While you don’t have much choice when it comes to paying taxes, you can benefit from significant deductions that reduce the amount you owe Uncle Sam.
Deductions shield a portion of your earnings from income tax, and they are especially important now that personal exemptions have been eliminated.
In the past, taxpayers could claim an exemption of $4,050 for themselves and each of their dependents. However, those exemptions were eliminated for the 2018 tax year under the Tax Cuts and Jobs Act, making deductions now the prime way to reduce taxable income.
Taxpayers have two deduction options: a standard deduction or itemized deductions. While the standard deduction is the government’s built-in subtraction that you can take while preparing your taxes, itemizing is composed of individual deductions that, together, can help lower the amount of taxable income you pay.
Read on to discover the pros and cons of a standard deduction vs. itemized deduction to decide which approach is best for you.
To compensate for the loss of personal exemptions, the standard deduction was nearly doubled for the 2018 tax year, and it was again adjusted upward for 2019 and 2020. Depending on your tax-filing status, you are entitled to take one of the following standard deductions:
- Single or married filing separately: $12,400.
- Head of household: $18,650.
- Married filing jointly or qualified widow(er): $24,800.
Anyone can receive a standard deduction, and the increased amounts ushered in by the Tax Cuts and Jobs Act have been particularly beneficial to lower-income families, those without mortgages and others who traditionally haven’t been able to itemize deductions. “It really helps a lot of seniors,” says Daniel Laginess, a certified public accountant and president of Creative Financial Solutions in Southfield, Michigan.
Here are the key benefits of the standard deduction:
- It’s easy, convenient and saves time.
- Some taxpayers qualify for a bigger deduction.
- Anyone can claim it.
It’s easy, convenient and saves time. If you like to keep your taxes as easy as possible, opting for the standard deduction might be the wise way to go. “The standard deduction definitely makes most people’s lives simpler,” says Eric Bronnenkant, head of tax for online advisory firm Betterment. The standard deduction is essentially an automatic process that doesn’t require you to devote time or energy to tracking expenses. As a result, it saves you the trouble of providing documentation, filling out a Schedule A form or needing to understand nuances of tax law.
Some taxpayers qualify for a bigger deduction. Some individuals might be eligible for an increase in their deduction based on age or disability. Taxpayers who are age 65 and older or blind are entitled to an additional deduction of $1,300 to $1,650, depending on their tax filing status.
Anyone can claim it. You’ll be allowed to take a standard tax deduction even if you don’t have expenses that qualify you to make itemized deductions.
Although the standard deduction is a simple method, it might not be the best option based on your financial situation. Here are the drawbacks of taking the standard deduction:
- Standard deductions have filing limitations.
- You might end up with a smaller deduction.
Standard deductions have filing limitations. You won’t be able to take a standard deduction in a few scenarios. If you’re married and filing separately, you can’t claim a standard deduction if your spouse itemizes his or her deductions. Though not as common, if you’re a nonresident alien, a dual-status alien or someone who is filing a tax return for a period of less than a year, then you won’t be eligible for the standard deduction. Your deduction can also be limited if you’ve been claimed as a dependent on someone else’s taxes.
You might end up with a smaller deduction. The standard deduction amount might be lower than the amount you could deduct if you itemize. For example, the standard deduction might be less than the total amount of mortgage interest, real estate taxes and charitable contributions you’ve paid and could deduct. However, this won’t be the case for many people. “It’s probable most taxpayers will do better with the standard deduction,” says Patrick Colabella, CPA and associate professor at the Tobin College of Business at St. John’s University in New York City.
Unlike the standard deduction, itemized deductions can result in a different amount for each taxpayer. Itemized deductions are claimed on a Schedule A form and are broken down into five main categories:
- Medical and dental expenses.
- Taxes you paid.
- Interest you paid.
- Gifts to charity.
- Casualty and theft losses.
There is also a line for other itemized deductions, which covers less common situations such as gambling losses and certain unrecovered investments in a pension. “Most tax software does a pretty good job of helping you identify those things,” Bronnenkant says. However, for most people, state and local taxes, mortgage interest and charitable donations will make up the bulk of their itemized deductions.
Here are the benefits of itemized deductions:
- You can claim more expenses.
- You can save more money in taxes.
You can claim more expenses. Mortgage interest, property taxes and medical bills are just a few of the expenses allowed with itemization. While some of these categories have caps or limitations, taxpayers with large mortgages who give generously to charity may find they get a larger deduction by itemizing.
You can save more money. Because you can include more deductions when itemizing, you might stand to earn a larger tax refund. The amount itemizing saves you will depend on your tax bracket. For instance, income taxed in the 24% tax bracket will see a 24 cent tax savings for every dollar itemized above the standard deduction.
Itemizing deductions comes with some drawbacks, however. Here are the disadvantages of itemized deductions:
- It takes more paperwork and effort to itemize.
- There are restrictions on some itemized deductions.
It takes more paperwork and effort to itemize. Unlike standard deductions, itemizing is a manual process that requires gathering documentation and tallying expenses. Depending on how good your records are and the amount of your deductions, this time-consuming process might not reduce your taxable income enough to make it worth the effort.
There are restrictions on some itemized deductions. The Tax Cuts and Jobs Act caps the itemized deduction for state and local taxes, including property taxes, at $10,000. What’s more, interest on home equity loans taken out for purposes other than a renovation are no longer deductible, and only interest on the first $750,000 of a new mortgage can be included. If you want to deduct medical and dental expenses, only those in excess of 7.5% of your adjusted gross income are eligible to be itemized.
Should You Itemize Deductions?
Anyone with deductible expenses that exceed the standard deduction should itemize. For most people, that means having mortgage interest or property taxes to deduct. Unless someone has significant charitable gifts or a major medical event, it may be difficult to find enough deductions to itemize otherwise. “Tripping over the standard deduction (amount) isn’t easy,” Colabella says.
However, those who can’t itemize on an annual basis may be able to do so for some years if they bundle their charitable contributions. “Maybe you don’t make (donations) every year,” Laginess says. “Maybe you make them every other year.” By combining two years’ worth of contributions into a single year, taxpayers may be able to benefit from an increased itemized deduction.