As taxpayers navigate the complexities of filing their tax returns, one key decision stands out: whether to take the standard deduction or to itemize deductions.
Itemized deductions offer a tailored approach to reducing taxable income, allowing taxpayers to deduct specific eligible expenses like mortgage interest, state taxes, and charitable donations.
What Are Itemized Deductions?
Itemized deductions are specific expenses allowed by the IRS that taxpayers can subtract from their adjusted gross income (AGI) to reduce their taxable income. Unlike the standard deduction, which is a flat amount based on filing status, itemized deductions require taxpayers to list (itemize) deductible expenses on their tax returns.
Common itemized deductions include:
- Mortgage interest on a primary or secondary residence
- State and local taxes paid, including property taxes (up to a certain limit)
- Charitable contributions
- Medical and dental expenses above a certain percentage of AGI
- Certain job-related expenses
Taxpayers should itemize their deductions if the total of these expenses exceeds the standard deduction for their filing status.
Itemizing deductions can potentially reduce a taxpayer’s tax liability more than the standard deduction. However, it requires keeping detailed records and receipts to substantiate the expenses claimed.
What Qualifies As Other Itemized Deductions?
“Other itemized deductions” refer to a variety of expenses that are eligible for itemization on a taxpayer’s Schedule A (Form 1040) and are not categorized under the main itemized deductions like state and local taxes, interest, charitable contributions, or medical expenses. These can include less common expenses that the IRS allows taxpayers to deduct. Some of these are subject to various limitations:
Gambling Losses: Deductible to the extent of gambling winnings.
Casualty and Theft Losses: From a federally declared disaster, deductible after subtracting $100 from each casualty event and then only to the extent that the total loss exceeds 10% of AGI.
Unreimbursed Employee Expenses: Deductions for unreimbursed employee expenses like tools, uniforms, and work-related travel have been suspended for tax years 2018 through 2025 for most employees due to the Tax Cuts and Jobs Act of 2017.
Tax Preparation Fees: These fees, along with certain other miscellaneous deductions, including investment expenses, are no longer deductible due to changes from the Tax Cuts and Jobs Act for tax years 2018 through 2025.
Other Miscellaneous Deductions: Subject to the 2% floor of AGI, these are no longer deductible for tax years 2018 through 2025.
Because tax laws change and the availability of deductions can vary from year to year, it’s important to consult the latest IRS guidelines or a tax professional to understand which deductions are currently allowable and how they can be claimed.
Do Itemized Deductions Get Phased Out?
Itemized deductions used to be subject to a phase-out or limit based on income, known as the Pease limitations. This limitation reduced the amount of itemized deductions that high-income taxpayers could claim. However, the Tax Cuts and Jobs Act (TCJA) of 2017 temporarily suspended these limitations through 2025.
Under the Pease limitations, itemized deductions were reduced by 3% of the amount by which a taxpayer’s adjusted gross income (AGI) exceeded a specified threshold, but they could not be reduced by more than 80% overall, regardless of income.
The suspension of the Pease limitations is in effect for tax years 2018 through 2025. This means that during this period, there is no phase-out of itemized deductions based on the taxpayer’s AGI. High-income taxpayers can itemize deductions without being subject to the reduction that was previously in place.
How Much Do Itemized Deductions Save You?
The amount of money itemized deductions can save you on your taxes depends on your marginal tax rate and the total amount of deductions you can itemize. The marginal tax rate is the rate at which your last dollar of income is taxed, and the U.S. federal income tax system uses progressive rates, which means as income increases, it is taxed at a higher rate.
Here’s a simplified example to illustrate how itemized deductions might save you money:
Marginal Tax Rate: Suppose your taxable income puts you in the 24% tax bracket.
Itemized Deductions: Assume you have itemizable expenses totaling $20,000.
Standard Deduction: For comparison, let’s say the standard deduction for your filing status is $14,600.
By choosing to itemize, you would deduct $20,000 from your taxable income rather than the standard deduction of $14,600. The difference between these amounts is $5,400.
The tax savings from itemizing would be the difference in deductions ($5,400) multiplied by your marginal tax rate (24% in this example):
Tax Savings = Difference in Deductions×Marginal Tax Rate
Tax Savings = $5,400 × 24%
Tax Savings = $1,404
In this scenario, by itemizing deductions, you would save $1,692 in taxes compared to taking the standard deduction.
Keep in mind that the actual calculation can be more complex because:
- Some itemized deductions may have their own limits (e.g., medical expenses must exceed a certain percentage of AGI).
- State income taxes might differ in how they handle deductions.
- Various tax credits, additional taxes, or alternative minimum tax (AMT) considerations could affect your tax savings.
To get a precise figure on the savings from itemizing deductions, it is recommended to calculate your taxes both ways or use tax preparation software, which can automatically determine which method saves you more money.
How To Keep Track Of Itemized Deductions?
Keeping track of itemized deductions requires organization and a system for maintaining records throughout the year. Here are some steps and tips to help you track your itemized deductions effectively:
Know What to Track
Familiarize yourself with the types of expenses that are deductible. Common categories include medical and dental expenses, taxes paid, interest paid, charitable contributions, casualty and theft losses, and miscellaneous deductions.
Keep Receipts and Documentation
Save all receipts, bills, invoices, and statements that may relate to deductible expenses. For charitable contributions, always get a receipt or written acknowledgment from the charity.
Use Financial Software or Spreadsheets
Utilize financial software like Quicken or use spreadsheets to record expenses throughout the year. There are also apps specifically designed for tracking expenses that can categorize and store digital copies of your receipts.
Bank and Credit Card Statements
Review your bank and credit card statements regularly to identify deductible expenses.
Have a designated place, such as a folder or file cabinet, where you keep all tax-related documents.
If you use your vehicle for deductible activities like charity work, medical transportation, or business (if self-employed), keep a mileage logbook in your car or use a mileage tracking app.
For non-cash donations, keep a detailed list of items donated, their condition, and their fair market value. Take photos if possible.
Home Office Deduction
If you’re eligible for a home office deduction, maintain records of all expenses related to the home office, including utilities, insurance, and repairs.
If you’re deducting educational expenses, keep receipts for tuition, books, supplies, and any other related expenses.
Here is a simple chart outlining common itemized deductions and their respective requirements or notes:
|Type of Deduction
|Medical and Dental Expenses
|Only the amount above 7.5% of AGI is deductible.
|State and Local Taxes (SALT)
|Capped at $10,000 for married filing jointly, or $5,000 for married filing separately.
|Includes home mortgage interest and investment interest.
|Must be made to qualified organizations. Special rules apply for non-cash contributions.
|Casualty and Theft Losses
|Only deductible if the loss occurred in a federally declared disaster area.
|Other Miscellaneous Deductions
|Many miscellaneous deductions subject to the 2% AGI floor have been suspended for tax years 2018-2025.
This chart provides a general overview of itemized deductions and some key considerations for each category.
What Deductions Can I Claim Without Receipts?
The IRS generally requires you to keep documentation to support your deductions. However, there are certain deductions that you can claim without having a physical receipt, as long as you have other sufficient documentation, or the deduction is subject to specific exceptions.
For all deductions, even if a receipt isn’t required, you must have some form of documentation to prove the expense in case of an IRS audit.
Here are some examples:
- Standard Deduction: You don’t need receipts to claim the standard deduction, which is a set amount based on your filing status.
- Mileage Logs: For business, charitable, medical, or moving purposes, you don’t need a receipt for each trip, but you should keep a detailed log of the miles driven, the dates, the destinations, and the purpose of the trips.
- Charitable Contributions: For cash contributions less than $250, a bank record or a statement from the receiving organization can suffice instead of a receipt.
- IRA and HSA Contributions: Statements from the financial institution can serve as proof of contributions to Individual Retirement Accounts (IRAs) and Health Savings Accounts (HSAs), rather than receipts.
- Bank Records for Interest and Taxes: For mortgage interest and property tax deductions, a year-end statement from the bank or tax authority can be used instead of monthly receipts.
- Educational Expenses: Form 1098-T from educational institutions can be used to claim tuition and fee deductions or education credits without additional receipts.
- Non-reimbursed Work-related Expenses: While most unreimbursed employee expenses are not deductible for tax years 2018 through 2025, qualifying reservists, performing artists, and fee-basis government officials can use other documentation, like contracts or billing statements if they lack receipts.
- Medical and Dental Expenses: You don’t need to submit receipts with your tax return, but you should retain records like statements from medical providers or insurers that show the amounts paid.
- Gambling Losses: A diary or log of losses, along with corroborating documents like wagering tickets or statements from the gambling establishment, can be used without individual receipts.
What Happens If Itemized Deductions Exceed AGI?
If your itemized deductions exceed your adjusted gross income (AGI), this situation is typically uncommon but could happen in cases where you have experienced significant losses, such as large medical expenses, casualty losses, or other sizable deductible expenses. Here’s what could occur:
Negative Taxable Income: Normally, deductions are subtracted from your AGI to determine your taxable income. If deductions exceed AGI, theoretically, you would have a negative taxable income.
No Tax Liability: You would not owe any federal income tax since your taxable income would be zero or negative.
Refundable Credits: If you are eligible for refundable tax credits, such as the Earned Income Tax Credit or Child Tax Credit, you could still receive a refund even if your taxable income is negative.
Non-Refundable Credits: Non-refundable credits can reduce your tax liability to zero but cannot result in a tax refund on their own. So, if your tax liability is already zero due to your deductions exceeding your AGI, these credits would not provide any additional benefit.
Loss Carryovers: In some cases, you may be able to carry forward a portion of your losses to future tax years. This is commonly seen with capital losses and certain business losses.
Net Operating Loss: If you run a business and your expenses exceed your income, you may have a net operating loss (NOL). Certain types of NOLs can be carried forward to future years to offset taxable income, but the rules for doing so are complex and have been subject to recent legislative changes.
Excess Deductions on Termination of an Estate or Trust: There are special rules that allow for excess deductions on termination of an estate or trust to be passed out to beneficiaries.
Alternative Minimum Tax (AMT): If you are subject to the AMT, some deductions that are allowed for regular tax purposes may be disallowed, which could potentially reduce the impact of high deductions.
Itemized deductions offer a strategic way for taxpayers to lower their taxable income and potentially increase their tax savings. We have explored various deductible expenses, such as mortgage interest, state and local taxes, charitable contributions, and medical expenses, each with its specific rules and limitations.
Key takeaways include:
- the importance of meticulous record-keeping,
- understanding the nuances of each deduction category,
- and the need to assess whether itemizing offers more benefit than the standard deduction based on individual financial circumstances.
Itemizing can be more labor-intensive than taking the standard deduction, but for those with considerable deductible expenses, the effort can be well worth it.
If you have additional questions, let me know, or TurboTax addresses the topic as well.