Itemized Deductions

When filing your taxes, you are always faced with the decision of taking Itemized Deductions or the standard deduction.  To be exact, you had to make that decision on line 39 of the IRS Form 1040.  In nearly all cases, your taxes will be less if you take itemized tax deductions instead of the standard deduction.

Itemizing Taxes

For many of us filing our income taxes and filling out the forms can be a tiresome task that we would rather avoid. But when it comes to itemizing taxes you don't want to take any short cuts or you might be missing an important tax deduction.

In simplified terms, taxpayers have the opportunity to take the standard deduction or itemize their deductions.  This deduction is then subtracted from your adjusted gross income or AGI to calculate your taxable income.  In other words, itemizing is probably your last shot at lowering your tax liability or increasing your tax refund.

The standard deduction might look temptingly large, but if you have a loan such as a mortgage and pay property taxes, then you would probably be better off itemizing your taxes.  The only thing you have to lose is the time it takes to fill out the IRS Schedule A.  If itemizing doesn't work for you, then you can still take the standard deduction.

Itemized Tax Deductions

Itemized tax deductions are calculated using Schedule A (Form 1040).  The IRS has broken down the itemized deductions into seven distinct categories of expenses.  Below we are going to briefly discuss each category and give some common examples of itemized deductions you can take in Schedule A.

Medical and Dental Expenses

To take a deduction for medical and dental expense, your expenses must exceed 7.5% of your AGI.  The deduction you can take is for the expenses in excess of the 7.5%.  One significant deduction you might be able to take is for the premiums you paid toward your medical and dental insurance - if those premiums were paid with after-tax dollars.

In other words, if you did not pay any income taxes on the dollars used to pay the insurance premiums, then you cannot deduct those amounts.  You can take deductions for prescription medications, Medicare Supplemental Insurance, routine and emergency medical care, and the costs of certain expenses such as lodging if the expense is associated with receiving medical care.

Taxes You Paid

This is where you take itemized deductions for taxes you have paid to other jurisdictions. That means you cannot take deductions for federal income taxes, Social Security or Medicare taxes.  Typically, this is a category that should add considerably to your deductions.

For example, you can include here state and local income taxes, sales tax, real estate taxes, and personal property taxes such as registration fees on a car.  The largest of these deductions will probably be state income tax and real estate taxes you've paid to your township or municipality.  If you have a mortgage, the real estate taxes paid should be shown on a form you get from your lender - Form 1098, Mortgage Interest Statement.

Interest You Paid

Once again, if you own a home and have a mortgage or another qualifying loan, then this category of expenses should add considerably to your total itemized deductions.  Your lender will send you a Form 1098, which includes all of the interest expenses you've paid on your loans.

Generally, the points you've paid to purchase a home are deductible the year you purchased the home and these amounts are included in Form 1098.  If however, you paid points to refinance an existing home, then the points are deductible over the life of the loan.

Gifts to Charity

Charitable gifts are one of those itemized deductions that can get you into trouble during a tax audit.  You can deduct cash gifts, property donated and even expenses you've incurred while volunteering.

Gifts made by check can be proved through the check itself.  If you are making a property gift such as donating a car or clothing, then make sure you get a receipt for the gift or an appraisal of its fair market value - This is not the same as the price you paid for the property.

Casualty and Theft

If you've suffered casualty or loss due to theft, then you need to complete IRS Form 4684.  Similar to medical and dental expense, you can take an itemized deduction for this category if the calculated loss exceeds 10% of your AGI.  Typical losses include vandalism, storm / flood damage, and even the bankruptcy of others.

Job Expenses

Most employers are pretty good at reimbursing their employees for job related expenses.  However, if you have unreimbursed expenses such as the purchase of tools, uniforms or travel expenses, this is the category to take these deductions.  Only those expenses in excess of 2.0% of your AGI can be deducted.

Miscellaneous Expenses

This is another complex area of deductions; in fact, the IRS put together a 29 page publication dedicated to miscellaneous Expenses - Publication 529.  If you are in certain professions - teaching, the military or performing arts, it may be worthwhile to look through the publication.

Beating the Standard Deduction

The last step in this process is to take all of these itemized deductions appearing on Schedule A and add them together to see if they are higher than the standard deduction you're allowed.  If they are higher, then it was time well spent.  The following table contains the standard deductions for the tax years 2006 and 2007:

Standard Deductions 2006 / 2007

If you can't beat the standard deduction, then at least you have a good idea of what changes in your financial life might enable you to eventually take the itemized deductions.  If you can beat these standard deductions, then you are better off filing Schedule A along with your 1040.

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