You are allowed to take either certain specific itemized deductions when you file your income tax return, or a standard deduction. Filers typically choose to file according to which method results in the higher total deduction. Itemized deductions are for things you paid for during the year. A standard deduction is allowed regardless of what you actually spent. The amount of standard deduction allowed varies with your filing status.
Medical expenses, contributions to charity, mortgage interest expense, and real estate and state income taxes are the most common deductions. Some casualty or theft losses are also deductible, with some limitations. Medical expenses are only deductible if they exceed 7.5 percent of your income. Non-cash items given to charity are sometimes deductible. You may have others available to you, so check with your tax professional when you do your tax return. These deductions are subject to audit by the IRS, so you may have to show proof that you actually incurred them.
A standard deduction requires no proof. The amount you may deduct from your income solely depends on your status when you file your return. If you are married filing jointly, the amount for 2011 was $11,600, for example. Single taxpayers or married taxpayers filing separately can deduct $5,800. In-between is a head of household, whose standard deduction is $8,500. People who are blind or older than 65 get additional amounts. If you are married, and your spouse files a separate return itemizing deductions, you will not be allowed a standard deduction.
Say you own a home with a $100,000 mortgage at 5 percent interest and your real estate taxes are $5,000. You gave $1,000 to charity and paid state income taxes of $2,000. You are married and file a joint tax return. Your itemized deductions total about $13,000, which is more than the $11,600 standard deduction. In this case, you would list your itemized deductions on Schedule A of your 1040 tax return and deduct them in computing your taxable income.
How much money you save depends on the tax bracket you fall into after taking all your deductions into account. Deductions are different from tax credits, which reduce the tax you have to pay dollar for dollar. If you are in the 25 percent tax bracket, each dollar of itemized or standard deduction will save you 25 cents. If your situation changes, such as buying or selling a house, the availability of deductions may change as well. There is no substitute for running the numbers each year.
Richard Friedkin has many years of experience as a Certified Public Accountant, a Certified Financial Planner and a corporate CEO. He has been a writer for more than 30 years, writing everything from dense technical memos to whimsical children's stories. Friedkin's work has been published locally and performed on stage.