All Tax Deductions Are Not Created Equal
Itemized deductions are deductions you can claim if the total amount of the deductions is greater than the standard deduction applicable to your filing status. For the tax year 2010, the standard deduction is $5,700 for single taxpayers or for those married filing separately; $11,400 for married taxpayers or qualifying widow(er)s; and $8,400 for heads of household.
SCENARIO No. 1: If taxpayer Mary Smith had a total income of $40,000 for 2010 and $5,000 in non-itemized deductions, she would have $35,000 in adjusted gross income (AGI).
However, all itemized deductions aren't equal. Itemized deductions may be subject to floors, ceilings and other limitations.
SCENARIO No. 2: After non-itemized deductions, Mary Smith has an AGI of $35,000. She has $21,500 in itemized deductions, including a large charitable donation. Assuming she's single, she must have more than $5,700 in itemized deductions in order to itemize. She does, so she may take the itemized deduction.
If you itemize your deductions, you may be able to deduct medical expenses for which you paid during the year for yourself, your spouse and your dependents. However, you may deduct only the amount by which your total medical expenses for the year exceed 7.5% of your AGI; the 7.5% threshold is sometimes referred to as a "floor" since you can only deduct the expenses over that amount.
If you itemize your deductions, you may be able to claim one or more deductible non-business taxes on your Schedule A. These include state, local and foreign income taxes; state, local and foreign real estate taxes; state and local personal property taxes; state and local sales taxes, and qualified motor vehicle taxes. To be deductible, the tax must have been imposed on you and paid during your tax year. Assuming that the taxes otherwise qualify, there are generally no floors or ceilings on the amount you can take as a deduction.
SCENARIO No. 3: Mary Smith has $2,000 in medical expenses. In order to claim medical expenses, she must have medical expenses that total at least 7.5% of her AGI. That means that she would need $2,625 ($35,000 x 7.5%) in medical expenses before she could take a deduction for medical expenses, so her actual deductible medical expenses equals 0.
SCENARIO No. 4: Mary Smith remembers that she has an extra $1,000 in health insurance premiums, bringing her total medical expenses to $3,000. She's now met the "floor" for her AGI of $2,625, so she can claim the overage as an itemized deduction. The overage is $375 -- $3,000 (actual medical expenses) - $2,625 (7.5% of AGI). Mary can claim $375 in medical expenses on her Schedule A.
If you paid points (prepaid interest on a home mortgage) or regular home mortgage interest during the year, you may be able to claim the interest on your Schedule A. Generally, home mortgage interest is interest that you paid on a secured loan to buy your home and includes a second mortgage, a line of credit or a home equity loan. In most cases, you can deduct all your home mortgage interest as long as you qualify; some limits apply, depending on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds. For most taxpayers, however, the amount of the deductible home mortgage interest will not be affected by tax ceilings or floors.
SCENARIO No. 5: Mary Smith paid $2,000 in real estate taxes for 2010. She also paid $1,500 in state and local income taxes. She can claim $3,500 as a deduction on her Schedule A.
While home mortgage interest might not be dependent upon AGI, mortgage insurance premiums may be reduced or eliminated if your AGI exceeds certain limits. For 2010, if your AGI is greater than $100,000 ($50,000 for married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced; if your AGI is more than $109,000 ($54,500 for married filing separately), you cannot deduct your mortgage insurance premiums.
SCENARIO No. 6: Mary Smith paid $4,625 in home mortgage interest for 2010 for a mortgage on her home. Assuming she otherwise qualifies, she can claim the entire $4,625 as a deduction on her Schedule A.
Qualifying charitable contributions are generally completely deductible for most taxpayers who itemize on a Schedule A. However, exceptions do apply. If your total charitable contributions for the year are 20% or less of your AGI, there are no limits for qualified deductions. In other cases, the amount of your deduction for charitable contributions is limited to 50% of your AGI, and may be further limited to 30% or 20% of your AGI, depending on the type of property you give and the nature of the charitable organization.
SCENARIO No. 7: Mary Smith paid $200 in mortgage insurance premiums for 2010. Assuming she otherwise qualifies, she can claim the entire $200 as a deduction on her Schedule A.
SCENARIO No. 8: Mary Smith donated $1,500 in cash to the American Cancer Society, a qualified 501(c)(3) organization. Since $1,500 is far below the 20% threshold, she may deduct the entire amount.
Finally, if you have expenses that qualify as miscellaneous itemized deductions, they are only deductible to the extent that they are more than 2% of your AGI. There are generally three types of expenses that fall into this category: unreimbursed employee expenses, tax preparation fees and the catch-all "other expenses." You figure your miscellaneous itemized deductions by subtracting 2% of your AGI from the total amount of these expenses.
SCENARIO No. 9: Mary Smith donated a car worth $10,000 to the Purple Heart Car Donation Program. The donation of the car is more than 20% of Mary's AGI (20% of $35,000 is $7,000) and is, therefore, subject to restrictions.
SCENARIO No. 10: Mary Smith had $2,000 in job-related expenses and tax preparation fees. She can deduct those expenses over $700 (2% of $35,000), or $1,300.
Of course, these are general principles that apply to taxpayers. Your own scenario may be different, so it's always best to check with a tax professional if you have questions about how the rules apply to you.