Every year it's up to you to decide whether you should you itemize or take the standard deduction. You'd be amazed about how many people get this wrong and end up costing themselves extra taxes.
The Standard Deduction
The standard deduction is a specified dollar amount you are allowed to deduct each year to account for otherwise deductible personal expenses such as medical expenses, home mortgage interest and property taxes, and charitable contributions. You take the standard deduction instead of deducting your actual personal expenses. The amount you are allowed to deduct depends on your filing status and is adjusted for inflation each year. Check the IRS website for the current year standard deduction amounts.
Instead of taking the standard deduction, you always have the option of itemizing your deduction. This means you individually deduct the actual amounts of certain expenses item by item instead of taking the standard deduction. You must list all the deductions on IRS Schedule A and include this schedule with your tax return. This is a lot more work than taking the standard deduction. You have to know what expenses are deductible and keep track of them. You also need to keep records of your expenses. Cancelled checks or credit card statements are not enough—you need to keep receipts and other bills showing what you spent the money on.
Itemized deductions are usually personal in nature, and don’t include business expenses (although they do include job expenses). Some of the more common ones are:
- medical and dental expenses
- state and local income taxes, or sales tax
- real estate and personal property taxes
- home mortgage and investment interest
- charitable contributions
- casualty and theft losses
- job expenses, and
- miscellaneous deductions for such things as investment expenses, hobby expenses, gambling losses, and tax preparation fees.
The largest of these deductions are those for home mortgage interest, property taxes, and state income tax. For this reason, homeowners usually itemize, while renters often do not.
However, most of these expenses cannot be deducted in full. Instead, they are subject to special limitations—for example, medical expenses can be deducted only to the extent that they exceed 10% of your adjusted gross income (AGI), and job expenses to the extent they exceed 2% of AGI. Consequently, you may find that few or none of your personal expenses are deductible.
Choosing Whether to Itemize
You must choose whether to itemize or take the standard deduction each year. The IRS won’t tell you what’s in your best interest—it doesn’t care if you make the wrong choice and overpay your taxes. You (or your tax preparer) must decide. Obviously, you should itemize if it will give you a larger total deduction than the standard deduction for that year.
Unfortunately, many people get it wrong. Failing to itemize personal deductions is the single biggest mistake people make when they do their taxes. According to a recent Government Accountability Office report, as many as 2.2 million taxpayers overpay their taxes by an average of $610 per year because they fail to itemize their deductions.
If you itemized last year, you should probably do it this year too unless there has been a major reduction in your deductible expenses. If you took the standard deduction last year, you may be better off itemizing this year if you:
- had large uninsured medical and dental expenses during the year
- paid interest and taxes on your home
- had large unreimbursed job expenses or other miscellaneous deductions
- had significant uninsured casualty or theft losses, or
- made large charitable contributions.
The only way to know for sure if you’d be better off itemizing is to keep track of your deductible expenses each year. Through careful planning, you can often increase your deductible expenses so that it pays to itemize.