What is an Itemized Deduction?

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Definition:

An itemized deduction is an expense that you can claim on your taxes to reduce your taxable income based on a qualified purchase or expense.

🤔 Understanding itemized deductions

When you calculate your taxable income, you’re allowed to deduct certain things from your income before determining the amount that you owe. You can choose to use the standard deduction, which is a flat amount that you can subtract from your income. Or you can itemize deductions. If you use itemized deductions, you can subtract the amount that you spent on certain things, such as mortgage interest or charitable donations, from your income when calculating your taxes owed. You cannot take both the standard deduction and itemized deductions, so you should choose the one that lets you deduct the most from your taxes.

Example

Imagine that you earn enough in a year to have an adjusted gross income of $50,000, before accounting for the standard or itemized deductions. If you take the standard deduction, you can reduce your AGI by $12,550, for the 2021 tax year. This reduces your AGI to $37,450.

Some expenses that you can take an itemized deduction for include:

  • State and local taxes
  • Mortgage interest
  • Charitable gifts
  • Losses from federally declared disasters

If you made $10,000 in qualifying charitable donations and spent $5,000 on state and local income and property taxes in 2021, you could use those itemized deductions to reduce your AGI to $35,000. In this case, using itemized deductions would give you a lower AGI and reduce your tax bill.

Takeaway

Using an itemized deduction is like getting a rebate for a purchase…

Sometimes, you save money by buying things on sale. Other times, you have to mail in proof of purchase to get your money back in the form of a rebate. Itemized deductions are like mailing in for a rebate. You give the government an itemized list of what you spent money on — In exchange, the government lets you deduct some of those expenses from your taxable income, keeping an extra bit of money in your pocket.

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What is an itemized deduction?

An itemized deduction is a tax deduction that you can take for specific purchases or expenses. Tax deductions let you subtract amounts from your income when calculating your income tax owed, so a tax deduction allows you to pay less tax.

Itemized deductions are itemized because you have to specifically note the expense(s) you’re deducting and the amount that you’re deducting for each expense. It’s like receiving a bill at a restaurant. You see a list of all of the food and drinks you ordered and how much they cost. With itemized deductions, you give the government a list of your qualifying expenses, and the government lets you pay less in taxes.

Itemized deductions are different from the standard deduction, which is a flat amount that a person can deduct from their income when calculating their taxes owed. For 2020 taxes (due spring 2021), the standard deduction is $12,400 for those who are single or married filing separately; for married couples filing jointly, the standard deduction is $24,800. For 2021 taxes (due spring 2022), the standard deduction is $12,550 for those who are single or married filing separately; for married couples filing jointly, the standard deduction is $25,100.

You can choose to use either itemized deductions or the standard deduction — You cannot use both. If your goal is to pay the smallest amount in taxes possible, you should choose the deduction that reduces your income the most. Most taxpayers wind up using the standard deduction because it can be hard to find more than $12,400 in itemized deductions. In 2018, for example, fewer than 14% of taxpayers itemized their deductions.

How do tax deductions work?

Tax deductions help reduce your income when calculating your income taxes. In this way, they directly reduce the amount of tax that you owe.

If you earned $50,000 in taxable income in a year and have $15,000 in deductions, you can reduce your taxable income by that amount. That means that you’ll only pay income tax on $35,000 of income.

Deductions can have a significant impact on the taxes that you owe. Consider a taxpayer whose Adjusted Gross Income is $60,000 before deductions. Their federal tax bill would be $9,058.50 based on that amount. If that taxpayer takes the standard deduction of $12,400, their taxable income becomes $47,600, making their tax bill $6,268.

If the person itemized deduction instead, they could deduct each dollar they itemize. Someone who itemizes may be able to deduct $21,000 instead of $12,400, reducing their taxable income to $39,000. That makes their tax bill $4,486. Those with even larger incomes can often deduct even larger amounts.

Depending on your taxable income, deducting one dollar will typically save you between 10 and 35 cents in taxes.

It’s important to understand that tax deductions and tax credits are not the same things. Deductions let you reduce your taxable income, that is the base on which your taxes are calculated, which means that you owe less in taxes at the end of the year.

Tax credits don’t affect your taxable income. Instead, they effectively pay part of your tax bill for you.

Both reduce the amount you must pay out of pocket, but their mechanism for doing so is slightly different.

Why does the government allow itemized deductions?

One of the reasons that the government allows itemized deductions is to recognize the costs that some taxpayers bear that may make it difficult for them to cover their tax bill. One example of this is the deduction for medical expenses.

Taxpayers can take an itemized deduction for medical expenses that exceed 7.5% of the adjusted gross income (AGI). If you experience a medical emergency and spend a long time in the hospital, you’re likely to lose out on income from work and have to spend a significant sum of money on medical care. This can make paying taxes a major burden. The government allows these types of deductions to help unburden people who will likely struggle to pay their taxes.

The government uses other types of itemized deduction to influence people’s behavior. By offering financial incentives for certain actions, the government can encourage people to act in ways that benefit the government or society.

The charitable giving deduction is a prime example of this. There are numerous charities that give help to people who are experiencing specific types of hardship. These hardships could be anything from hunger to homelessness. By letting people deduct their charitable giving from their taxes, the government encourages taxpayers to give money to charities that help the less fortunate members of society.

The deduction for mortgage interest is another example of this. Governments tend to encourage homeownership. Providing a tax benefit for people who are paying off their home makes homeownership less expensive, so the government uses this deduction to encourage more homeownership.

How can itemized deductions cut my tax bill?

Because anyone can take the standard deduction instead of itemizing, itemized deductions only cut your tax bill if you can itemize more deductions than the standard deduction amount. For 2020 taxes, the standard deduction is $12,400 for individuals (and $24,800 for married couples filing jointly), so you must be able to itemize at least that much in deductions for itemizing to reduce your tax bill.

Which expenses can be itemized?

The IRS maintains a complete list of expenses that you can itemize. Some of the expenses you can itemize include:

  • Medical expenses in excess of 7.5% of your adjusted gross income (AGI)
  • State, local, and foreign income, sales, and real estate taxes, up to $10,000
  • Home mortgage points
  • Interest paid on investments, mortgages, student loans, and business expenses
  • Charitable contributions
  • Business use of your home or car
  • Business travel costs
  • Work-related education expenses
  • Losses due to casualty, disaster, or theft
  • Gambling losses that offset gambling income

What is the standard deduction?

The standard deduction lets you subtract an amount from your taxable income, reducing the amount of income tax that you owe. Unlike itemized deductions, which can vary in amount based on your spending, the standard deduction is the same for everyone.

For the 2020 tax year (taxes that are due spring 2021), the standard deduction is $12,400 for those who are single or married filing separately; for married couples filing jointly, the standard deduction is $24,800. For the 2021 tax year (taxes that are due spring 2022), the standard deduction is $12,550 for those who are single or married filing separately; for married couples filing jointly, the standard deduction is $25,100.

Almost everyone is eligible to take the standard deduction. The following taxpayers are not eligible:

  • An individual who is married, filing separately, whose spouse itemizes deductions
  • Nonresident aliens or dual status aliens who do not meet specific requirements
  • Students and apprentices who are residents of India and eligible for benefits under the United States-India Income Tax Treaty

All other taxpayers can take the standard deduction if they choose to apply for it rather than the itemized deduction.

Should I take the standard deduction or should I itemize?

The decision to itemize or take the standard deduction is typically based on the size of each deduction. Most people want to minimize the taxes that they pay, which means they should take the deductions that let them pay the least tax.

Some people also consider the effort of itemizing over taking the standard deduction. Itemizing deductions takes more work because you must account for every expense that you deduct. You’ll also want to have records of these expenses available in case you’re audited. If you can only save a small amount by itemizing instead of taking the standard deduction, you may decide it’s worth saving less money to avoid the work involved with itemizing deductions.

How do I know if I itemized my deductions?

When you itemize your deductions, you need to submit Form 1040 Schedule A outlining your deductible expenses and the amount that you’re deducting. If you do not remember whether you itemized your deductions last year, you can check your tax forms to see if you submitted Form 1040 Schedule A. If you did, you itemized your deductions. If you did not submit Schedule A, then you did not itemize your deductions. Unless you were ineligible for the standard deduction, this means that you took the standard deduction.

Another way to check whether you itemized your deductions or took the standard deduction is to look at your Form 1040. Line 9 lets you enter the amount that you are deducting for itemized or standard deductions. If you entered the amount of the standard deduction ($12,000 for 2018), you took the standard deduction. If you entered a different number, then you itemized.

How can I calculate my itemized deductions?

The best way to calculate your itemized deductions is using the form that the IRS provides for itemizing, Form 1040: Schedule A. This form will let you determine which expenses you can deduct and the amount that you are eligible to deduct. Once you’ve filled out the form, you can submit it along with your tax return to claim the deductions that you’ve itemized if you want to itemize. If you decide not to itemize, you can submit your tax return without the form, opting for the standard deduction.

Tax preparation software also helps you calculate your itemized deductions. Most programs ask you to enter information about your deductible expenses and determine whether itemizing makes sense. If it does, the software will typically calculate your itemized deductions automatically.

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