One of the decisions you have to make when preparing your tax return is whether to take the standard deduction or to itemize your deductions. When filling out your Form 1040 this decision comes after you have figured your adjusted gross income. Your standard deduction or your itemized deductions further reduce your income, helping you arrive at your taxable income. Your taxable income is the number used to determine your tax liability.
But what should you do? The answer is usually arrived at by running the numbers. The standard deduction is available to everyone. For the 2010 tax year, the standard deduction is $11,400 for those who are married filing jointly and $5,700 for single filers. There are some special additions you can make to the standard deduction as well such as for being 65 and older or for blindness. Figure out what your total standard deduction is first and then compare it to what you would get if you itemized.
Schedule A is used to itemize deductions. These deductions include such items as mortgage interest, property taxes, charitable donations, and un-reimbursed medical expenses (if you qualify).
To calculate your total itemized deductions go through Schedule A and see which deductions you qualify for. Add them all up and see whether the total exceeds the amount of the standard deduction. If your itemized deductions exceed $5,700 (for single filers) or $11,400 (for married filers) you are better off itemizing. The larger your itemized deduction the lower your taxable income and thus your tax owed to the government.
A commonly touted benefit of having a mortgage is that you can deduct mortgage interest off of your taxes. However, for most middle class families the mortgage interest deduction is often not enough alone to make itemizing worth it. A couple that files joint taxes would need to have more than $11,400 in interest payments to see any tax benefit – that’s $950 per month in interest!
When mortgage interest is combined with charitable contributions and other itemized deductions the story is often different. Make sure you explore your itemization options by running the numbers to see what is likely to benefit you the most.
It is also important to remember that there are phase outs for itemizers. As your income goes up your ability to fully deduct various expenses is reduced. The income level at which the phase outs begin is indexed to the rate of inflation. You may be able to claim a full itemization one year, but if your income changes more than the change in inflation you may find yourself with a partial phase out.
Currently tax law has the phase outs beginning at $167,000 for those who are married and filing jointly. However, for the 2010 tax year the phase outs have been done away with. This favorable situation has been extended through the 2012 tax year. This provides an opportunity for high earners to take better advantage of itemized deductions. (Note that charitable donations cannot exceed 50% of your adjusted gross income in any year — although you can carry some of your charitable deductions forward to another year if you are beyond the 50%.)
I often have my accountant run two or three scenarios with my tax return to see which is the most beneficial for me. Whether you do your taxes on your own or with the help of a professional, it is worth it to try a couple of different ways of preparing your tax return, just to compare. Many tax software programs now allow you to make the comparison between taking the standard deduction and itemizing. With this knowledge you can make a more informed decision — and possibly save a little money.