What’s the Difference Between Standard and Itemized Deductions?
Tax is a perpetually confusing and complicated matter that every individual must understand. If you’re someone who looks at their tax computation with confusion, this blog post might be for you.
In general, a tax deduction is good for all working adults and entrepreneurs doing taxes. However, there’s a lot to unpack from these two words. Although it means lower tax obligations, it could also mean a steep loss if done wrong.
Studying taxes and their intricacies is a lifelong learning process, and we’re here to supplement your knowledge regarding this elaborate topic. By the end of this content, you’ll understand tax deductions and how you can apply them appropriately to your finances as a business owner or an individual.
What Is a Tax Deduction?
Before we dissect the differences between standard and itemized deductions, it’s vital to understand the essentials of tax deductions. By formal definition, a tax deduction is an amount that can be taken from your taxable income, which is the total amount of money you make in a year minus all taxes and exemptions. In other words, it’s anything that reduces the taxes you owe on your total income. To prevent excess tax deductions, the Internal Revenue Service (IRS) publishes a schedule of tax deduction limitations annually, which differs for different taxpayers. If you’re curious about your current limitations, you can conveniently check it on the IRS’s official website. Listed below are some of the items you can write off or deduct from your taxes:
Charitable donations
Health savings account (HSA) contributions
Mortgage interests
Student loan interests
Retirement plan contributions
State and local taxes
What Is the Standard Deduction?
Now that you know the general definition of tax deduction, it’s time to dive deep into one of its types: standard deduction.
A standard deduction is a predetermined and fixed amount of money that can be deducted from your total income without requiring you to itemize each individual deduction. The basic idea is that it simplifies taxes for those who don’t have enough deductible expenses to itemize their deductions.
Despite its ease and accessibility, the standard deduction has its own set of limitations. However, this shouldn’t cross this out of your options; here are the advantages of standard deduction:
Skip the complicated mathematics: Right off the bat, you skip the complex aspect of taxes: the computation. Since a standard deduction has a set amount, all you have to do is review the figures and see what applies to you.
Potentially maximize your tax deductions: Depending on your situation, you may claim higher deductions than itemized deductions because of the fixed amount concept. Moreover, the limit for standard deduction changes annually, as demonstrated on the IRS website. This means you have a chance to reduce your taxable income maximally.
Available for anyone (almost): Other than married couples filing separately or non-U.S. residents, you might qualify for a standard deduction. Furthermore, you may still apply for a standard deduction even if you don’t have expenses eligible for itemized tax deductions.
What Is an Itemized Deduction?
Now comes the second type of tax deduction, itemized deductions. Unlike standard deductions, itemized deductions require taxpayers to list down every tax-deductible expense they paid for. In other words, it’s a detailed record of all the eligible expenses you made in a year that qualify for deductions.
Going back to the items listed under the tax deduction section — those are the items you can claim for itemized deductions. Itemized deductions might take some time to complete or might involve a few computations, but these are the advantages you can get from it:
Potentially higher tax deductions: Unlike standard deductions, itemized deductions have no set total taxable amount. However, there are set limitations for each deductible item. For example, you can’t claim any deductions from mortgage interests on loan amounts over $750,000.
A wider list of deductible items: Due to the nature of the itemization process, you can claim several items for deductions, as shown in the specific IRS form. As long as it falls within the list of deductible items, it’s a green light. This is why most taxpayers with more sophisticated financial structures prefer to use itemized deductions.
Preferable for individuals with various assets: As mentioned above, individuals with complicated financial structures tend to opt for itemized deductions. This is because you can claim as many as you can as long as it falls under the list of tax-deductible expenses.
When To Itemize vs Taking the Standard Deduction?
Now comes the fun part: standard deduction vs. itemized deduction. A general rule of thumb is to test-run both scenarios and see which one will yield more savings. This is because some people may claim higher deductions with the standard deduction, while others would be better off with itemized deductions.
When doing this, it’s vital to consider the limitations applicable for each type of deduction, such as the set amount for standard deductions and the limit for specific itemized deductions.
If you don’t have enough expense items to make itemized deductions feasible, it’s better to stick with the standard deduction. This way, you won’t have to compute or dissect every single expense you made in the year.
In contrast, itemizing would be the better option if you have vast assets and many deductible items. As mentioned earlier, itemized deductions have no set total taxable amount, and you can claim as much as possible as long as it falls within the list of tax-deductible expenses.
State Tax Considerations for the Standard Deduction vs Itemized Deductions
Finally, it would be best to consider your state’s tax policies regarding standard and itemized deductions. This is because some states don’t allow taxpayers to claim itemized tax deductions on their state tax returns.
Even if your standard tax deduction is higher than your itemized deductions, you cannot use the former because of the surrounding state legislation. This rule is evident in states like Michigan and Massachusetts. Make sure to read up on your state’s laws regarding tax deductions or ask an expert to help you sort out your taxes.
Maximize Your Tax Savings With the Right Deduction
For many years now, individuals and business owners still get confused about taxes and their many moving parts, like tax deductions. Claiming the wrong thing can cost you more on taxes or leave you with an unfavorable refund. Understanding and properly managing your standard and itemized deductions is critical for a successful tax filing process.
If you need an extra set of hands to help you sort your tax filing, our team can help you with that. Our experts have impressive experience helping individuals and businesses maximize their benefits by properly filing taxes. Contact us now to learn more about our services and see the changes we make to our client’s lives.