Recently, I caught up with an old friend over a casual lunch that mostly gravitated around recalling shared stories from college and updates on our current work lives. Naturally, the subject of taxes came up and his ears perked up. “So, my wife and I have been keeping track of our donations this year because we’ve heard it can help lower our taxes. Does it help?” Most people versed in tax may be tempted to drop the convenient tax answer “It depends” and leave it at that point. Of course, as an old friend of his, I opted to elaborate how itemized deductions and the standard deduction work. “So which one is better? The standard deduction or itemized deductions?” At that point, I was put into a checkmate and had to serve up that answer. “It depends. Every person’s situation may be different.”
Deductions in the Income Tax Formula
Deductions are important in the income tax formula. It factors into your Adjusted Gross Income (AGI), determines what income tax bracket you will fall under, and ultimately how much you owe in taxes. Taxpayers may claim either the standard deduction or itemized deductions on their income tax return. You cannot claim both.
As the name implies, the standard deduction is standard across the board for filers and adjusts each year to inflation. Currently, the standard deduction (2021) is set at $12,550 (single), $25,100 (married filing jointly). It easily fits into your income tax calculation without additional work.
Itemized Deductions in Brief
Itemized deductions are a bit more complex. Filers must submit the Schedule A with their Form 1040 income tax return. Several qualified expenses are available for taxpayers to claim as itemized deductions, such as medical expenses, charitable donations, and state taxes paid. Additional documentation and calculations are often needed when including itemized deductions. However, the biggest caveat is that in order to claim itemized deductions, the total of claimed deductible expenses must EXCEED the standard deduction.
Standard vs Itemized: Head to Head
In short, itemized deductions may not be very beneficial to filers who do not have too many qualified expenses. Let’s take an example:
Mr. & Mrs. Lee are a retired couple living on a fixed income of about $70,000 a year. They report on their 2021 Schedule A the following: charitable contributions of $4,500, qualified medical expenses deduction of $6,500, home mortgage interest of $1,200, and the State & Local Tax (SALT) deduction of $500. Summed up, they report $12,700 of itemized deductions on Schedule A. Unfortunately this isn’t enough to exceed the current standard deduction of $25,100 and they decide to just claim the standard deduction.
Filers with many qualified expenses tend to benefit more from itemized deductible expenses by exceeding the standard deduction, potentially moving them into lower tax brackets if planned accordingly. Of course this means incurring those many qualifying deductible expenses, so in some ways it may be better for others to not absorb those expenses at all and just go with the standard deduction when filing a return.
Overall, whether a taxpayer should claim standard or itemized deduction inevitably returns to the classic answer, “it depends.” Situations may be unique, and factoring any related business expenses for those who own small businesses can complicate their personal income taxes further. Consulting with trusted resources may help, such as us here at MiklosCPA. We are a California-based CPA firm helping emerging business owners with their business and personal income tax & accounting needs. Let’s chat so we can learn how our services meet your needs. Also, follow us on our social media pages for additional “good to know” articles and other tax tidbits.