Though we all groan about having to pay taxes, the government is nice enough not to tax us on everything we earn.
There are two big buckets of deductions the government gives us: The first are called "above the line," and the second are called "below the line," which we'll cover here. (The "line" these deductions refer to is a literal line on your 1040 form for the Adjusted Gross Income.)
Below the Line Deductions
You can take your below the line deductions in one of two ways: Either you can claim the standard deduction, or you can claim itemized deductions.
• The Standard Deduction. The standard deduction is an amount of income that the government will not tax any taxpayer on. The Tax Policy Center estimates that about 70 percent of taxpayers take the standard deduction on their returns, which is worth anywhere from $5,950 to $11,900, and opt out of the whole process of itemizing. It's as simple as saying, "I'm a single person (or married filing singly, or married filing jointly), and yes, I would like the standard deduction." For some, this is just fine. After all, that's a lot of money, and taking just the standard deduction makes your taxes simpler and faster. What's not to like? (Check out the chart below to find out what the standard deduction is for your filing status.)
*Do not use this chart if you were born before January 2, 1948, or are blind, or if someone else can claim you (or your spouse if filing jointly) as a dependent. Use Table 7 or 8 on this IRS page instead.
Itemized Deductions. Itemizing your deductions means listing each deduction you qualify for. People do this when the sum of all their deductions is greater than the standard amount. Some things people might itemize include medical expenses, charitable donations and mortgage interest payments.
But How Do You Know Which One Is Right for You?
At stake in this decision are savings in terms of money and time. For some people, taking the time to itemize could save them hundreds or thousands of dollars in taxes.
The most recent study by the General Accounting Office estimated that in 1998, 2.2 million people overpaid their taxes because they chose not to itemize. It seems many of us take the standard deduction because it's easier, because we forgot to keep records during the year, or because we assume we don't have enough deductions to make it worthwhile.
Then again, there are the people who decide to itemize even though it's not worth it. They just made their lives needlessly more complicated (and expensive, if they relied on an accountant to do this for them) for no financial benefit.
Should You Itemize?
Here are some instances in when you should consider itemizing. Did you:
Have large uninsured medical and dental expenses?
Pay a significant amount of interest or taxes on your home?
Have large unreimbursed employee business expenses?
Have large uninsured casualty or theft losses?
Make large charitable contributions?
And sometimes, you have no choice but to itemize, like when:
You are married and filing a separate return, and your spouse itemizes deductions
You are a nonresident alien or a dual-status alien
If you're still not sure, take this quiz to find out if itemizing makes sense for you.