Tax deductions are items that help you reduce your taxable income before your tax liability is calculated. There are two types of deductions namely:
- Above the line deductions â€“ which we already discussed on our previous post.
- Below the line â€“ (personal exemptions, standard deductions or Â itemized deductions)
On this post we will be discussing primarily the itemized deduction or items you can deduct on the 1040 Schedule A. These types of deductions are called below the line deductions because they are applied after the adjusted gross income (AGI or the â€œLineâ€) has been calculated. In general, you would need to itemize your return if they are greater than the standard deduction or if you are not allowed to claim the itemized deduction. Below are the reasons on why you may need to itemize:
- You have a large amount of Â health care expenses not covered by your insurance company
- You payÂ interest on your home or investment property
- You have large amount of taxes paid
- You made large donations to qualified charities
- You have a lot of unreimbursed employee business expenses
- You have large casualty or theft losses not covered or reimbursed by your insurance company.
This is a very good question. Taxpayers need to itemize if they fall into the following:
- A married person whoseÂ filing status is married filing separately and whose spouse is itemizing deductions.
- An individual who is a nonresident alien or dual-status alien during any part of the current tax year. Dual status occurs when you are considered both a nonresident and resident alien during the same year.
- An individual who changes his or her annual accounting cycle and is filing a return for a period of less than 12 months.
Limitations on the Itemized Deductions
Not all expenses can be fully deducted. Some of them are subject to the floor amount, which are calculated by taking a specific percentage of the AGI. The â€œfloorâ€ means that you can only take deductions that exceed that amount.
- Healthcare or medical expenses are subject to a 7.5% of the AGI floor
- Miscellaneous subject to a 2% of the AGI floor
- Casualty or Theft losses are subject to the 10% of the AGI floor
Example of calculating the floor:
If your AGI is $100,000 and your qualified health expenses are $8,000, your â€œfloorâ€ amount is $7,500 (7.5% of $100,000). This means that the first $7,500 of your qualified health expenses will be excluded from your itemized deduction. Thus, you will only be able to deduct $500 of those expenses.
Most Common Itemized Deductions
- Healthcare Expenses – Medical and dental expenses which may include qualified expenses not covered by the insurance companies such as insurance co-pay or deductible, prescription pharmacy, long-term care.
- Interest Paid – Includes mortgage interest paid for purchase debt of up to $1,000,000 of home values, qualified mortgage insurance premium, points paid, interest paid on home equity loans of up to $100,000 loan value, and investment interest.
- Taxes paid â€“ real estate property tax, personal property tax, state income tax, local government (county or city) income tax
- Charitable contributions â€“ Cash contributions and non-monetary such as clothing, car, household items or mileage for volunteer work to qualified charitable organizations.
- Gambling losses â€“ Gambling losses are only deductible if you have winnings. In addition, you can only deduct up to the amount of the winnings.
- Casualty or Theft Losses â€“ any losses not covered or not reimbursed by your insurance company.
- Miscellaneous Expenses – unreimbursed employee business expenses, tax preparation fees, legal fees, qualified educational expenses, union dues, professional license, subscription to professional magazines, etc.
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