A tax deduction decreases your taxable income, which in turn can lower your tax bill. There are generally two ways you can claim deductions on your federal income tax return: you can itemize deductions, or you can take the standard deduction.
A review of the standard deduction amount and what qualifies for itemizing can help you determine which is right for you.
1. Why itemize?
When it comes to deductions, you generally want to choose the option that lowers your taxable income the most.
The standard deduction is a fixed amount, while itemized deductions are made up of a list of eligible expenses.
Expenses that qualify for itemized deductions include qualified mortgage interest, state and local income taxes, medical and dental expenses, and charitable contributions.
2. Standard deduction
The standard deduction amount varies based on your income, age, filing status, and whether you’re blind, and changes each year.
If you’re married and filing jointly, your standard deduction for 2021 will be $25,100 (plus $1,350 per person age 65).
If you’re single or filing as an individual, your standard deduction will be $12,550 (plus $1,700 if age 65 or older).
3. Tax rates
The rate at which your income is taxed can play a role in whether you choose standard or itemized deductions.
There are seven tax brackets, ranging from 10-37%. The highest bracket for single filers and married couples filing jointly begins with taxable incomes over $518,400 and $622,050, respectively.
4. Mortgage interest
The cap on mortgage debt that you can take interest deductions on is $750,000, down from $1 million. This applies to mortgages taken after December 15, 2017.
5. State taxes
The itemized deduction for state taxes is capped at $10,000.
Residents of high tax states like California, New York and New Jersey will have a more difficult time surpassing the standard deduction because of that limitation.
6. Medical and dental expenses
You’re allowed to deduct qualified, unreimbursed medical expenses that exceed 7.5% of your adjusted gross income.
Medical expenses for which you’ve been reimbursed by your insurance or employer cannot be deducted.
Qualified expenses include surgeries, preventive care, treatment, dental and vision care, and prescription medications.
7. Charitable deductions
Contributions to qualified charities are still fully deductible, but you may have to approach your giving strategy differently to take advantage of the tax benefits.
For example, if you bunch your donations into one year instead of multiple, you’re more likely to exceed the standard deduction.
8. Only one way to find out
There’s no substitute for running the numbers. Use an IRS Schedule A form to itemize your mortgage interest expense, charitable donations, medical expenses, state taxes and other itemizable expenses.
This is where significant out-of-pocket medical expenses or charitable donations could play a big role.
9. What should you do?
If your deductions put you over the standard deduction threshold, then itemizing will work for you.
If you’re below the threshold, taking the standard deduction will make more sense.
Tax planning shouldn’t be a once-a-year activity. Consider these 6 year-round tax tips that could help lower your tax bill in April.