There is probably no area that causes more confusion among taxpayers than itemized tax deductions. When you have an unexpected financial event or change in circumstances, the next thing you know your lawyer/employer/neighbor/cousin Vinnie is there to give you advice. Telling you things such as "Don't worry about it, you can take it off your taxes!" Leaving you to wonder, can I really do that? How? Good questions.
In order to see if you really can or even should take tax deductions, keep in mind the following:
There are two ways to take deductions. There is the standard deduction. This is based on your filing status and is a set dollar amount that increases annually. And there are itemized deductions. Here the amounts spent on certain types of expenses are totaled up. Either can be subtracted from your income. It is both legal and smart to use whichever number benefits you the most.
To figure your standard deduction, you need to determine your filing status. These are: Single, married filing jointly, married filing separately, head of household, or qualifying widow or widower. If you are not sure what your filing status is, go to IRS Part 1, Section 2 to figure it out. Then go to Part 5, Section 20 to get the dollar amount of your standard deduction. Keep in mind that these amounts increase every year, so always check the IRS website or your current tax forms.
To figure these out, you will need to add up what you paid or had withheld from your paychecks in the following areas:
Medical: The following is a list of items that are the most common medical expenses:
- Health insurance
- Long term care insurance
- Co-payments for any doctors, dentists, eye doctors, etc.
- Fees for physical therapy
- Medical equipment
- Doctor recommended weight loss programs
- Certain alternative therapies
- Payment for prescription drugs
- Contact lenses
- Mileage to and from doctors and pharmacies
Keep in mind that any insurance premiums that come out of your paycheck on a "pre-tax" basis cannot be deducted again. Since this is an area that is subject to certain limitations, be sure to follow the instructions on Schedule A carefully to be sure you are not deducting more than is allowed.
State and local taxes you have paid: This includes state income tax withheld from your paycheck, state unemployment or disability tax, real estate taxes, personal property taxes, and prior year back taxes or balance due paid in the current tax year.
Note: If you pay your real estate taxes to your mortgage lender monthly along with your mortgage payment, the amount paid for the year will appear on your mortgage interest statement. If you pay them yourself you will need to keep track of the amount.
Mortgage interest: Interest paid on mortgage loans for first or second homes can be a federal income tax deduction. This also includes home equity loans. If you have refinanced during the year with a different lender make sure you add both amounts. If you got the mortgage or refinanced during the year make sure you include any points paid. Lenders typically issue a form 1098 for all interest received during the year. If you have a private mortgage, you will need to provide the name, address, and federal identification number of the lender, as well as the amount. Commercial lenders include this information on the 1098.
New refinancing points: When you refinance a mortgage you pay for a certain amount of points. As long as you are paying on this new loan these points can be tax deductible. All you need to do is subtract the total monthly amount.
Old points: Once you refinance, you may have a points balance from the previous loan. These unamortized points can be deducted as well.
Charitable contribution: Charitable contributions fall into two categories and both can be taken as tax deductions. The first is contributions by cash or check. This would include weekly amounts given to any church, temple, or mosque you attend, as well as any one time or irregular amounts given to a registered U.S. charity. Don't forget donations by cash made at the grocery store or another retailer that just adds the donations to your bill. This is the same for organizations such as the Salvation Army Santa, the kids collecting for UNICEF, or the animal shelter set up at the pet food store. If you cannot get a receipt, make a note of the amount. A few dollars here and there every other week adds up by the end of the year.
The second category is gifts other than by cash or check. For most people this is the annual closet clean out and drop off, at Goodwill or a similar organization. Make a list of the clothes, toys, sports equipment, and household goods that you give to one of these organizations. You are allowed to deduct the resale value, not what you paid. Most large charities that accept these donations can give you a value guide.
Job expenses and other miscellaneous deductions: This is also an area subject to limitations, so again read the instructions carefully. This section would include unreimbursed employee business expenses such as union dues, work boots, safety goggles, work gloves, uniforms or uniform cleaning, fees for licenses and certifications, reference materials, and other items required to do your job that your employer does not pay for. In this area you may also deduct tax preparation fees, the cost of safe deposit box rentals, and certain investment related expenses. The big area for most people is moving expenses for first jobs. If you move more than fifty miles from your residence you can deduct all the related expenses.
Child care: If you are a parent that pays for child care you can deduct this amount from your taxes. If you have a reimbursement account through your employer for child care deductions you can claim this amount as well.
Teachers: Teachers can deduct up to $250 worth of products that they purchase per year.
College: If you are attending school and make no more than $65,000 per year or $130,000 if filing jointly, you can deduct some of the expenses. The total amount that can be deducted in this category per year is $4,000. After college, the interest you pay on your student loans can be deducted as well.
Hybrids: If you purchased a brand new hybrid vehicle in the year 2007, you can deduct a certain amount of the price. Depending on the vehicle you could take anywhere from $250 to $1,000 from your taxes. Also, you can gain additional clean fuel deductions that range from $400 to $2,400.
Note: These credits are becoming obsolete. Consult a tax professional before you make this deduction.
Investments: Any expense you incur in relation to investments made or tax planning can be deducted. This amount can equal no more than two percent of your annual gross income.
Retirement: Some workers whose income is equal to a certain amount can deduct monies placed in a retirement fund. You can take up to $2,000 off of your taxes from such a contribution. Also, payments made into IRA and other such accounts are tax deductible. There are limitations to this category so make sure to consult a tax professional.
Other possible deductions: There are federal income tax deductions available for casualty losses, theft, fire, flood, or other disaster and a few other areas, such as gambling losses. But remember, you can only write off what you've lost on lottery tickets up to the extent that you have won. So if you have won $600, but lost $2000, you only get to deduct $600. These do not affect most people, and they may require a special form. If you think one of these situations applies to you, contact a tax professional or the IRS for advice on how to proceed.
Remember, there is nothing wrong with taking a legitimate deduction. Don't decide how to do your tax return based on fear of audits, a desire to save time or the desire to save money. Keep good records of all your tax information using whatever method (from shoebox to spreadsheet) works for you. When in doubt, check with the IRS or a trained tax professional. And learn to keep as much of your money as you are legally entitled to.