Income tax: Using the itemized deduction vs standard deduction

Deductions are one of the principal methods of avoiding undue taxation by the U.S. Internal Revenue Service (IRS). As unpleasant as tax filing season may be, it is important to know the benefits and distinctions of each type of tax deduction in detail so as to correctly file taxes and report accurate taxable income. When filing taxes only one or the other of the standard deduction or itemized deductions can be used. Consequently, knowing which tax deductions will yield the more precise taxable income can be worth the time spent deciding which methods is best.

The standard deduction

The standard deduction is a pre-set value appearing on the IRS form 1040 that varies on one's filing status. The filing status includes one's marital and household standing in addition to spousal filing information. The three filing statuses used by the U.S. Internal Revenue Service and corresponding standard deductions are as follows:

• Married Filing Jointly: $10,700.00
• Head of Household: $7,850.00
• Single or Married Filing Separately: $5,350.00

It pays to be married and file a joint tax return if the standard deduction for such filing is higher than itemized deductions, and if filing jointly does not adversely affect one's tax bracket and taxable income to the point of negative benefits. In other words, if the cost of filing as jointly married outweigh the benefits it may be better to file as married filing separately or head of household.

Head of household filing status requires a familial and dependent relationship who both lives with the tax filer and who pays less than half the annual living expenses for the household. More detailed qualification details for this filing status and deduction can be found on pages 13-17 of the form 1040 filing instructions.

The single or married filing separately filing status has the lowest standard deduction and the least impact on taxable income of the three options. This standard deduction is more likely to be compared with the itemized deductions in terms of total deduction to adjusted gross income because it is the smallest. That is to say, the itemized deductions have the greater chance of being larger than the single or married filing separately standard deduction.

The itemized deduction(s)

Itemized deductions are voluntary individual deductions that can be used instead of the standard deduction. Itemized deductions can be filed using a Form 1040 Schedule A-Itemized deductions. Some of the more significant deductions are listed as follows:

• Medical and Dental Expenses over 7.5% of one's adjusted gross income
• State and local income taxes paid or sales tax ex.7.25% in California, 2.5% in Colorado
• Residential Mortgage interest expense
• Charitable donations ex: clothing, cash, equipment
• Employee expenses not paid for by an employer ex: International Travel

If the total itemized deductions are greater than the applicable standard deduction, the itemized deductions will contribute to lower taxable income. Mortgage interest expenses and income tax may yield a significantly large enough deduction to justify using the itemized deductions.

To illustrate the above point, a home with 200 thousand dollar mortgage at 6 percent charges approximately $12,000.00 in mortgage interest expense in its first year not including reverse compounding. This mortgage interest expense alone is higher than the highest standard deduction. Generally, the higher the standard of living a household maintains in terms of income and mortgage taxes and expenses, the more likely it is itemized deductions will be the correct tax filing deduction choice.

Itemized vs standard deduction filing tips

The following tips can help one determine which type of deduction is more likely to yield a lower taxable income. In cases of lower income and standard of living, the standard deduction is more likely to be the correct choice. However, in some cases both ways may come close in terms of dollar amounts of the deductions while in cases of high mortgage interest and taxable income, the itemized may be the better choice.

• Taxable income: Taxable income is the final amount tax will be assessed on. Making this number as low as possible and understanding that it can be reduced via deductions is key to reducing income tax.

• Filing status: Filing status may benefit taxable income if the joint income is lower than the additional deduction. Ex-If one spouse is not working, the additional deduction amount will yield a significantly lower taxable income.

•Audits: Sometimes deductions may trigger IRS audits. Whether the deductions are for business expenses, charitable donations or another purpose, ask for and keep receipts is essential in proving the legitimacy of the deduction in case of audit.

• Sales vs Income tax deductions: Comparing sales tax deductions with income tax deductions using pages A-4, A-11 and A-12 of the form 1040 Schedule A instructions can help identify the higher deductible if any. Sometimes calculations will be necessary to determine which deduction yields the greatest income advantage.

• Charitable contributions: Charitable contributions aren't necessarily beneficial if the donation amount does not lead to a greater amount of saved income tax. Calculating charitable contributions with the potential aim of lowering tax bracket ex. 28 to 25 percent, or 25 to 15 percent is one way to optimize charitable contributions tax deductions.

• Schedule A: Complete a Schedule A even if the standard deduction is believed to be the better choice. This will enable a more accurate comparison than a rough estimate of total itemized deductions.

Taxes can be thought of as the necessary evil that lubricates and maintains the regulatory machinery that keeps a country safe, functional and operational. Nevertheless, not many people if any want to over pay the government during tax filing season. For this reason it can be a good idea to determine which tax deductions are the most exact representation of deductions to one's taxable income.

Source: http://www.irs.gov