Want a Bigger Tax Refund? Don't Itemize
by Cheryl A. Morse
Monday, March 15, 2010
Six reasons why many taxpayers can save money and time by claiming the standard deduction.
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Did you know you can legally take a deduction that is more than the total of your receipts? It's called the standard deduction and for a lot of taxpayers it's a money and time saver.
Year after year taxpayers spend hours hunting down and organizing all their receipts and canceled checks for totally legitimate deductions -- gifts to charity, medical expenses, unreimbursed business expenses and so on. Then they're told by their tax professionals, (or discover while using software such as Intuit's TurboTax or H&R Block's At Home) that all their conscientious record keeping is for naught. Those itemized deductions won't be showing up on their tax returns, because they'll get a bigger refund by claiming the "standard deduction."
Often people are left feeling a little cheated and confused by the process. So it helps to understand why you may be better off not itemizing, particularly this year. Here are six reasons:
1. The Standard Deduction Isn't So Small or So Standard
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The standard deduction is an amount assigned to each filing status. The base amount for 2009 is $5,700 for a single filer and double that -- $11,400 -- for a married couple filing jointly. A head of household (a single parent with kids, for example) gets a standard deduction of $8,350. There are additions to these standard amounts for those who are blind or over age 65.
In addition, for 2009 filers using the standard deduction can claim some extra breaks, including a $1,000 per couple ($500 for a single) deduction for real estate taxes paid. In fact, there are so many special breaks the Internal Revenue Service created a new tax form this year: Schedule L, Standard Deductions for Certain Filers. You use Schedule L to claim the extra real estate tax deduction, certain casualty losses and a special deduction for sales tax on a new vehicle purchased after Feb. 16, 2009 and before the end of 2009. With such add-ons, the standard deduction can quickly become a large number, and more beneficial than deducting your actual expenses. The common complaint I hear is: "I don't get to take anything anymore." I explain it as "Let's Make A Tax Deal." Behind door No. 1 are all your receipts and behind door No. 2 is the standard deduction. You want to pick the door that will get you a bigger deduction.
2. Medical Expenses Aren't Easy to Deduct
The list of allowed medical deductions is long and includes out-of-pocket expenses such as medical co-pays, dental work, glasses, $0.24 per mile to get to and from medical appointments, nursing home costs, health and long-term care insurance and even the cost of adding a wheelchair ramp to your home. (Note: If you're self-employed, the cost of medical insurance is deductible on more favorable terms on your Schedule C.)
One point of confusion: Many people help pay for their health insurance with pre-tax money taken out of their pay. Even though those insurance premiums are a big and rising expense, they aren't deductible since they come out of untaxed money.
Here's another catch: You can only deduct medical expenses to the extent they exceed 7.5% of your income. So most people, while they may feel their out-of-pocket medical costs are high, will not qualify for much of any medical deduction unless they have a catastrophic illness or a family member in a nursing home.
Let's take the example of Charlotte, a single mom filing as a head of household. Charlotte works in a job with medical insurance and has an adjusted gross income of $42,000, She had out-of-pocket medical expenses totaling $3,300. But only expenses above $3,150 (7.5% of $42,000) are deductible for Charlotte. So she can deduct only $150 in medical expenses. (If she had a medical flexible spending account at work, she could have paid all of her expenses out of that -- pre-tax.)
3. Some Real Estate Taxes Are Deductible Either Way
Yes, real estate taxes on your first and second home are deductible. Charlotte paid real estate taxes of $1,200. That means if she itemizes, she can deduct $1,200. But remember, for 2009, if she claims the standard deduction, she can deduct $500 of that tax anyway.
4. Your Deductible Mortgage Interest Could Be Shrinking
Yes, this can be a big itemized deduction. But as you pay down your mortgage your interest deduction is lower, and that write-off becomes less valuable as an itemized deduction. Moreover, when you refinance to get a lower interest rate, your mortgage deduction also goes down. Note that points you pay on a new mortgage may be deducted in full the year you pay them, but those paid to refinance a mortgage must be deducted over the life of the new loan. Also be aware that closing costs are never deductible on a personal residence, although many of my clients seem to be told otherwise.
5. Charity Requires Record Keeping
You need receipts for any and all donations, including $20 you put in the church collection plate on Sunday. The Internal Revenue Service is serious about the records part, and if you're chosen for one of its "correspondence audits," it will deny charitable deductions you can't substantiate.
You cannot take a deduction for your time, but your travel to perform charitable works is deductible at $0.14 per mile. Back to Charlotte, who keeps fastidious receipts, gives generously and volunteers frequently at her church. Between donations and mileage, her deduction for charitable giving if she itemizes is $2,200.
6. Miscellaneous Deductions Are Deductible, but ...
Various items, including preparation fees, safe deposit box fees, and unreimbursed job related expenses are also deductible -- but like medical deductions, only to the extent that they exceed a certain percentage of your income. For miscellaneous deductions, that is 2%.
Charlotte paid $195 to have her taxes done, $30 for a safety deposit box and $560 in job search expenses. Her total is $785, but only amounts above $840 (2% of $42,000) are deductible. So she can't claim any miscellaneous itemized deductions.
Let's recap. Charlotte's allowed deductions, if she itemizes are: real estate taxes, $1,200; sales tax on a car $650; state and local income tax withholding from her pay, $1,100; medical expenses, $150; mortgage interest, $3,000; charity, $2,200. Grand total: $8,300. (Normally, you can deduct either state and local sales taxes or income taxes, but the car provision is an extra for 2009 that can be claimed in addition to state and local income taxes.)
Charlotte's standard deduction, as figured on Schedule L, is $8,350 for head of household status, $650 for the car taxes and $500 for real state taxes. Grand total: $9,500. So she, like many filers, receives of a larger tax break by not itemizing.
In some cases, whether itemizing saves you money will vary from year to year. But the point is this: Don't assume you're being deprived of some benefit if your tax preparer or your tax software tells you to take the standard deduction.
Cheryl Morse has been an enrolled agent specializing in individual and small-business taxes for more than 25 years and is a tax manager with Emerging Business Partners in eastern Massachusetts. She is a national instructor for the National Association of Tax Professionals, an instructor for the University of Massachusetts Tax School and area chair of the IRS Taxpayer Advocacy Panel.