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Itemized Deductions vs. the Standard Deduction

The new tax reform, which was signed into law in December, will present an interesting question going forward for many taxpayers: should you itemize deductions when you prepare your tax return or claim the standard deduction?

Standard Deduction Increased Significantly

The reason why this is becoming an important question is because the tax reform act nearly doubled the standard deduction, taking effect next year for tax year 2018 (though it bears remembering that the personal exemption has been eliminated, so while the new standard deduction is “better,” it hasn’t really “doubled” at the end of the day).

The standard deduction can be claimed by any taxpayer without having to keep track of deductible expenses, like charitable contributions, mortgage interest, and state and local taxes (the SALT deduction).

About 70% of taxpayers claim the standard deduction, with only 30% itemizing deductions. This is usually because the standard deduction is larger than the total of itemized deductions would be, or they simply don’t want to go through the extra work required to itemize deductions.

The higher a household’s income, the more likely they are to itemize deductions. According to data compiled by the Tax Policy Center, 92% of households with adjusted gross income (AGI) of more than $500,000 itemize deductions, while just 7% of households with AGI of less than $30,000 itemize deductions.

Crunching the Numbers

Before tax reform, the standard deduction for tax year 2018 was scheduled to be $6,500 for singles, $9,550 for heads of household and $13,000 for married couples filing jointly. However, tax reform increased the standard deduction for tax year 2018 to:

  • Singles: $12,000
  • Heads of household: $18,000
  • Married couples filing jointly: $24,000

This increase will change the equation for many taxpayers, especially those for whom the decision to itemize deductions is a close call.

For example, suppose you are single, your AGI in 2016 was $100,000 and you had $10,000 in itemized deductions. If your AGI and itemized deductions in 2017 are about the same amount, then it probably makes sense to itemize again this year when the standard deduction will be $6,350. (Remember, the higher standard deduction is effective for tax year 2018, for which you’ll file your federal income tax return next spring.)

However, if your AGI and itemized deductions are about the same in 2018 as they were last year, it probably won’t make sense to itemize deductions next spring. This is because the standard deduction of $12,000 will be higher than itemized deductions of $10,000. Not only would itemizing deductions require more time and effort when filing your taxes, but it would also cost you money.

But let’s say that you get a new job and a nice income boost this year to $130,000. You also purchase a home, which enables you to deduct your mortgage interest, and you increase your charitable contributions proportional to your higher salary. As a result, your itemized deductions now total $13,000, or $1,000 more than the standard deduction.

From a purely financial standpoint, it would make sense to itemize deductions next year in order to obtain a higher deduction. But itemizing deductions does require extra recordkeeping and the filing of Schedule A along with Form 1040 with your federal income tax return.

When the standard deduction and total amount of itemized deductions are this close, some taxpayers may choose to claim the standard deduction from a pure simplicity standpoint. Also, if you use a CPA to help you with tax preparation, choosing the standard deduction may lower your tax prep fees since the filing of Schedule A won’t be required.

SALT Deductions Capped

The tax reform act made another change that could affect the decision about whether to itemize deductions. Starting in tax year 2018, the annual deduction for state and local taxes (or SALT) will be capped at $10,000. So if you have claimed large SALT deductions that are higher than this in the past, the total amount of your itemized deductions will probably be lower starting next year.

Now would be a good time to begin planning your 2018 tax strategies with regard to itemizing deductions next year. Be sure to speak with a tax professional for more detailed guidance given your specific situation.

Read our free Personal Capital 2018 Tax Guide for Holistic Financial Planning to learn more about taxes and your long-term financial planning.

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This blog is for informational purposes only; we are not in the business of providing tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.

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