You’ve probably heard the terms “Standard Deduction” and “Itemized Deductions” but have no idea what they mean. You wonder which is better and why? We are going to show you difference between the two and give you examples to help you save money when filing your taxes.
What is the Standard Deduction?
In 1944, Congress decided that everybody in the United States is entitled to at least one deduction. That deduction is called the Standard Deduction.
When it was first created it was a percentage of your income (10%), but now it’s a flat amount. Every year, the IRS increases the Standard Deduction (based on inflation). Here is a chart that shows what the Standard Deduction is by year:
|Standard Deduction Tables|
|Year||Single||Married||Head of Household|
|Tax Year 2020||$12,400||$24,800||$18,650|
|Tax Year 2021||$12,550||$25,100||$18,800|
|Tax Year 2022||$12,950||$25,900||$19,400|
|Tax Year 2023||$13,850||$27,700||$20,800|
It doesn’t matter if you work as a Yoga Instructor, or are the CEO of Twitter, you can use the standard deduction against your income. Here’s an example:
If in 2023 you are single and made $30,000, you will only have to pay tax on $16,150 ($30,000 of income minus $13,850 standard deduction).
What does it mean to Itemize?
Congress also decided that if a bunch of small deductions added together are bigger than your standard deduction, you can use those instead. That’s called Itemized Deductions (sometimes referenced as “to itemize”). You report your Itemized Deduction on a form called Schedule A. It’s almost always better to itemize, since you will get a bigger deduction, and pay less tax.
When you itemize, it means you will list out all the deductions one by one. That way the IRS can look at each of them (remember, the IRS is always watching). Below we are going to go over the common deductions you can itemize.
Itemized Deduction Examples
Unreimbursed medical expenses such as preventative care, doctors’ visits, co-pays, dental work, vision care, etc., are deductible if you itemize. However, there’s a catch. You can only deduct anything over 7.5% of your adjusted gross income (AGI). The calculation for AGI is very complicated, so we tell our clients to use their income as a back-of-the-napkin calculation to see if their medical expenses are deductible.
Here’s an example. Mike makes $50,000 a year. He had $5,000 medical surgery he paid for out of pocket. Assuming that his AGI is also $50,000, he would only be allowed to deduct what he paid for over $3,750 (7.5% of $50,000). That means his medical expense deduction is $1,250 ($5,000 minus his 7.5% limit of $3,750).
State and Local Taxes (S.A.L.T.)
There are many State and Local Taxes (also referred to as SALT) that you can deduct on your taxes if you itemize. They include:
- State income tax
- Local sales tax
- Property taxes for your home
- Property taxes on investments (e.g., land investment)
- DMV Taxes associated with registering your car or boat
- Sales tax on large ticket items (such as buying a new car)
However, just like Medical Expenses, there is a limit. Currently, you can only deduct up to $10,000 in SALT. Members of Congress are trying to increase this limit. If the limit increases, we will update this page to let you know as soon as possible.
Mortgage Interest Deduction
Mortgage Interest paid on your primary residence (and 2nd home) are deductible. However, there are limits (are you starting to see a pattern?). You are allowed to deduct your mortgage interest, up to the first $750,000 of debt you take out to purchase your home (if you purchased your home before December 15th, 2017, it’s up to $1,000,000). In other words, if you finance an expensive property over $750K, you don’t get as big of a deduction.
Here’s are a couple of examples:
Steve buys a new home for $1 million. He decides to put down $300,000 to buy the property and now has a $700,000 home mortgage. His mortgage interest is $21,000. Because the loan is under $750,000, he can deduct the entire $21,000 of mortgage interest.
In a similar example, Sara buys a $1.3 million home. She puts down $300,000 and has a $1,000,000 mortgage with $30,000 a year in interest. Because the mortgage is over $750,000, she cannot deduct the full $30,000. She will only be able to deduct $22,500 (ratio of $750K divided by $1M, is 75%. $30,000 x 75% = $22,500).
Mortgage Insurance Premiums
If you’ve ever gotten a home loan, there is this pesky little fee you may have to pay every month as part of your mortgage called PMI (Private Mortgage Insurance). It’s there to protect the bank (not you) incase you default on your home loan. If you make under $100,000 you can deduct all of it. If you make between $100K and $109K you can deduct part of it. If you make over $109K, it’s not deductible.
Investment Interest Deduction
Interest you paid on money you borrowed to make an investment is also deductible if you itemize. Examples of this are margin interest you paid your stock brokerage if you borrow money to buy or short stocks. Another example is interest you paid on a loan for a piece of land purchased as an investment.
Donations to Charity
Donations to charity are also deductible if you itemize. In order to deduct your gifts to charity, payment must go to a qualified 501(c)3 organization (basically an organization that the IRS says qualifies). There are two main types of chartable deductions:
- Personal items you give to places like Goodwill or Salvation Army
There are also special rules for donating stocks, or vehicles. Will be writing an additional article on charitable deductions so will know what to do with more complicated charitable contributions.
Example Standard vs Itemized
Here’s an example to help you understand the difference between the standard deduction or itemizing.
Below is a chart of two people, Adam and Betty, with different deductions for 2022:
|Itemized Deduction||Adam’s Deductions||Betty’s Deductions|
|Mortgage Insurance Premiums||$1,100||$1,100|
|Gifts to Charity||$500||$1,500|
Adam’s total itemized deductions are $10,800, which is less than the standard deduction of $12,950. Steve will take the standard deduction. However, Betty’s deductions are $19,600, which is more than the standard of $12,950, so Sara will itemize.
We decided the cover the most common itemized deductions we believe would help you the most. As always, the tax code is complicated so we encourage you to talk to a CPA to make sure you maximize your deductions before filing your taxes. We want you to pay the least amount of tax legally possible.