Standard Deduction or Itemized Deduction for the Most Tax Benefits
When taking deductions to receive the most tax benefit from your federal income tax return, there are two choices: take the standard deduction or itemize deductions. The more you are able to deduct, the less taxes you’ll pay. However, it’s a little more complicated than a simple statement like that. This article will walk you through the definitions of standard deduction versus itemized deduction, and will offer things to consider, as well as two scenarios. Ultimately, we hope this helps you keep more of your hard-earned money!
Standard Deduction
The standard deduction changes each year and varies based on factors including age, income, and filing status. It is a flat-rate reduction of adjusted gross income.
Here are the standard deduction amounts for 2020 tax returns:
Single or Married Filing Separately - $12,400
Head of Household - $18,650
Married Filing Jointly - $24,800
The standard deduction is higher if you are over 65 years of age or blind, and smaller if someone can claim you as a dependent. Also, there are various reasons that certain taxpayers cannot use the standard deduction.
Itemized Deductions
Itemized deductions, also called below the line deductions, are expenses that the IRS allows to decrease taxable income. The total amount of deductible expenses is subtracted from the adjusted gross income, which results in the amount of taxable income.
Itemizing is recommended for taxpayers whose deductions are greater than the standard deduction, or if due to a reason listed in the article linked above, a taxpayer is not able to take the standard deduction. Itemized deductions are determined using Schedule A (Form 1040 or Form 1040-SR) and can include:
Charitable gifts,
Amounts paid for state and local income and sales taxes,
Real estate taxes,
Personal property taxes,
Mortgage interest,
Amount paid for medical and dental expenses,
Certain casualty and theft losses, and
Disaster losses from a federally declared disaster.
A complete list of available deductions for 2020 taxes can be found in this article from nerdwallet.com. Investment fees, job expenses, and tax preparation fees are deductible for businesses but are no longer deductible on individual tax returns.
Things to Consider When Choosing Between Standard and Itemized Deductions
The standard deduction has increased significantly over the last few years. This means that if you itemized before, you may no longer benefit. Continue to check the standard deduction each year. The standard deduction amounts for 2021 tax returns are now available, and they increased from 2020.
There are rules for itemized deductions. For example, if you are deducting medical expenses, you can only deduct the portion that exceeds 7.5% of your adjusted gross income.
Itemizing deductions is time-consuming! It requires the completion of additional forms as well as finding proof for each deduction, whereas the standard deduction does not require either.
Following are Two Scenarios for Standard vs Itemized Deductions
Scenario 1
A head-of-household taxpayer made $75,000 in 2020, which puts the taxpayer in the 22% tax bracket. When the taxpayer takes the standard deduction of $18,650, this brings the taxable income to $56,350, and the taxpayer stays in the 22% tax bracket. However, after itemizing, the taxpayer determines that the deductible amount is actually $21,000 (more than the standard deduction.) The taxable income is now $54,000, and the taxpayer makes a major jump down to the 12% tax bracket. This taxpayer significantly benefited from taking the time to itemize.
Scenario 2
Married-filing-jointly taxpayers made $125,000 in 2020, which puts them in the 24% tax bracket. When the taxpayers take the standard deduction of $24,800, their taxable income is $100,200 and they remain in the 24% tax bracket. They invest the time and determine that their itemized deduction is $24,000. Their taxable income with itemized deductions is $101,000, which is lower than the standard deduction – and the tax bracket remains unchanged at 24%. The taxpayers benefit slightly by sticking with the standard deduction
A final thought.
If you take the time to itemize and ultimately choose the standard deduction, you will at least know that you did not miss out on additional tax savings! Please contact me with your questions about deductions.