Paying taxes is part of the responsibility of living in the United States. But most people understandably don’t want to pay more than they have to. An important part of minimizing your federal income tax liability is to understand the rules and make the most of your tax planning opportunities. Personal deduction planning is one aspect of tax planning. You should aim to use your deductions in the most efficient manner and take all deductions to which you’re entitled.
Deductions lower your taxable income
Your first step is to understand how deductions work. You subtract certain deductions from your total income to arrive at your adjusted gross income (AGI); these deductions are commonly referred to as adjustments to income or as “above-the-line” deductions. Then, you subtract other deductions and exemptions from your AGI to determine your taxable income; these deductions are sometimes referred to as “below-the- line” deductions. Your tax liability is calculated based on your taxable income. Generally speaking, therefore, the higher your deduction level, the lower your tax liability.
You can either take a standard deduction or itemize
After you’ve computed your AGI, you’ll generally want to subtract the greater of either the standard deduction or the total of your itemized deductions. The standard deduction is a fixed dollar amount, indexed for inflation yearly, that is determined according to your filing status (e.g., married filing jointly, single) and certain circumstances. Itemized deductions are various deductions that are reported on Schedule A of your federal tax return (Form 1040). They involve certain personal expenses, such as medical expenses, mortgage interest, state taxes, and charitable contributions. If you have enough of these types of expenses, your itemized deductions may exceed your standard deduction. In that case, it would generally be to your advantage to itemize.
When filling out your tax return, how do you know whether to take the standard deduction or itemize? You should calculate your taxes (including any alternative minimum tax) using both methods, and go with the one that lowers your tax liability the most. Be aware that there are some limitations regarding who can use the standard deduction and who can itemize. Also, certain itemized deductions are available to you only if your expenses exceed a particular percentage of your AGI. For example, your medical expenses itemized deduction is allowed only to the extent that medical expenses exceed 10 percent of your AGI (in 2019, 7.5 percent of your AGI in 2018). So, if your AGI is $100,000, your first $10,000 of medical expenses won’t count toward your total itemized deductions.
There may be circumstances where it is better to itemize deductions even if the standard deduction is greater than itemized deductions. For example, if you are subject to alternative minimum tax, even a small amount of some itemized deductions may be preferable to the standard deduction, which is reduced to zero for alternative minimum tax purposes.
The medical and dental expenses deduction: what it is, and how it involves your income level
The medical and dental expenses deduction is an itemized deduction that you may take (within certain limits) for un-reimbursed medical and dental expenses you paid during the year for yourself, your spouse, and your dependents. You may be surprised to learn which medical and dental expenses are deductible and which are not; the line is sometimes blurry. For example, you can’t deduct your expenses for nicotine gum, but you can deduct your fee for a smoking cessation program. Many expenses qualify for this deduction, including acupuncture treatments, crutches, eyeglasses, and prescription drugs. You should obtain IRS Publication 502, Medical and Dental Expenses, for an authoritative list of eligible and nondeductible expenses. If you don’t review this list, you may miss out on some important tax-saving opportunities.
You can take this deduction only to the extent that your un-reimbursed medical expenses exceed 10 percent of your AGI (in 2019, 7.5 percent of your AGI in 2018). That might sound complicated, but here’s how it works. First, add up your eligible medical expenses. You can deduct only part of that total on Schedule A of your federal income tax return. The schedule will actually lead you through this calculation. On that form, you’ll multiply your AGI by 10 percent (0.1). The figure you come up with will represent the amount of your medical expenses that you cannot deduct. Subtract this figure from your total eligible medical expenses. The remaining amount is your medical deduction.
Proper timing of your deductions will minimize your taxes
For most people, income is reported in the year that it’s received, while deductions are generally taken for the year in which expenses are paid. In many cases, you can control whether you incur an expense this year or next. That means that you can control the timing of your itemized deductions to some extent. If you’re in a higher income tax bracket this year than you expect to be in next year, you may want to accelerate your deductions into the current year to minimize your tax liability. You can do this by paying deductible expenses before year-end and making charitable contributions before year-end. For example, if you have major dental work scheduled for January of next year, you can reschedule for December to take advantage of the deduction this year. Here are some tips:
- If you pay a deductible expense by check, make sure it’s dated and mailed before year-end. It needn’t clear the bank by year-end, however.
- If you pay by credit card, the expense is deductible in the year the charge is incurred, not when the credit card bill is paid.
- A mere pledge or promise to make a charitable contribution is not deductible.
- Along with your cash contributions to a charity, remember to deduct non-cash contributions like clothes. You can also deduct mileage if you use your car for charitable purposes.