View Full Version : Tax Deduction Wisdom - Should You Itemize?

01-08-2009, 05:17 PM
Tax season pressure may tempt you to accept a standard tax deduction, rather than exploring the potential benefit of itemizing your deductions. Browse this tax deduction and exemption overview to avoid paying more taxes than you actually owe.

To figure out whether itemizing would be profitable for you, consider some of the factors that affect what you can deduct, such as home ownership, taxes, charitable donations, medical expenses, and miscellaneous expenses. Compare your potential deduction with the standard deduction you're entitled to on 2007 returns:

Standard deduction for single taxpayers - $5,350
Standard deduction for married taxpayers filing a joint return - $10,700
Standard deduction for head of household taxpayers - $7,850
If you're 65 or older or blind, you get to increase the standard tax deduction.

Single or Head of Household: 65 or older $1,300
Blind $1,300
Both 65 or older and blind $2,600
Married or Widow(er): One spouse 65 or older, or blind $1,050
One spouse 65 or older, and blind $2,100
One spouse 65 or older, and both blind $3,150
Both spouses 65 or older $2,100
Both spouses 65 or older, and one blind $3,150
Both spouses 65 or older, and both blind $4,200

Now consider how well you will do with itemized deductions, in the following areas.

Tax Deduction Opportunities
If you own a home
State and local taxes
Charitable donations
Medical expenses
Miscellaneous deductions
If You Own a Home
Many taxpayers take the standard deduction rather than itemizing their tax deductions, even though some taxpayers with mortgages or home equity loans could have saved money by itemizing. If you have a mortgage or home equity loan on your home, fill out Schedule A to see if your itemized tax deductions are larger than the standard tax deduction to which you're entitled.

In January, your mortgage lender should provide the amount of mortgage interest you paid during the previous year. Look for Form 1098, Mortgage Interest Statement. If you paid points as part of the financing for your home, the points will also be shown on that form. Tip: Mortgage lenders sometimes attach Form 1098 to your December or January mortgage bill.

Here's a quick rule of thumb. Compare your mortgage interest (plus any points paid on the purchase of your residence) with your standard deduction. If you have refinanced your mortgage, points on the refinancing are deducted gradually over the life of the loanó1/30th a year on a 30-year mortgage, for example. Don't forget to add each year's share to your deductions. For more information, consult IRS Publication 936, Home Mortgage Interest Deduction.

If the interest you paid on your mortgage is larger than your standard tax deduction, you definitely benefit by itemizing -- and all the rest of your deductible expenses (including real estate taxes and state and local income taxes) are frosting on the cake.

Many lenders provide a year-end tax summary that includes any real estate taxes and insurance paid through escrow accounts. The real estate taxes are deductible, but homeowner's insurance and homeowner's association fees are not.
If your real estate taxes aren't paid through an escrow account, review your property tax bills and canceled checks and add up what you paid. You can't deduct any penalties you paid for late payment of property taxes: you can only deduct the actual taxes assessed and paid.
If you closed on a home mortgage in 2007 and had to pay private mortgage insurance (PMI), the premiums you pay in 2007 can be deducted, if your adjusted gross income falls below a certain level. This new write-off phases out as income rises between $100,000 and $110,000 (except on married filing separate returns, for which the phase out zone is $50,000 to $55,000). If you're paying PMI on a mortgage issued before 2007, you're out of luck on this one. As it stands now, the write-off is set to expire at the end of 2007, although Congress may well extend it. Watch this Web site for updates.

State and Local Taxes
Even if you don't own a home, itemizing can pay off handsomely. Look at the income taxes that you paid to your state, and to your city or county, if applicable. Income taxes you pay to these governments are deductible. Add up the state and city taxes shown on your W-2s and compare the total to your standard deduction.

If you made estimated tax payments to your state or local government (including any 2006 refund you had applied to your 2007 tax bill), be sure to total those amounts. And don't forget to add in any money you sent with your 2006 state and local tax returns in the Spring of 2007.

Charitable Donations
You can deduct charitable donations only if you itemize your deductions. Add up the money you donated to organizations like the Red Cross, churches, synagogues, mosques, and other nonprofit organizations.

If you donated things like clothing, furniture, or other household items, you need to determine their value. One way is to find out what your local thrift shop is charging for similar items or you could use a software program like ItsDeductible that does this work for you.

Make sure you use good judgment and that you don't overvalue your donations.

Also, note that the law now demands more substantiation than in the past to back up charitable donation deductions. Under the old rules, taxpayers needed a receipt to back up any charitable contribution of $250 or more (a cancelled check was not sufficient). That's still the case for contributions of $250 or more. But now, you also need a receipt or a cancelled check to back up deductions for even smaller donations.

Medical Expense Deductions
Although medical expenses are deductible, very few taxpayers get to deduct them. Why not? Because you get to deduct such costs only to the extent that unreimbursed expenses exceed 7-1/2% of your adjusted gross income. So if your AGI is $50,000, for example, the first $3,750 ($50,000 x 0.075) effectively don't count. Before you go through all of your doctors' bills and prescription receipts, do a quick calculation based on your income to make sure your time will be well spent.

Deductible medical expenses include doctors' and dentists' fees, chiropractors' fees, lab fees, contact lenses, glasses, prescription drugs and medical supplies.

If you have a question about a particular medical expense, consult IRS Publication 502, Medical and Dental Expenses.
You can deduct the premiums you pay for health insurance coverage, unless your employer pays for your coverage through a payroll deduction using pre-tax dollars. If so, you've already received a tax benefit for your premium payments, so don't deduct those premiums on your return. Consult your employer's benefits department if you're not sure.

Miscellaneous Tax Deductions
Most of the remaining deductions are subject to a limitation similar to the one for medical expenses.

Review the miscellaneous deductions listed below.
Add up the ones you can take.
Calculate 2% of your adjusted gross income.
Compare the two figures.
If the total of miscellaneous deductions is larger than 2% of your adjusted gross income, subtract the 2% figure from your total miscellaneous deductions. The difference is the amount you can actually deduct on your return.

If the total of miscellaneous deductions is less than 2% of your adjusted gross income, you can't deduct any of these items.

Examples of qualifying miscellaneous expenses that you could deduct include:

Dues you pay to a union or a professional organization in connection with your employment
Subscriptions to magazines and other publications that are related to your work
Business liability insurance premiums
The cost of protective work clothing, such as hard hats or safety shoes and glasses, and the cost of uniforms you're required to wear to work
Tools and supplies used in your work
Medical examinations required by an employer
Tuition for classes that maintain or improve the skills required for your present job
Expenses you incur while looking for a job in the same line of work you normally do (examples: resume' costs, career counseling, and employment agency fees)
Depreciation on your computer or cellular phone, but only for the part of the time you use your equipment to keep track of your taxable investments (stocks, bonds, mutual funds) or as part of your job, if required by your employer
The fees you're charged by your financial institution to maintain your IRA account, but only if you pay them from funds outside of your IRA account (if your financial institution just deducts the maintenance fees directly from your IRA, you can't deduct them)
Safe deposit box rental fees, if you use the box to store stocks, bonds, or other investment-related documents (if you just store jewelry and other personal items there, the fees aren't deductible)
What you pay to get your taxes done, whether it's by a professional or with tax preparation software. You can also deduct the cost of any books or publications that help you with preparing your return, and, if you file your return electronically, you can deduct any costs associated with that process
Legal fees that you pay to protect your taxable income, or to produce your taxable income (This includes fees for legal assistance for helping you keep your job, for tax planning or investment counseling, or for handling an audit of your tax return. Legal fees for divorces aren't deductible, except for any portion specifically related to helping you collect alimony payments or for advice about the taxability of your alimony. You can only deduct legal fees that you pay in your efforts to collect income that's taxable to you.)
Miscellaneous deductions not subject to the 2% rule
There are a few miscellaneous expenses that guarantee tax savings to itemizers because they are deductible without regard to the 2% threshold. These three are most likely to be of any benefit:

Amortizable bond premium is the amount over face value that you pay for certain bonds because they are paying higher-than-current-market interest rates.
Gambling losses. This write-off comes with its own restriction. You can't deduct more than the amount of gambling winnings you report as taxable income.
Federal Estate Tax on Income in Respect of a Decedent. This is becoming an increasingly important deduction as more and more taxpayers inherit money in company retirement plans or traditional IRAs. Such amounts are considered "income in respect of a decedent" because the decedent had a right to the income at the time of death, but the income is not included on the person's final tax return. Instead, the beneficiary is taxed on the amounts. You might also deserve a deduction, though, if the decedent's estate was large enough to pay federal estate taxes. Say, for example, that you inherit a $50,000 IRA which, because it was included in your mother's taxable estate, boosted the estate tax bill by $20,500. Although you have to pay tax as you pull money out of the IRA, you also get a deduction for that $20,500. If you pull the full $50,000 out at once, you'd get the full deduction. If you pull it out equally over two years, you'd deduct $10,250 each year. This miscellaneous deduction is not subject to the 2% limit but it's up to you to know the rules to take advantage of them.
There are many other expenses that you can deduct. For example, if you're involved in estates, trusts, and investments, or if you have significant job-related expenses, it's worth your time to investigate a bit further. For more information, see IRS Publication 529, Miscellaneous Deductions.

Another way to find more deductions is to use tax preparation software. Tax preparation software such as TurboTax can help you decide whether you should itemize your deductions. Simply enter all of your information when prompted, and let the program determine if it's better for you to itemize or take the standard deduction.

01-10-2009, 09:20 AM