Death and taxes may be the only two sure things in life, but you can at least get some wiggle room on your taxes. You can achieve breathing room on your taxes through tax deductions, which let you use certain expenses to lower your income and therefore your tax liability. The concept itself is quite simple but, like all things tax-related, putting the theory into practice on your tax return can be a bit tricky.

Death and taxes may be the only two sure things in life, but you can at least get some wiggle room on your taxes. You can achieve breathing room on your taxes through tax deductions, which let you use certain expenses to lower your income and therefore your tax liability. The concept itself is quite simple but, like all things tax-related, putting the theory into practice on your tax return can be a bit tricky.

Definition: Standard Deduction vs Itemized Deductions

Life is expensive. As such, not all of the money you make in a year is yours to spend as you wish. You’ll need some of it to pay for food, shelter, clothing and other necessities of life. The IRS understands this and so gives you a break.

This break is known as the standard deduction. It’s money the IRS takes right off the top of your earnings and ignores when it’s time to pay your taxes. It’s called the standard deduction, and its amount varies by tax year and filing status.

2020 Standard Deduction Amount

For the tax year 2020, this standard is $12,400 for single filers, $24,800 for married taxpayers filing jointly and $18,650 for those filing as head of household. These numbers will change for the 2021 tax year, increasing to $12,500, $25,100 and $18,800, respectively. 

If you’re married filing separately, use the same deduction as single tax filers. Note that filing separately when you’re married can have some drawbacks, such as disqualifying you for the earned income credit. Although there are times when this filing status is necessary, most taxpayers do best to avoid it whenever possible.

The standard deduction amount provides a fat and easy way to reduce your taxable income, but it may not be accurate for you. It’s just the government’s educated guest at the average cost taxpayers will spend on the business of living throughout the year. Your actual expenses could be significantly higher — especially if you had large medical bills or paid a lot of interest on a new mortgage. To account for this, the tax law created the itemized deduction.

Itemization allows you to bypass the standard and deduct the actual expense you paid during the year rather than going with the government’s estimate. It takes more work to itemize your deductions, but the payoff is sometimes well worth the effort.

Who Should Itemize for 2020-2021?

As is often true when you have more than one option, the IRS allows and even encourages taxpayers to take the path that benefits them the most. When choosing between taking the standard or itemized deduction, you may choose the one that lowers your income and taxes the most.

Thankfully, there is no magic formula or complicated ritual for figuring this out. You simply grab your receipts and add up the expenses you’re allowed to deduct. If your number is higher than the standard, it makes sense to itemize your deductions. If your number is less than the standard, take the standard. It’s that simple to resolve the standard deduction vs. itemized deduction debate.

In the spirit of full disclosure, we do have to confess that itemizing your deductions does take more work than using the standard. Itemizing means tracking your expenses and keeping good records. This makes it easier to calculate your deduction at the end of the year. It also allows you to backup and justify your expense claims, which you could have to do in the event of an audit. If your itemized deduction is only $100 more than the standard, the extra effort may not feel worthwhile. If the difference is $1,000 or more, however, you’ll likely feel quite differently.

Deductions You Can Itemize

Before you add up your deductions to see if they exceed the standard you will, of course, need to know what items you’re allowed to deduct. You can actually deduct quite a bit, but you need to understand the rules for doing so properly. It’s not always as simple as adding up your total expenses and deducting them.

Medical Expenses

One of the biggest deductions for many people is medical expenses. This is quite a broad category and includes medical bills, dental expenses, cost of transportation to and from doctor’s appointments and more. Some gutsy taxpayers have even deducted the cost of swimming pools installed primarily for aquatherapies. Note that we at Picnic Tax Solutions are absolutely and unequivocally NOT advocating this and advise talking to a CPA (or several) before taking this kind of plunge!

Swimming pools aside, there is a catch to deducting your medical expenses. You can only deduct the portion of your medical expenses that exceeds 7.5 percent of your adjusted gross income (AGI).

Mortgage Interest

Another common deduction for homeowners is mortgage interest. This deduction isn’t always helpful at the end of your mortgage when most of your payments go toward your loan principal. At the beginning of the mortgage when you’re paying lots of interest, however, this deduction can prove substantially beneficial. You can deduct any interest you pay on a mortgage of $750,000 or less, including points and mortgage insurance premiums. You can deduct your interest on a mortgage up to $1 million dollars, as well, but only if you secured the loan before December 16, 2017. We’ll talk more about this later.

Charitable Donations

You can also take a deduction for your charitable contributions, but be careful on this one. If you dropped off a box of clothes at Goodwill or tithed to your church, you made a charitable contribution. But if you got cookies at the school bake sale or ordered a gospel CD from your favorite television minister, you made a purchase — not a contribution. It’s only a contribution if you got nothing in return for your money. 

And although you could perhaps argue that you got nothing in return for a contribution you made to a political campaign, especially if your candidate lost his election, remember that contributions to politicians are never tax deductible. Unfortunately politicians often think they are and unintentionally mislead their supporters when seeking donations.

Other Tax Payments

The IRS also allows you to reduce your taxable income by deducting other tax bills, as well. You can’t deduct federal income tax payments from your taxes. You can deduct the amounts you paid for state and local income tax as well as sales tax. You can further deduct property taxes and real estate taxes. The current tax law caps the deduction for taxes paid at $10,000.

Gambling Losses, Student Loan Interest, Self-employment expenses, etc.

Other tax deductions you can take include gambling losses and investment interest expenses. You can also deduct up to $2,500 of student loan interest and $250 if you’re a teacher who bought supplies for your classroom. Some taxpayers are also eligible for the self-employment expense deduction as well as the home office deduction.

Casualty & Theft Losses, Estate Taxes, and More

In some cases, taxpayers are eligible to deduct casualty and theft losses, estate taxes, unrecovered pension investments, impairment-related work expenses, amortizable bond premiums, and claim of right repayments. If these deductions sound a little more complicated than the others, it’s because they are. These particular deductions don’t apply to most taxpayers. If they apply to you, we’ll be honest and tell you that you may want a professional to help you figure out this part of your tax preparation process. No worries though — we can absolutely help you with this!

Tax Law Change Summary

We have an article here outlining how Covid-19 legislature can impact your taxes. In addition to that here are some fairly new tax reform information you should be aware of.

If you used to itemize your deductions and then stopped, you’ll notice a few changes in the tax law if you decide to itemize your deductions again. These changes are due to the passing of the Tax Cuts and Jobs Act (TCJA) in 2017.

Under the new law, you can only deduct mortgage interest on loans of up to $750,000. As we mentioned previously, you used to be able to deduct your interest on mortgage loans up to $1 million. If you got your mortgage after December 16, 2017, however, you’re now limited to loans of $750,000 or less for this deduction.

Your tax deduction for other taxes paid is also now limited. You can still deduct state, local, income, sales and property taxes up to $10,000. You can’t deduct more than $10,000, though, even if you paid more.

While the new tax law only reduced some deductions, it completely eliminated others. Unless you are an active-duty member of the military, you may no longer deduct your moving expenses on your taxes. The TCJA also eliminated the previously allowed deductions for unreimbursed employee expenses and tax preparation expenses. If you got divorced after December 31, 2018, you’re no longer allowed to deduct alimony payments made to your former spouse.

The TCJA also placed limits on deduction allowances for natural disasters. You can still deduct expenses related to these events, but only if the United States President declares your home or property to be in a natural disaster area. Before the TCJA, losses from a house fire or flood were deductible to taxpayers if they weren’t fully reimbursed by their insurance company. Under the new rules, these deductions are limited to declared disaster areas. Flooding after a major hurricane blows through your town will probably still result in deductible expenses, but flooding from a broken water main on your street probably won’t.

As the TCJA and many previous tax law amendments show, your tax picture can change dramatically, even if you don’t do anything differently. Itemized deductions you took on your tax return just a few short years ago may now be invalid or substantially reduced. It’s important to understand these changes before you file.

This isn’t just important from a legal perspective but also from a financial one. The decision to use the standard or itemized deductions can have a significant impact on your tax liability. While taking either is a viable option as far as the IRS is concerned, getting this decision wrong can really cost you on April 15. 

If you’re not sure what to do, give us a call and let us help. The experts at Picnic Tax are happy to work through this decision with you no matter how many receipts and expenses we need to talk through together. We’re here to help you not only file your taxes but to feel confident in them.