When calculating your taxes for the year, the IRS allows you to deduct dollar-for-dollar a certain amount from your total income before arriving at your taxable income. The amount of the deduction depends on whether you take the standard or itemized deduction. The IRS allows you to take whichever deduction is more beneficial for your situation, regardless of which deduction you used in the past.
Standard Deduction
The standard deduction is a fixed amount that the IRS allows you to deduct from your gross income. The amount of the standard deduction depends on your filing status for the year, among a few other factors.
In 2023, the standard deduction for taxpayers filing as:
- Single is $13,850
- Head of household is $20,800
- Married filing joint status is $27,700.
Therefore, if your itemized deductions do not exceed the standard deduction for the year, you will take the standard deduction when filing your tax return.
For certain taxpayers, the standard deduction may deviate from the amounts previously mentioned. For taxpayers aged 65 or older as of the last day of 2023, the standard deduction increases $1,850 for a taxpayer filing as single or head of household, and $1,500 per qualifying individual when using the married filing joint status. This means that if each taxpayer on a married filing joint tax return is over 65 years old, their standard deduction will increase $3,000 from the base amount.
For someone who can be claimed as a dependent on another taxpayer’s return, the standard deduction is either a flat $1,250, or however much their annual earned income was plus $400, whichever is greater. Note: If using the earned income plus $400 standard deduction, the amount may not exceed the normal standard deduction available for their filing status.
Itemized Deduction
There are many factors that play into how an itemized deduction is calculated. The most common factors are:
- Out-of-Pocket Medical Expenses – this includes most medical expenses that were not covered or reimbursed by your health insurance, and not paid through HSA or FSA funds. For your medical expenses to count toward your itemized deductions, your out-of-pocket medical expenses must exceed 7.5% of your adjusted gross income (AGI), and only the portion of medical expenses that exceed that the 7.5% of income mark will count. So, a taxpayer with an AGI of $100,000 with out-of-pocket medical expenses of $10,000 for the year, only $2,500 will count toward their itemized deductions, as that is the excess medical expense using the 7.5% of AGI mark.
Qualified medical expenses can include, but are not limited to, co-pays, dental expenses, prescriptions, eyeglasses or contacts, chiropractic care, long-term care expenses, etc.
- State & Local Taxes – this includes any taxes paid at the state and local level, including income taxes, property taxes and sales taxes. The most a taxpayer can claim in state and local taxes is $10,000 per year, which was imposed by the 2017 Tax Cuts & Jobs Act. Before this tax reform many N.J. residents were able to claim itemized deductions due to the state’s high property tax rates. However, after this legislation was enacted, the cap on the amount of state and local taxes allowable caused many N.J. taxpayers to switch from claiming the itemized deduction to the standard deduction.
- Mortgage Interest – the interest portion only of your mortgage payments can be claimed as an itemized deduction. Mortgage servicers will issue a Form 1098 each year, which shows the exact amount of your mortgage payments that was allocated to interest. The full amount of the interest paid counts toward your itemized deductions unless your mortgage principal was over $750,000 at any point during the year, in which case limitations will apply.
- Charitable Contributions – this includes both cash and non-cash donations made to qualified charitable organizations throughout the year. For non-cash donations over $500 for a single year, additional forms are required to be filed with the tax return stating the name of the organization the goods were donated to, the purchase price of the goods, and the fair market value of the goods at the time of the donation. For cash donations, no additional reporting is required regardless of the amount. Even where additional reporting is not required for charitable contributions, we highly recommend you keep receipts for all cash and non-cash donations in the event that your tax return is ever subject to audit.
If the sum of the above-mentioned items is greater than the standard deduction allowable for the taxpayer’s filing status for the year, then the taxpayer will benefit from taking the itemized deduction for the year.
One important caveat is that for N.J. residents, even if they do not take the itemized deduction on their tax return, their medical expenses may still have a favorable impact on their N.J. tax return. The state of N.J. allows all resident taxpayers to take a deduction for any medical expenses in excess of 2% of their N.J. gross income. Unlike the medical expense calculation used for itemized deductions, the state of N.J. allows you to include medical insurance premiums deducted from your payroll. The IRS does not include medical insurance premiums deducted from your W-2 income in your taxable wages, so they’re already tax-free and an additional tax deduction for the on your federal tax return is not allowed. However, since N.J. state does not back out your medical insurance premiums paid through payroll deductions from your taxable income, they do allow you to include those costs in the calculation of your medical insurance deduction.
While you may be overwhelmed reading about all the factors that go into determining whether you should take the standard or itemized deduction when filing your taxes, working with a trusted tax professional can make this process a breeze. At Eiger, Lang & Company, we will work with you to make sure that you claim whichever option is most favorable to your tax situation, while minimizing how many credit card statements you need to sift through to add up your charitable donations and medical expenses for the year. After all, Eiger, Lang & Company is here to make your life less taxing.