In this week’s post, I explain the difference between using the standard deduction and itemizing deductions.
What are deductions?
Last week, we reviewed the basic income tax formula. After calculating adjusted gross income (AGI), deductions are subtracted to arrive at taxable income. In other words, deductions reduce taxable income.
It is important to distinguish deductions from credits. Deductions reduce taxable income, whereas credits reduce tax owed, dollar-for-dollar.
Here is the formula we reviewed last week:
Standard deduction vs. itemized deductions
A taxpayer will deduct the greater of their standard deduction or their itemized deductions.
The standard deduction is a set amount that can be deducted based on the taxpayer’s filing status. A taxpayer will use the standard deduction when they do not have many itemized deductions. For 2022, the standard deduction amounts are $12,950 for the single filing status and $25,900 for married filing jointly filing status.
Itemized deductions are certain expenses or other financial transactions that are deductible. Common itemized deductions include:
Medical and dental expenses that are above 7.5% of AGI
State/local income taxes, real estate taxes, personal property taxes ($10,000 cap)
Interest (mortgage and investment)
Gifts to charity
Casualty and theft losses
If the total of a taxpayer’s itemized deductions is greater than their standard deduction, they will itemize. This reduces taxable income as much as possible and minimizes taxes paid.
There is also a qualified business income deduction that applies to small business owners. We will not discuss this deduction in this post.
Should you take the standard deduction or itemize your deductions?
Should you be taking the standard deduction or itemizing your deductions? As stated above, you will want to start itemizing your deductions as soon as your itemized deductions exceed your standard deduction. This will minimize your taxable income and reduce the amount you pay in taxes.
Although every situation is a little different, there are several factors that make someone more likely to use the standard deduction:
Low income – likely results in deductible expenses being low
Live in a state with low/no state income taxes
Low giving
And there are factors that make someone more likely to itemize their deductions:
Owning a home – mortgage interest and property taxes are deductible
Living in a state with high state income taxes
High giving
Very high medical/dental expenses
Examples
It’s helpful to look at a couple of examples:
Joy recently bought a house and received a large pay raise. During 2022, she pays $7,000 in state income taxes. Joy also pays $2,700 in property taxes on her new home and $300 in personal property taxes on her car. The interest on her new home mortgage for the year totals $7,500. Finally, she donates $11,000 to her church. Joy is wondering if she should be itemizing. These itemized deductions total $28,500 – Joy should definitely be itemizing as this amount is much larger than the standard deduction for the single filing status ($12,950):
Alternatively, Stacey and Cameron were recently married. Cameron is currently in graduate school and Stacey is working as a nurse assistant. They are renting an apartment. Stacey and Cameron pay $1,000 in state income taxes. They also pay $250 in personal property taxes on their one car. They give $3,000 to charity. Stacey and Cameron should use the standard deduction as their itemized deductions total $4,250, which is much lower than the standard deduction for married filing jointly status ($25,900):
If you have any comments, questions, or ideas for future posts, please let me know
I hope you found this post helpful and educational. If you have any comments, questions, or ideas for future posts, please let me know. You can reach me directly via email at crawford@ulmerfinancial.com.
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