Itemized Deduction

DEFINITION of 'Itemized Deduction'

Taking itemized deductions allows taxpayers who qualify to deduct more from their adjusted gross income (AGI) than they could using the standard deduction. Complicated rules govern which goods and services, contributions and other expenses qualify as legitimate. The specific deductions that are allowed are outlined by the Internal Revenue Service (IRS) and include such expenses as mortgage interest, charitable gifts and medical expenses.

BREAKING DOWN 'Itemized Deduction'

Every year, the US government provides potential tax relief to taxpayers in the form of tax credits and deductions.

  • A tax credit reduces the final tax bill of a taxpayer. If an individual’s tax liability is $15,000 and they qualify for a $3,500 tax credit, they will only have to pay $11,500 in tax.
  • A tax deduction reduces the taxpayer's taxable income in a different way. If a taxpayer qualifies for $8,000 in tax deductions and is in the 25% bracket, those deductions will lower their taxable income by 25% of $8,000, or $2,000. So if their taxable income were $75,000, the deduction would lower their taxable income to $73,000.

A tax deduction can either be claimed as a standard deduction or as itemized deductions through filing Schedule A along with the 1040 Form. The route to take depends on which deduction type lowers the taxpayer’s liability the most; they have to make that choice each year. 

Standard vs. Itemized

A standard tax deduction is a fixed dollar amount that reduces taxable income, and the amount depends on the tax payer’s filing status. For 2017, a single taxpayer can claim $6,350 standard deduction, while one who is married filing jointly can claim $12,700. For 2018, the standard deduction increases to $12,000 for single filers, $18,000 for heads of household and $24,000 for married couples filing jointly. 

Itemized deductions are expenses allowed by the Internal Revenue Service (IRS) to decrease a taxpayer’s taxable income. Itemized deductions allow taxpayers to list out qualified expenses on their tax return, the sum of which (based on their tax bracket) is used to lower their adjusted gross income (AGI). Itemizing can result in a larger reduction of taxable income if a taxpayer's final itemized deductions, based on their tax bracket, exceed the amount of the standard deduction. 

Not all filers have the option to choose whether to itemize their deductions or claim the standard deduction. Non-resident aliens must itemize their deductions. Also, married couples who are filing separately must claim the same type of deduction. If a spouse itemizes deductions, her partner must also do the same. The same is true if one spouse opts for the standard deduction. In addition, there is an income limit on taxpayers who itemize; if your AGI reaches a certain level, your ability to take deductions begins to phase out (see details, below).

Which Expenses Can Be Itemized? 

The list of expenses that can be itemized in 2017 is extensive. That includes mortgage interest on a mortgage of $1 million or less; mortgage insurance premiums (MIP); charitable donations; medical and dental expenses; personal property tax; state and local sales tax; gambling losses; investment interest; tax preparation fees; and home office expenses.

In 2018, the deduction for mortgage interest will drop to interest on loans of $750,000  for people buying a home starting Dec. 15, 2017 (the only exception: you can still refinance a home under the old rules if it was purchased before that date). The deduction for charitable donations will increase to 60% of adjusted gross income, up from 50% in 2017. There will also be a cap on state and local tax deductions, with deductions for income, sales and property taxes limited to $10,000. The $2,500 student loan interest deduction and the $250 deduction for educators who purchase their own supplies will remain intact. 

Some itemized deductions will go away entirely in 2018. Those include deductions for alimony payments, moving expenses, home-equity loans (both current and new), unreimbursed employee expenses, job hunting expenses, tax preparation expenses and natural disaster losses (unless a tax break for a specific event is specifically authorized by Congress). For 2017, you'd still be able to itemize miscellaneous deductions that exceed 2% of your adjusted gross income. 

Itemized deductions are listed on Schedule A of Form 1040. Needless to say, this takes longer time to do than simply taking the standard deduction since taxpayers will have to input each expense item on the form. The shorter and simpler 1040A and 1040EZ Forms cannot be used if you itemize deductions. In addition, taxpayers who itemize must save all receipts for any expenses made throughout the tax year in the event that the IRS asks for documentation. Additional proof of expenses includes bank statements, insurance bills, medical bills and tax receipts from qualified charitable organizations.

In some categories, an itemized deduction is limited to a specific percentage of AGI. Tax laws set spending thresholds that must be exceeded before the deductions can be made. For example, in the medical category, only expenses that exceed 7.5% of your adjusted gross income may be deducted. The new tax bill set this lower figure – last year it was 10% –  for both the 2017 and 2018 tax years. In 2019, the threshold returns to the previous level of 10%.

Limits on Itemized Deductions for Wealthy Taxpayers

Based on rules known as the Pease limitations, the total amount in itemized deductions that can be claimed is reduced or phased out if the taxpayer’s AGI exceeds the limit set for their filing status. The limits for the 2017 tax year are shown in the table below:

Filing Status Adjusted Gross Income Limit
Single $261,500
Head of Household $287,650
Married Filing Jointly & Surviving Spouses $313,800
Married Filing Separately $156,900

Some deductions are exempt from the limit rule. These include medical expenses, gambling losses, investment expenses, and certain casualty and theft losses.

The reduction rate that will be applied if the taxpayer’s AGI is above these limits is 3% of the amount by which the AGI exceeds the threshold or 80% of total non-exempt itemized deductions, whichever is less. The itemized deduction limit increases with each dollar earned above the AGI limit up to a maximum of 80% of total deductions. Individuals subject to the Pease limitations will need to complete the Itemized Deductions Worksheet to determine the amount to enter on line 29 of Schedule A. 

Starting in 2018, these limitations will be eliminated through the 2025 tax year.