DEFINITION of Itemized Deduction
Itemized deductions permit taxpayers who qualify to deduct more from their adjusted gross income (AGI) than they could by 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 U.S. government provides potential tax relief to taxpayers in the form of tax credits and deductions.
- A tax credit reduces your final tax bill. If your tax liability is $15,000 and you qualify for a $3,500 tax credit, you will only have to pay $11,500 in tax.
- A tax deduction reduces your taxable income in a different way. If you qualify for $14,000 in tax deductions and are in the 22% bracket, those deductions will lower your taxable income by 22% of $14,000, or $3,080. So if your taxable income is $75,000, the deduction will lower it to $71,920. In this case your tax liability drops by $671, from $12,434 to $11,763.
A tax deduction can either be claimed as a standard deduction or as itemized deductions through filing Schedule A along with Form 1040. The route to take depends on which deduction type lowers your liability the most. You must 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 your filing status. For 2018 a single taxpayer can claim a $12,000 standard deduction, while a married couple filing jointly can claim $24,000.
Itemized deductions are expenses allowed by the IRS to decrease a taxpayer’s taxable income. Itemized deductions allow you to list qualified expenses on your tax return, the sum of which (based on your tax bracket) is used to lower your AGI. Itemizing can result in a larger reduction of taxable income if your final itemized deductions, based on your tax bracket, exceed the amount of the standard deduction.
Not all filers have the option to choose whether to itemize deductions or claim the standard deduction. Nonresident aliens must itemize deductions. Also, married couples who are filing separately must claim the same type of deduction. If your spouse itemizes deductions, you must too. The same is true if one spouse opts for the standard deduction.
Which Expenses Can Be Itemized?
The list of expenses that can be itemized in 2018 is extensive, but there are limits and exclusions. You can, for example, deduct mortgage interest on a loan of $750,000 or less for any home bought on or after Dec. 15, 2017. Previously, you could deduct interest on a mortgage of $1 million or less. (You can still refinance a home under the old rules if it was purchased before Dec. 15, 2017.) You can also deduct mortgage insurance premiums (MIP); charitable donations up to 60% of AGI; medical and dental expenses over 7.5% of AGI for 2018 and over 10% of AGI for 2019 and beyond; state and local income, sales and personal property taxes up to $10,000 ($5,000 if married filing separately); gambling losses and investment interest; $2,500 in student loan interest and $250 if you are an educator who buys supplies for your classroom.
Some formerly available itemized deductions go away starting in 2018. Those include deductions for alimony payments, moving expenses (except for active-duty military moving due to military orders), unreimbursed employee expenses, job-hunting expenses, tax preparation expenses and natural disaster losses (unless a tax break for a specific event is authorized by the President). Home-equity loan debt was also affected, in complicated ways: If you have a home-equity loan or line of credit, check with your tax advisor on whether the interest is deductible.
Itemized deductions are listed on Schedule A of Form 1040. You can’t use the shorter and simpler 1040A or 1040EZ forms if you itemize. You must save all receipts in case the IRS asks to see them. Additional proof of expenses could include bank statements, insurance bills, medical bills and tax receipts from qualified charitable organizations.