Categories
Taxes

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.

Exit mobile version