 of a mortgage’s debt).
    • Charitable contributions.
    • Unreimbursed medical expenses.
    • Unreimbursed employee business expenses.
    • Personal and real property taxes.
    • Casualty losses.
    • Theft losses.
    • And more.

Having any given one of these expenses or losses does not qualify you for an itemized deduction on them. Nearly every itemized deduction must be an expense worth at least 2 percent of your adjusted gross income, if not more. For example, for an itemized deduction on unreimbursed healthcare costs, the total cost must exceed 7.5 percent of your adjusted gross income (AGI).

Charitable contributions can only be tax deductible up to a limit of 60 percent of your AGI. The list goes on. There are rare exceptions. For example, gambling losses are deductible regardless of your AGI. However, they are limited to an equal amount of reported gambling winnings (i.e., if you lost $8,000 gambling but won and reported $2,400 as income, you can only deduct $2,400 of your gambling losses).

While you can significantly reduce your taxes via itemized deductions, a certain income level will invoke the alternative minimum tax (AMT). In 2022, married couples filing jointly with an AGI of more than $118,100 ($75,900 for single filers or married filers filing separately) may qualify for the alternative minimum tax calculation. Finally, your itemized deductions used to be reduced if you earned a certain income level.

However, the TCJA eliminated this reduction until 2025. To help counter this loss, the TCJA expanded and increased the child tax credit and other dependent credits. The TCJA also eliminated individual exemptions, which were used to support larger families further offset their tax costs by claiming a dollar amount exemption on each dependent.

Should You Itemize Your Deductions?

The question of whether to claim a Schedule A tax form and begin filling each of your itemized deductions is one of pure math. Please consider all applicable tax-deductible costs (as mentioned above) over the last year and determine whether they exceed the standard deduction.

A professional tax preparation service or software can help you decide whether or not it is best to itemize or choose the standard deduction for this tax year. There are circumstances under which you must itemize. For example, if you are married and filing separately, and your spouse is itemizing, you must also itemize.

Itemized Deductions on Your Tax Return

If you are planning to itemize your deductions on your tax return, you will need Schedule A in addition to your Form 1040. You may also need Form 13614-C. For more information, you can refer to Publication 17. Linked is the version for 2021 – the IRS publishes a new one for each tax filing year.  

You Can Change Your Mind

It’s important to note that deciding to itemize today doesn’t mean you have to itemize next year. You are encouraged to determine whether itemizing is better for your tax return each year. And while the TCJA’s adjustment to standard deductions has simplified that question for many Americans, if your circumstances change severely from one year to the next, it is worth checking if you are better off itemizing your deductions rather than picking the standard deduction this tax year.

What If You Made a Mistake?

If you picked an itemized deduction that you did not qualify for (such as an unreimbursed medical cost that did not exceed the prerequisite percentage of your AGI), the IRS would adjust your tax return based on this discrepancy and bill you for the additional tax owed. If you have any tax credit or refund still owed to you, the IRS may take the amount owed out of that refund. Otherwise, you will be sent a balance due and requested to pay the amount in full.

The IRS can and does penalize failure to pay back taxes, even on simple mistakes. Keep an eye out for letters or correspondence from the IRS warning you about a due balance and potential penalties. Tax preparation services can help take the mystery out of filing your tax returns and help you ensure that you aren’t missing out on crucial savings. Talk to a tax professional today to determine how you should handle your tax deductions.

State Tax Garnishment Rules to Know 

When it comes to state tax garnishment rules, they are effectively non-negotiable. If you have an eligible income, you have a tax liability, and if you are self-employed, you will have to report and file your taxes diligently and single-handedly. But certain circumstances – from an ineligible deduction on a return to a penalty for tardiness – can leave you with more taxes than you might have expected and an unexpected (and unwanted) tax bill.

The smaller the bill, the easier it is paid off. But as your tax debt grows, so does the affected tax authority’s interest in collecting on it. Failing to communicate an interest in repaying your debt may lead to collection actions on behalf of the local tax authority or federal government (the IRS). And when push comes to shove, the IRS and state tax authorities can turn to their last resort: the wage levy or wage garnishment.


What is Wage Garnishment?

Wage garnishment involves taking a portion of every paycheck you make to go towards paying off your debt. The only way your wages can be garnished is through your employer, so a self-employed debtor need not worry about them. In cases of self-employment, the state tax authorities will issue a levy on certain properties or bank accounts instead.

Once wage garnishment begins, it doesn’t end until the debt is paid or the garnishment is otherwise discharged. All debtors are entitled to enough of their earnings to cover their legal obligations, namely state, federal, and local taxes, their share of Social Security and Medicare, and State Unemployment Insurance tax. Any income past that, however, counts as disposable income – even when it’s needed for rent and food.

The government does have a limit on when wage garnishment can kick in for most wage garnishment orders, however. If a debtor’s weekly disposable income is less than 30 times the federal minimum wage, no garnishment can take place.

Anything above 30 times minimum wage may be garnished, up to a certain maximum percentage of weekly wages depending on the type of debt (up to 15 percent for student loans and taxes, but up to 50-60 percent for child support and alimony, for example).

When you’re dealing with back taxes, however, your situation might look a little different. The IRS, for example, will levy your wages based on how many dependents you have, as well as standard deductions.

State and federal tax debt, as well as wage garnishment applied as part of certain bankruptcy court orders, do not take these limitations into consideration.

That is wage garnishment in a gist. There are, of course, important details. First, your rights as a debtor:

      • You must be notified of the government’s intent to garnish. If it’s news to you on the day that your HR department notifies you of your garnished wages, you may be able to appeal the wage garnishment.
      • You can otherwise dispute an order to garnish your wages if the information the government is acting on is incorrect.
      • Certain benefits may be exempt for wage garnishment (veteran’s benefits, for example).
      • You cannot be fired for having your wages garnished once. However, the more concurrent creditors you have, the less protection is afforded to you and your job.
      • There are state-to-state differences on how wages are garnished, what limits apply, and what an employer can or cannot do in response to wage garnishment.

The first thing you should do if you are about to face wage garnishment in your state is contact an attorney. A tax professional can help you navigate the issue and find the best solution for your circumstances.

For example, in the District of Columbia, wages cannot be garnished by creditors if the debtor’s weekly disposable income is less than 40 times the state minimum wage ($15 per hour). On the other hand, in Florida, if the debtor is the head of their family and makes less than $750 a week, their wages cannot be garnished either.


When Will State Tax Authorities Consider Garnishment?

Wage garnishment is a powerful collection action levied by the state when a taxpayer has failed to pay their debt and other collection actions have failed.

While it may take a while for the IRS to garnish your wages, state tax authorities tend to jump the gun more often. Take your state and federal tax debts very seriously – until paid, they typically don’t go away. It’s important to consult a professional on how to deal with your back taxes to the government before they become insurmountable.


What Does the State Consider Earnings?

The government doesn’t plan on only claiming one paycheck. The Consumer Credit Protection Act defines earnings as compensation paid or payable for personal services. This includes wages, salaries, bonuses, payments from pension or retirement, and bonuses. Examples include:

      • Commissions
      • Performance bonuses
      • Profit sharing
      • Sign-on bonuses/referral bonuses
      • Incentive payments
      • Cash awards
      • Merit increases
      • Severance pay
      • Termination pay
      • Worker’s comp payments
      • And more

Whenever tips are involved, these count as wages if they exceed the tip credit claimed by the employer, if a tip credit exists. Otherwise, they do not.


What Can I Do about State Tax Garnishment Rules?

While limited, you do have options when it comes to state tax garnishment rules. You can file a dispute if the wage garnishment notice is inaccurate. You can seek the help of a tax attorney or find legal aid. You can contact the state tax authorities and work out a payment plan. Or, you can work your way through the garnishment.


What If You Don’t Owe Taxes?

Federal agencies and affiliated collection agencies under contract with them can still garnish your wages for other defaulted debts owed to the US government.

However, if you feel that your wages are being unfairly or incorrectly garnished, you need to get in touch with a tax professional in a timely manner and discuss your case.


Get Professional Help Today

Certain factors can greatly complicate your situation, like losing employment or trying to pay off another creditor while the government garnishes your wages. If you are in financial trouble and are considering bankruptcy or other options for your state tax debt, contact a local tax professional immediately. You may have more options than you would expect, depending on individual circumstances.

We at Rush Tax Resolution have multiple tax debt experts on hand ready to help you navigate your situation and find the best way forward through your state tax garnishment rules. Get in touch today.

What Happens If You Don’t File Taxes for 5 Years?

Failure to file taxes can lead you to hot water with the IRS, but what happens if you don’t file taxes for 5 years? 

If you’ve ever failed to file your taxes, you’re sure to have received a notice from the IRS detailing the penalty you have to pay as a result of your late filing. But have you ever wondered what happens if you forget (or fail) to file for multiple years?

Surprisingly, the answer might be nothing – at first, at least. The IRS generally isn’t fond of taxpayers who don’t pay their fair share or provide the required paperwork for the tax system to function. Tax returns are part of how the IRS cross references information across large populations to find red flags and reduce the tax gap.

But just because the IRS doesn’t come down hard on some taxpayers who haven’t filed for years doesn’t mean that there are no consequences at all – or that you can fly under the radar forever. The IRS doesn’t forget. But it can forgive, if you play your cards right.


The IRS Doesn’t Forget

It’s important to mention that the IRS does not necessarily need you to file anything to know what you’ve earned, at least roughly. The IRS uses information returns filed by employers, banks, and other institutions to determine what you owe in taxes, and it will receive that money either through withholding or your monthly payments.

You can (and should) make these payments even if you don’t file taxes for 5 years. If the IRS discovers that you’re earning elsewhere – through reports from the bank or returns filed by other people – their software can pick up on that discrepancy and will call it out as a red flag.


You May Have Had a Return Filed for You

If you fail to provide the IRS with the information they need to make the pieces fit together, they will file a substitute return for you based on the information they have. This means that you won’t have any deductions or tax refunds applied to the income the IRS will report for you. Think of it as a passive aggressive statement – because you aren’t filing, the IRS takes your paperwork, says “fine, we’ll do it for you”, and gives you just about the worst possible deal it can.

On top of that, your tax account will carry a penalty.


Understanding IRS Penalties

There are two major IRS penalties: a failure to pay penalty for any outstanding tax balance, and a failure to file penalty whenever a tax return is significantly overdue.

If you fail to file, the IRS gives you a flat penalty to start, and adds 5 percent of what your unpaid tax bill every month your return hasn’t been filed, culminating at a 25 percent maximum after five months.

Depending on how hefty your estimated tax bill is, the IRS will pursue collection actions against you. If you don’t file taxes for 5 years, expect collections to be reaching out.


Why You Should File Your Old Returns Anyway

Despite the IRS filing for you, these substitute tax returns still don’t count as the real thing. If you have a tax bill – and you do, because of the penalty and accumulated interest – you will eventually need to pay off that tax bill.

When you decide to do so, the IRS will usually not accept any payment plans or offers until your tax returns are in order. That means you will have to get your paperwork straight first, before you can wipe your debt.


Settling Your Debt with the IRS

Once you’re in the position to make things right, you will want to start by getting caught up as quickly as possible. Thankfully, if you work with tax professionals, this will not take too long.

Start with the most recent year and work your way backwards. You can file this year’s late return electronically via the IRS’ website, where you will also find all the information you will need to file returns you haven’t kept very good records on, via the IRS’s transcript records.

You can basically ask the IRS to send you the information they have on you, combine it with what you know or have left in your records, and create an accurate tax return for years you’ve missed. To do so, you will need to fill out Form 4506-T. Keep in mind that it can take well over a month for the IRS to finish processing your request.

As you work your way through your returns, you will be able to start negotiating a payment plan with the IRS. You can do so either in a single transaction, in a short period (via multiple lump sums), or monthly (until it is done). If your tax debt is quite large, you may have other options you can explore with a tax professional.


What Happens If You Don’t Pay?

Willfully ignoring your duty as a taxpayer theoretically can be a criminal offense. However, it’s more likely that if the IRS hasn’t done anything at this point, they will continue to let interest rack up on your tax account until they come knocking and demand payment – as well as the overdue tax returns.

If you refuse to pay, the IRS has multiple different ways of turning up the heat without threatening imprisonment. The first is through a tax lien. A federal tax lien effectively blocks you from accessing certain forms of financing by making the government itself the top priority creditor in line for your money. This applies to every asset and account in your name. This also means you cannot seek a secured loan or use anything you own as collateral for financing.

From there, the IRS can turn to tax levies as its next step. A tax levy is a physical claim of an asset or account, and everything therein, for the purpose of repaying your tax debt. The IRS cannot claim the home you live in, nor any assets you strictly need to survive, but they can take certain properties and clean out certain accounts.

Any action the IRS takes must first be announced via the mail. You will receive multiple different letters and notices as the IRS proceeds to place a lien and levy on your tax account and belongings. Only by repaying your debt, taking them to court, writing an appeal to the Independent Office of Appeals, or becoming Currently Not Collectible can you keep the IRS from levying further collection actions against you.

If you are worried about trouble with the IRS due to being behind on tax returns and tax payments, know that time is of the essence. If you don’t file taxes for 5 years, or any amount of time, get in touch with us today at Rush Tax Resolutions, and get your situation sorted out quickly.

Itemized vs. Standard Deductions: What’s Right for You?

When preparing your taxes, you likely look towards deductions, but when it comes to itemized vs. standard deductions, which one is right for you?

Out of the few ways you can reduce your income taxes each year, the only two you can rely on year after year are the standard deduction and itemized deduction.

While the amount of income tax you owe can be lowered by tax credits and education, investment, or healthcare deductions as well, every American taxpayer is entitled to standard or itemized deductions on their annual tax return. However, you can only pick one of the two.

Understanding how itemized vs. standard deductions work, how they’re calculated, and why you might consider one over the other can help you cut down on your taxes and save money.


Itemized vs. Standard Deductions: What Are They?

Tax deductions are applied to income before it is calculated for tax. This means that if you have a fixed deduction of $10,000, then you take your annual taxable income and slash $10,000 off of it before calculating your tax rate.

Additional tax deductions help drive your taxable income even lower, usually through certain medical expenses, student loan interest, and work-related deductions.

This is in contrast to a tax credit, which reduces the amount of tax you owe. While the difference seems semantic, it’s easier to think of it this way – tax deductions can play a role in determining your tax rate, while a tax credit is a flat number taken off your total owed taxes for the year. Tax deductions can reduce your tax liability, while credit can lead to a refund from the IRS if you don’t owe any tax.

Choosing between itemized vs. standard deductions is largely a matter of determining just how many itemized deductions you can reliably qualify for.

What this means is that the standard deduction is something you’re easily entitled to, while itemized deductions can raise red flags for the IRS if they seem implausible or if a tax return is simply using too many of them.


How the Standard Deduction Was Reworked

When determining itemized vs. standard deductions, we must understand what standard deductions include. The standard deduction is a set amount of money shaven off your total taxable income at the end of the year.

Your standard deduction is determined by your age and filing status. You can specify that you choose to claim the standard deduction on your income tax return—only taxpayers who decide to itemize need to fill out a Form 1040 Schedule A.

One of the many changes to the tax code made by the Tax Cuts and Jobs Act of 2017 includes an overhaul of standard and itemized deduction amounts. For example, the rates for the standard deduction in 2020 were:

      • $12,400 for single taxpayers/married individuals filing separately.
      • $28,650 for the head of the household filing status.
      • $24,800 for married couples filing jointly.
      • $24,800 for qualifying widow(er)s.

Taxpayers aged 65 and older, as well as blind taxpayers, receive a higher standard deduction.


The Pros and Cons of a Standard Deduction

Prior to the rework in 2017, many taxpayers were benefiting immensely from going for multiple itemized deductions rather than picking the standard deduction. This would result in more work but a better tax cut.

However, with the new amounts, many taxpayers (as many as 90 percent) are better off claiming the standard deduction rather than going through the trouble of listing their itemized deductions.

If you didn’t spend your own time going through your expenses to figure out your itemized deductions, chances are that you were paying a professional tax preparer to do so. Choosing the standard deduction instead can save you an average of over $100 in your tax prep bill.

Of course, there is still one significant consideration – you may be leaving money on the table. It’s worth bringing the idea up with your financial planner or tax preparation provider or personally going through your expenses for the year. If it was a particularly life-changing year – with medical issues, home office investments, charitable donations, and more – you may save more through itemized deductions.


How Itemized Deductions Work

When it comes to itemized vs. standard deductions, you will have more work when choosing an itemized approach. Form 1040 Schedule A presents you with a long list of itemized deductions that you may claim to reduce your tax liability. These include:

      • Medical and dental expenses.
      • Local taxes.
      • Interest on loans.
      • Gifts to charity.
      • Casualty and theft losses.
      • And other types of itemized deductions.

If you’ve had substantial costs or losses related to any of the above, you may rack up considerable itemized deductions. However, you need to take note of a few things before you switch from your standard deduction.

First, there are restrictions and limits on deductibility, especially for disaster-related losses, mortgage interest, and charitable donations. Second, for medical and dental deductions, only expenses that exceed 7.5 percent of your total adjusted gross income for the year can be deducted.

Furthermore, note that if you file jointly with your spouse, then choosing to itemize forces them to itemize as well.


The Pros and Cons of Itemized Deductions

The most significant difference between itemized vs. standard deductions is that the greater your expenses, the higher the likelihood that you can shield more of your wealth through itemized deductions than the standard deduction.

But that comes at a price, either in the form of more work for you or more work – and higher costs – for the tax preparation service. Not only do you need to keep an accurate paper trail for every major expense over the year, but you also need to keep in mind that there are restrictions, limits, and rules for every type of itemized deduction.

Finally, there’s the risk of an audit. The IRS is more likely to flag down and investigate an account with an unusual number of itemized deductions for the person’s respective age, filing status, occupation, location, and annual income. They use algorithms to spot inconsistencies and have the right to ask for paperwork backing up all of your itemized deductions for the last three years.

Note that the IRS does not audit very often, at a rate of much less than 1 percent for taxpayers earning less than $1 million.

It all boils down to which one brings you the best savings. If you aren’t sure between itemized vs. standard deductions, working with a tax preparer can help.