With 2020 coming to a close soon, many are curious how much sense it makes to itemize their deductions. Although we don’t have a choice when it comes to paying taxes, we do have the opportunity to benefit from deductions. However, there are pros and cons to both that you should be aware of before making a decision.
Itemized Deductions vs. Standard Deduction
When you file your taxes, you will have the choice of whether to report individual itemized deductions or to claim a standard deduction. Itemized deductions are individual expenses that you add up and report to the IRS to deduct from your gross income. After the itemized deductions are totaled, your adjusted gross income is the amount you’ll pay income taxes on.
A standard deduction is something that you can choose to use instead of itemizing all of your deductions. If the total value of your itemized deductions is less than the standard deduction, it rarely makes any sense to file a smaller deduction when the larger deduction is right there, ready for the taking.
Standard Deductions Have Changed
In previous years, the standard deduction was low enough that it made sense for many people to itemize. However, the 2017 tax reform bill eliminated or restricted many itemized deductions beginning in the 2018 tax year and raised the standard deduction. That means fewer taxpayers are likely to itemize. Now, in 2020, many filers realize the significant impact these changes make on their income taxes and refunds.
Changes to Single Taxpayer Deductions
Previously, the standard deduction for a single taxpayer was $6,350 and $12,700 for married couples filing jointly. If you were single, you had to ask yourself, do all of my itemized deductions exceed $6,350? If the answer was yes, you most likely itemized. It was relatively easy to rack up more than $6,350 in deductions for many people. Now the standard deduction for single taxpayers has been raised to $12,400. It may be a lot harder to come up with over $12,400 in itemized deductions, so it will make more sense to claim the standard deduction instead.
Changes to Married Filing Jointly Deductions
For married couples filing jointly, the new standard deduction has risen to $24,800. In 2017, the couple would need to find $12,700 in itemized deductions to make it worth filing them rather than claiming the standard deduction. However, most couples will find it futile to itemize deductions, as they will be unlikely to exceed the new $24,800 standard deduction, which they can claim without having to itemize.
For example, if you are a couple filing jointly this year and your total itemized deductions total $22,000, it will still make more sense for you to claim the standard deduction. This is because you will not save any money by filing the itemized deductions this year with the larger $24,800 standard deduction available to you.
Why Most People Don’t Itemize
With all these changes to the tax code, fewer people are likely to itemize now than ever before. However, lest we think this is a significant change in itself, consider that even before the tax bill took effect, the vast majority of filers chose to claim the standard deduction.
Approximately 70 percent of all filers last year chose the standard deduction, despite it being much lower than it is now. Many of them chose this because it was just easier than digging up all those individual deductions. Others decided it because they couldn’t come up with enough deductions for it to be worthwhile. With the much higher standard deductions, we can expect very few people to itemize this year.
These increases in the standard deductions aren’t the only reasons people are choosing not to itemize. There are other changes to the tax code, which may lead to even more people filing for the standard deduction.
Changes to State and Local Tax Deductions
The State and Local Tax (SALT) deduction used to be one of the most significant itemized deductions claimed by taxpayers. The most recent tax bill caps that deduction at $10,000. Before, there was no cap on it. If your state, local, and property taxes totaled $25,000 last year, you could deduct all of them. This year, only $10,000 of those will be deductible. High-income filers are taxed at a higher rate, making them more likely to itemize and use the SALT deduction. If you have an expensive home in a prospering community, you will benefit from this deduction—likewise, those who live in very high tax states such as California and New York.
The mortgage interest deduction is still available, though the threshold has been reduced. Before, you could deduct the interest on loans of up to $1 million, but now the limit is $750,000. If you have a high mortgage or two mortgages, it pays to claim the mortgage interest deduction.
To Itemize or to Standardize: That is the Question
In light of all these significant changes to the tax code, should you itemize your deductions or claim the standardized one? The answer tends to be reasonably straightforward. If you can add up your itemized deductions and they continue to exceed the newly increased standardized deductions, then it still makes sense to itemize. If, like many people, your itemized deductions don’t add up to more than the new standard deduction, then you can say goodbye to itemizing.
What if you add up the itemized deductions, and it is within a few hundred dollars or so of the standardized deduction? Claim the standard deduction. Why? Because it is a lot simpler and more bulletproof. Itemized deductions can be challenged in an IRS audit and could potentially trip red flags if you aren’t careful (or in some cases, even if you are). By claiming the standard deduction, you aren’t giving the IRS anything to question.
The tax code can be complicated, and in most cases, it is wise to consult a professional. They can clarify any confusion you might have surrounding the tax reform bill and its ramifications on your filing of deductions. If you have any tips or suggestions of your own for fellow tax filers, feel free to share them in the comments below.