How do you know whether it is more effective to take the standard vs. itemized deduction? Tax specialist Sanae Takagawa, EA has the answers. The most common itemized deduction is interest on a mortgage and that is what gets most folks to start itemizing. However, there are other deductions (and credits) that can lower your taxes. The following is a summary of Sanae's expert opinion on the matter:
The 2012 standard deductions for single and married filing jointly are $5,950 and $11,900, respectively. It's a little more if you're over 65 or legally blind. If your itemized deductions are higher than those amounts, then go ahead and itemize. It's just that simple! And you'll pay less in taxes.
To determine the amount of your itemized deductions consider how much you spend on the following during 2012.
1. Money Paid for Medical Care
This includes a number of items like medical and dental premiums, qualified long-term care premiums, doctor fees, prescription medication and eyeglasses. As part of the new health care law, the floor for medical deductions increases from 7.5 percent of AGI to 10 percent for those taxpayers under age 65 starting in 2013. For clients who are on the cusp, Sanae suggests you pay as many medical expenses as you can in 2012. But hurry-time is running out!
2. Mortgage Interest
You can deduct any loan that is secured by your main residence or a vacation home, too! Additionally, you can deduct any investment interest expense paid on a loan tied to property held for investment.
You can select to deduct state and local income tax payments or sales tax payments. You may benefit by using the sales tax deduction if you had a large amount of purchases during 2012... think car, boat, aircraft, or major home renovation. Property tax also counts. Sanae had a client who had additional income due to Roth IRA conversion. He chose to pay two years' worth of real estate taxes and make an extra mortgage payment for the interest deduction so that he could bundle itemized deductions and reduce his taxable income. Pretty clever, if you ask me!
4. Charitable Contributions
Give to your favorite charity, and make sure it's registered as 501(c)(3)). If you have fluctuating income you will receive a greater tax benefit in years you have more income (i.e. you're in a higher tax bracket). Therefore, you should consider making charitable contribution in years with the highest amount of income. Another strategy is donating appreciated stock. Be sure it is held for more than one year (long-term capital gains) because this will allow you to receive a deduction for the fair market value of the stock and avoid paying tax on the capital gain. Unfortunately, you cannot deduct your time or the service you provided to a non-profit as a volunteer, but you may include any parking fees and tolls or other transportation expenses if you don't get reimbursed by the organization.
5. Casualty Losses
If you were affected by Sandy, then listen up! You can deduct any personal losses caused by floods, hurricanes, tornadoes, fire, theft, vandalism, even car or boat accidents, or money lost because of the bankruptcy of an institution.
6. Miscellaneous Deductions
There is a 2 percent floor for miscellaneous deductions. They include union dues, un-reimbursed employee expenses, tax preparation fees, job search expenses (must be in the same occupation), some legal fees (related to collecting income or keeping your job) and various fees related to the administration of investments.
If the total amount spent on the above categories is more than your standard deduction then you will likely benefit by itemizing. However, there is an exception to every rule. If you are a married couple filing separate returns and one spouse itemizes deductions, the other spouse must itemize his/her allowable deductions. This is the case even if his or her standard deduction is higher than the itemized deductions.
Fortunately, Sanae has some additional tax savings tips that apply whether or not you itemize. Perhaps you qualify for these common deductions and credits: IRA or retirement savings contribution, health saving account (HSA) contribution, student loan interest deduction, education credits, child care credits and the foreign tax credit.
Please remember that everyone's tax situation is a little different. If you think some of the ideas in this post apply to you, be sure to reach out to a qualified tax professional so you can maximize your tax savings in order to SaveUp!
This post was written by SaveUp's personal finance contributing writer, Catherine Hawley, CFP®.