As you sit down to file your taxes this year, you may be faced with the age-old question: Should I itemize on my return, or go with the standard deduction?
First, let's talk about deductions and why they're so valuable. A deduction works by excluding a portion of your earnings from being taxed. Standard deductions are set by the IRS and are designed to help all taxpayers exempt some income from taxes. Itemized deductions, meanwhile, let you apply specific expenses to lower your taxable income. Though the IRS has strict rules on itemized deductions, you can think of itemizing as a far more customized approach to tackling your tax return.
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While you have the option to take either the standard deduction or itemized deductions on your taxes, you can't claim both. It therefore pays to run the numbers and see which one results in the lowest possible tax bill.
Standard deductions for 2016
One benefit of taking the standard deduction is that it's incredibly easy. Rather than add up your expenses, you can simply copy the number that applies to you, as follows:
DATA SOURCE: IRS.
There's also an additional standard $1,250 deduction available to elderly or blind taxpayers for the 2016 tax year. That amount increases to $1,550 if you're unmarried and not a qualifying widow(er). Once you know what standard deduction you qualify for, you can compare that number to what you'd get by itemizing to guide your decision.
When you itemize your deductions, your personal expenses play a role in determining your overall tax bill. If you don't own a home, there's a good chance you'll come out ahead by sticking with the standard deduction. But property owners in particular tend to do better by itemizing their deductions because of all the tax breaks they get.
As a homeowner, you're allowed to deduct:
- Your mortgage interest
- Your property taxes
- The points you pay on your mortgage
- Your private mortgage insurance (PMI) premiums, provided you don't earn more than $54,000 as a single tax filer or $109,000 as a couple filing jointly
In addition to homeowner deductions, you can deduct expenses for the following:
- Retirement-plan contributions (such as money put into a traditional IRA)
- Charitable contributions, including both cash and non-cash donations
- Losses on investments
- Out-of-pocket medical expenses that exceed 10% of your adjusted gross income (AGI) for the year
- Moving expenses, provided you relocate for a new job and meet the associated criteria
- Job-search expenses that exceed 2% of your AGI, provided you're not a new graduate and are looking for work within your established field
- Up to $2,500 in student-loan interest, provided you don't earn too much
If you have self-employment income, you can also deduct additional expenses you incurred in order to do your job. For example, if you used your vehicle during the year to visit clients, you can claim a mileage deduction, and if you dedicated an area of your home for work purposes, you can take a home-office deduction. You can also deduct direct business expenses, like office supplies.
Crunching the numbers
In many cases, choosing between the standard deduction and itemized deductions is a simple matter of comparing two numbers and seeing which works out better tax-wise. Say you're a couple filing a joint return with $8,000 in mortgage interest, $3,000 in property taxes, $2,000 in charitable donations, and $1,000 in eligible medical expenses. In that case, you'd typically come out ahead by itemizing because your total deductions ($14,000) exceed the standard $12,600 assigned to your filing status.
Keep in mind, however, if you're a high earner: Due to certain provisions in the tax code, once your income exceeds a certain threshold, the value of some deductions begins to decline. While most high-income households will still come out ahead by itemizing, in some cases, it might pay to opt for the standard deduction. The good news is that if you're using a reliable tax-filing program, it will calculate what you're eligible for and help you decide between the two (as will a tax preparer, whom you may want to hire if your situation is complicated enough).
Remember, there's a reason why close to 70% of households take the standard deduction, while only 30% itemize. In most cases, you'll come out ahead by sticking to the IRS's preset amounts. On the other hand, the IRS reports that the majority of households with incomes of $75,000 and over itemize their deductions and forgo the standard deduction. Because there's no hard and fast rule about which is better, you'll need to run your own calculations and see what makes the most sense for you.
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