What is an Itemized Deduction?
An itemized deduction is an expense or contribution that can be subtracted from adjusted gross income to reduce a person’s income tax liability.
When preparing federal income taxes, taxpayers must choose to either itemize their deductions or take the standard deduction. Those who choose to itemize their deductions must identify each tax deduction they wish to make against their income to determine what their taxable income is.
Some people get “creative” or aggressive with taking tax deductions, which can result in underpayment of taxes or being charged with tax evasion.
For this reason, the government has instituted the alternative minimum tax (AMT) as an additional check to ensure that everyone pays their fair share of taxes.
How Itemized Deductions Work
When preparing federal income taxes, a tax preparer will start by adding up an individual’s or family’s annual earnings to arrive at adjusted gross income (AGI).
But before tax rates are applied to earned income, AGI is reduced by tax deductible items that the government has deemed eligible to offset taxable income.
There are two ways to handle tax deductions: the standard deduction and itemizing deductions. Taxpayers choose which method they want to use.
For the standard deduction, the IRS has set a uniform amount for people to deduct, depending on their tax filing status (singled, married, etc.). When itemizing deductions, the individual or family filing their taxes must specify each deduction they wish to take and must maintain the records that prove they are eligible to take those deductions.
For example, if an individual has $100,000 in adjusted gross income and has itemized three deductions totaling $25,000, their taxable income is reduced to $75,000.
Federal income taxes are applied only on taxable income. So in this example, the individual has protected $25,000 from being subject to income tax by claiming their deductions.
What Kind of Deductions Can Be Claimed?
Itemized deductions are listed on Schedule A of Form 1040. There is a wide-ranging list, but be aware that the deductions are subject to change based on IRS policies or laws established by Congress.
The table below highlights some of the most common deductions.
Taking the Standard Deduction vs. Itemizing
When preparing income taxes, a tax filer must choose whether to itemize deductions or take the standard deduction; they cannot do both.
The standard deduction is easier to administer because it doesn’t require keeping track of each individual deduction; however, not everyone is allowed to take the standard deduction.
The list of groups not able to take the standard deduction includes married people filing separately whose spouses itemized, nonresident aliens and their spouses, trusts, and estates.
For most people, the choice between taking the standard deduction and itemizing comes down to numbers. People who can take many deductions often find that they are better off itemizing, but many people simply haven’t kept good records or do not want to go through all their expenses to figure out if itemizing makes more sense.