Itemized deduction

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Individual taxpayers in the United States are allowed a choice when preparing their Federal income tax returns. After computing their Adjusted gross income (AGI), taxpayers can itemize their deductions (from a list of allowable items) and subtract those itemized deductions (and any applicable personal exemption deductions) from their AGI amount to arrive at their taxable income amount. Alternately, they can elect to subtract the standard deduction for their filing status (and any applicable personal exemption deduction) to arrive at their taxable income. In other words, the taxpayer may generally deduct the total itemized deduction amount, or the standard deduction amount, whichever is greater.

The choice between the standard deduction and itemizing involves a number of factors:

• A comparison between the available standard deduction and allowable itemized deductions - the larger number is generally advantageous
• Whether or not the taxpayer has or is willing to maintain the records required to substantiate the itemized deductions
• If the total itemized deductions and the standard deduction are very close in value, whether the taxpayer would prefer to take the standard deduction to reduce the risk of change upon examination by the Internal Revenue Service (IRS). (The standard deduction amount cannot be changed upon audit unless the taxpayer's filing status changes.)
• Whether the taxpayer is otherwise eligible to file a shorter tax form (like the 1040EZ or 1040A) and would prefer not to prepare (or pay to have prepared) the more complicated 1040 form and the associated Schedule A for itemized deductions.
• If the taxpayer is filing as "Married, Filing Separately", and their spouse itemizes, then they must itemize as well.

There are a number of allowable deductions:

• Medical expenses, to the extent that the expenses exceed 7.5% of the taxpayer's AGI. (e.g., a taxpayer with an AGI of $20,000 and medical expenses of $5,000 would be eligible to deduct $3500 of their medical expenses ( 20,000 X .075 = 1500; 5000 - 1500 = 3500 ).) The 7.5% floor means that most taxpayers are unable to take advantage of the medical expense deduction. Allowable medical expenses include:
  • Payments to doctors, dentists, surgeons, chiropractors, psychologists, counselors, physical therapists, osteopaths, podiatrists, home health care nurses
  • Premiums for medical insurance (but not if paid by another, or with pre-tax dollars)
  • Premiums for qualifying long-term-care insurance, depending on the taxpayer's age
  • Payments for prescription drugs and insulin
  • Payments for devices needed to treat or compensate for a medical condition (crutches, wheelchairs, prescription eyeglasses, hearing aids)
  • Mileage for travel to and from doctors and medical treatment
  • Necessary travel expenses
  • Non-deductible medical expenses include:
    • Over-the-counter medications
    • Health club memberships (to improve general health & fitness)
    • Cosmetic surgery (except to restore normal appearance after an injury or to treat a genetic deformity)
• State and local taxes paid, including:
  • Income taxes (or, alternatively, state and local general sales taxes^[1])
  • Property taxes (assessed by reference to the value of the property)
  • but not including:
    • Use taxes
    • Excise taxes
    • Fines or penalties
• Mortgage interest expense on debt incurred in connection with up to two homes, subject to limits (up to $1,000,000 in purchase debt, or $100,000 in home equity loans)
  • also, points paid to discount the interest rate on up to two homes; points paid upon acquisition are immediately deductible, but points paid on a refinance must be amortized (deducted in equal parts over the lifetime of the loan)
• Investment interest, up to the amount of income reported from investments (the balance is deferred until more investment income is declared)
• Charitable contributions to allowable recipients; this deduction is limited to either 30% or 50% of AGI, depending on the characterization of the recipient. Donations can be made as money, or in the form of goods. The value of donated services cannot be deducted as a contribution. Reasonable expenses necessary to provide donated services can, however, be deducted (such as mileage, special uniforms, or meals). Non-cash donations valued at more than $500 require special substantiation on a separate form. Non-cash donations are deductible at the lesser of the donor's cost or the current fair market value. Eligible recipients for charitable contributions include:
  • Churches, synagogues, mosques, other houses of worship
  • Federal, state, or local government entities
  • Fraternal or veterans' organizations
  • Non-eligible recipients include:
    • Individuals
    • Political campaigns or political action committees (PACs)
• Casualty and theft losses, to the extent that they exceed 10% of the taxpayer's AGI (in aggregate), and $100 (per event)
• Miscellaneous expenses related to the production of income or the calculation of taxes, to the extent that they exceed 2% of the taxpayer's AGI, including:
  • Job-related clothing or equipment, such as steel-toed boots, hardhats, uniforms (if they are not suited for social wear: suits and tuxedoes are not deductible, even if the taxpayer does not like to wear them, but nurses' and police uniforms are), tools and equipment required for work
  • Unreimbursed work-related expenses, such as travel or education (so long as the education does not qualify the taxpayer for a new line of work; law school, for example, is not deductible.)
  • Fees paid to tax preparers, or to purchase books or software used to determine and calculate taxes owed
• Gambling losses, but only to the extent of gambling income (For example, a person who wins $1,000 in various gambling activities during the tax year and loses $800 in other gambling activities can deduct the $800 in losses, resulting in net gambling income of $200. By contrast, a person who wins $3,000 in various gambling activities during the year and loses $3,500 in other gambling activities in that year can deduct only $3,000 of the losses against the $3,000 in income, resulting in a break-even gambling activity for tax purposes for that year -- with no deduction for the remaining $500 excess loss.)

If the taxpayer's income is above a threshold ($145,950 for single/HH/MFJ in 2005), then the total allowable itemized deductions is reduced according to a formula provided by the IRS.

[edit] Notes