Tax filing time is just around the corner, and most of us are probably either well on our way to filing our returns or at least starting to think about it. At this time of year, many people start to wonder what they can do to make sure they aren’t paying more taxes than they actually owe.
A tax deduction reduces your taxable income, meaning you owe less. For example, if your income is $50,000, but you have tax deductions of $5,000, then your taxable income is reduced to $45,000.
How much this deduction will save you will depend on your tax rate. Your tax rate (also known as your tax bracket) is the maximum tax rate that the highest portion of your income is charged. To use a general example, a person in the 25% tax bracket with a $1,000 deduction might save $250 in taxes.
When we file taxes, the government allows filers to choose between taking the “standard deduction” and itemizing deductions. You cannot do both. So the first thing all taxpayers need to do is find out what the “standard deduction” amount is for them.
The standard deduction for filing taxes is based on filing status. The amount is set each year by the federal government. For the 2016 tax year, the standard deductions are:
- Single or Married Filing Separately* – $6,300
- Married Filing Jointly – $12,600
- Head of Household – $9,300
- If you are 65 or older or blind, the standard deduction is increased.
*When a married couple files separate returns and one spouse itemizes deductions, the other spouse cannot claim the standard deduction, and therefore must itemize to claim his or her deductions.
Next, check to see what you could deduct if you went the “itemized deductions” route, and add up these deductions. Now, compare the two totals to see which amount is larger. If the standard deduction is larger, it is likely that the standard deduction is the way to go. But if itemizing deductions adds up to a larger total, then you may be better off itemizing deductions. For more information, refer to this helpful link from the IRS: Should I Itemize? (http://www.irs.gov/taxtopics/tc501.html)
What Can I Itemize?
Some examples of expenses that can be itemized include mortgage interest, taxes paid, charitable contributions, casualty and theft losses, unreimbursed job expenses, and medical expenses. Charitable contributions are donations to qualified non-profit organizations. It is called itemizing because the items mentioned have to be listed (itemized) on a form called a Schedule A. If you want to get an idea of exactly what you can itemize, download a Schedule A form (http://www.irs.gov/pub/irs-pdf/f1040sa.pdf) from the IRS.
For many homeowners, the first thing to check is mortgage interest. If the amount of mortgage interest that you paid is greater than or close to your standard deduction, then it is likely that it will be to your advantage to itemize deductions.
Qualified medical expenses that exceed 10% of your adjusted gross income may be itemized. For example if your adjusted gross income is $50,000 and your qualified unreimbursed medical expenses are $5,100, then you can deduct $100. If you are over 65, they only need to be more than 7.5% of your adjusted gross income. In order for a medical expense to be deductible, you must have paid for it yourself. For example, health insurance premiums you pay out of pocket count. However, if your employer pays your health insurance premiums, you cannot deduct them.
Job expenses are listed under a category that includes other miscellaneous expenses, such as tax preparation fees and safe deposit box expenses. In order for them to be deductible, the total for this category must exceed 2% of your adjusted gross income.
Alternative Minimum Tax and Deductions
Individuals with a higher income may be subject to the alternative minimum tax (AMT). The AMT is a parallel tax system that applies to taxpayers who have certain types of income that receive favorable treatment, or who qualify for certain deductions under tax law. The AMT sets a limit on how much these benefits can be used to reduce total taxes paid. Every taxpayer is responsible for paying either the regular tax or the minimum tax, whichever is higher. The Internal Revenue Service has an online calculator to help you figure out if you are subject to the alternative minimum tax. For more information, take a look at the AMT Assistant for Individuals.
It is important to understand your options when deciding whether or not to itemize on your return. Knowing your standard deduction and how it compares to your itemized deductions can save you money and time. For more information, check out the IRS website at www.irs.gov. The Interactive Tax Assistant at that site can also be very helpful.