There is a difference between itemizing deductions and taking the standard deduction.
While both can reduce your taxable income, itemizing deductions can result in lower tax bills for most people. However, it also has some disadvantages.
What are Itemizing Deductions
The first type of deduction is called itemizing deductions. These are deductions that you claim directly on your federal taxes. The most common types of itemized deductions include state and local taxes, mortgage interest, charitable donations, and medical expenses.
How does itemizing work
When you itemize your deductions, you break down your taxable income into several categories. The easiest way to understand this is to look at the example below.
Your taxable income is $10,000. This means you would have $10,000 after any adjustments (such as taxes) are considered. This means that when you itemize your deductions, you will need to subtract $10,000 from $20,000 to get to the number of taxable income you had.
To figure out your taxable income, you simply add up all of your income, including regular wages, dividends, interest, and capital gains. Then you subtract any taxes you paid.
For example, if you make $7,000 a year and pay 25% taxes, your taxable income will be $7,000. But because youíre itemizing deductions, youíll add the $2,500 you paid in taxes back into your taxable income. This makes it $9,500.
Now you subtract $10,000 from that, and you get $8,500.
Now you have your taxable income. Now you just need to figure out how much you spent on each type of deduction.
How much do you spend on these deductions?
Once you know your taxable income, you can figure out how much you spent on each type of deduction. For instance, if your taxable income is $8,500 and you spent $4,500 on mortgage interest, your mortgage interest is $4,500.
But if you spent $2,000 on medical expenses, your medical expenses are $2,000.
What is a Standard Deduction
While itemizing deductions can help you lower your taxes, it has some downsides.
One downside is that it can be difficult to estimate how much you will owe.
When you itemize your deductions, you must figure out how much you spent on each type of deduction. But it can be tricky figuring out exactly what these deductions are worth.
Because of this, many people prefer to take the standard deduction.
This means that instead of separating your income into several different categories, you simply list the total amount of money you made and subtract any applicable tax.
To determine your standard deduction, you simply take your adjusted gross income and divide it by your tax rate.
So, for instance, if you made $10,000 and paid $5,000 in taxes, your standard deduction will be $10,000 divided by 0.25.
When should you itemize instead of claiming the standard
The standard deduction is a part of the tax code that lets taxpayers take some of their income off the books each year. If you donít itemize, you can take the standard deduction and not have to pay any taxes on your income. But if you have a lot of deductions, you can pay less money to Uncle Sam than if you claimed the standard deduction and itemized all your expenses. In most cases, itís better to claim the standard deduction and itemize your deductions if you want to reduce your tax liability.
But what about those more than $100,000 away from the line where they would have to itemize? When is it appropriate to claim the standard instead of itemizing? Or is it always better to claim the standard and itemize?
Letís talk about these questions and see if we can figure out the best strategy for each situation.
First, we need to determine whether or not you have enough deductions to justify claiming the standard deduction instead of itemizing. This is a question of whether or not your total deductions exceed the standard deduction.
There is a formula for figuring out whether you are itemizing or taking the standard deduction:
Total deductions + Adjusted gross income <= $100,000
In our example, if your total deductions and adjusted gross income were $50,000, you are not above the line where you would have to itemize. Since you are below that line, you should consider using the standard deduction.
Letís talk about what happens when you take the standard deduction.
When you take the standard deduction, you can reduce your taxable income by the standard deduction amount. So if you take the standard deduction, the better option is to make sure you are not overpaying for taxes.
The standard deduction is the same every year. So if you plan to itemize next year, you should do it this year. Itís better to do it now so you donít have to deal with the headaches that come with figuring out what you can and cannot deduct when it comes time to file your taxes.
If you are currently paying taxes based on the standard deduction, this is a good time to ensure you get as much as possible. Once you file your taxes, you cannot change your mind. If you do, you will face penalties and interest.
Once youíre done filing, you should review the items you paid. Any deductions you didnít claim because you were overpaying for taxes should be taken back.
If you did take itemized deductions last year and your itemized deductions exceed the standard deduction, you may want to switch to taking the standard deduction. You will have to be careful to track which deductions you took and which ones you arenít allowed to take again.
If you donít, you risk paying more in taxes this year than you have to.
Why would a taxpayer choose to itemize deductions instead of using the standard deduction
Itemizing your taxes will typically cost you money because you have to pay a higher tax bill, but itemizing deductions is often worthwhile.
If you itemize, your tax bill will be based on the amount you spend on your expenses, including mortgage payments and child care expenses. In addition, you can deduct state and local income taxes from your federal taxes.
On the other hand, if you take the standard deduction, your taxes will be lower, but you can only deduct certain kinds of expenses.
Youíre Taxing The Same Income Twice
The biggest reason to itemize is that youíre essentially taxing the same income twice.
For example, if you earn $50,000 yearly but deduct $10,000 in medical expenses, youíve reduced your taxable income by $50,000 Ė $10,000. If you didnít deduct those expenses, youíd be taxed only on the $50,000 income and owe only $24,000 in taxes.
But because you deducted the medical expenses, you effectively increased your taxable income by $30,000, and you owe the IRS an additional $30,000 in taxes.
Youíre Saving Money on Your Taxes
Another benefit of itemizing is that you can save money on your taxes. For example, if you earn $100,000 a year, but your home costs $20,000, youíre paying $20,000 in taxes on your home. But if you itemize, your home costs are deductible against your $100,000 income, which means you only owe $80,000 in taxes.
That difference of $20,000 can be put toward retirement or college savings.
Other Tax Benefits of Itemizing
Here are other reasons to itemize your taxes:
ē You can deduct charitable contributions
ē You can deduct moving expenses
ē You can deduct taxes paid to another country
ē You can claim a credit for the adoption expenses of an adult child
ē State and local sales taxes can be deducted
ē You can deduct state and local property taxes
ē You can deduct a tax credit for being an American citizen
ē You can deduct a tax credit for having a low adjusted gross income
How do you get the biggest tax return
Let me tell you a secret: most people donít get a big enough tax refund. They wait until April to file their taxes, and by then, they are already out of money and havenít even had time to spend it.
And that is exactly why I created this guide. Iím not here to ask you to pay taxes, and Iím not trying to get you to send any money to the government.
I am here to give you some free tips on how to increase your refund. I will show you how you can make hundreds of dollars each year without ever having to worry about taxes again.
You should first go to the IRS website and head over to the ďHow do I file my taxes?Ē page. You should check your refund status and ensure that you have enough money before starting your tax return.
You should use it to pay off your debts if you have enough money. This way, when you file your taxes, you can deduct your debts from your taxable income and receive a bigger refund.
How to Calculate Your Itemized Deduction
Now that you know the main types of deductions, itís time to calculate how much you can take.
You need to add your medical, mortgage interest, and charitable contributions to do this. Then, you can either take the standard deduction or you can subtract this total from your adjusted gross income.
The standard deduction is automatically considered, so you wonít see the word ďstandardĒ anywhere. Instead, you will see a higher number than the standard deduction.
So, letís say that your medical, mortgage interest and charitable contributions add up to $1,500. That means the standard deduction is $12,200, while your actual itemized deduction is $1,500.
Now, if you have more than $12,200 in deductions, you can take the standard deduction or subtract that amount from your income.
You can find your adjusted gross income on page 1 of your tax return. Simply multiply your gross income by 1.5 to get your adjusted gross income.
Iím sure everyone here can tell you why the standard deduction is a bad idea. As for when to use the standard, it depends on what kind of income youíre receiving. If your gross income is $10,000 annually, you can usually expect to pay no taxes. If itís $50,000, you may want to file. The answer to ďHow do you get the biggest tax return?Ē is to calculate the correct amount of deductions you need to claim. When you do that, the best tax savings you can get is the difference between your adjusted gross income and the standard deduction.