The term “tax deduction” brings a smile to the face of most taxpayers. They know deductions are a good thing, like mini gifts from the IRS, but they don't always understand all the intricacies involved in claiming them. There are actually three separate kinds of tax deductions, and they all come with their own rules.
Three Kinds of Tax Deductions
All tax deductions fall into one of three categories:
- Standard deductions
- "Above-the-line" adjustments to income, or
- Itemized deductions
The standard deduction is a flat amount that you can shave off your income based on your filing status. It's been pretty significant since the Tax Cuts and Jobs Act or TCJA went into effect in 2018. It's set at $12,550 for single taxpayers in tax year 2021, the tax return you'll file in 2022. This increases to $18,800 for those who qualify as head of household, and to $25,100 for married couples filing jointly. These amounts are indexed for inflation, so they tend to increase a bit annually.
Then there are adjustments to income. These come off your income right at the start of your tax return, "above the line," to determine your adjusted gross income or AGI. These deductions are particularly nice because they come off your taxable income before you can additionally claim the standard deduction or itemize your deductions.
Itemizing your deductions involves tallying up everything you spent on tax-deductible expenses over the course of the year and deducting the total from your AGI. You can claim the standard deduction for your filing status or you can itemize your deductions and claim the total in lieu of the standard deduction, but you can’t do both. It's an either/or decision.
The itemized deduction bucket is relatively large, covering a good many expenses you probably commonly spend money on, and you might not even know that you can catch a tax break for doing so.
The Medical and Dental Expenses Deduction
The medical and dental expense itemized deduction is one of the most frequently claimed, probably because so many taxpayers spend money on their health and on that of their dependents. This includes most health insurance premiums unless you pay them with pretax dollars, such as through a plan offered by your employer. It also covers a good number of medical procedures and healthcare, as long as you – not your insurance company – pay for them. This would be the case if you have to meet an annual deductible before your benefits kick in, and your copays and coinsurance count, too.
Some medical expenses aren’t covered, however, such as elective surgery, diet food and nonprescription medicines other than insulin. That bottle of ibuprofen you bought won't get you a tax break. But you can claim 16 cents for each mile you drove for purposes of receiving medical care in 2021.
The Effect of Your Adjusted Gross Income
Unfortunately, you can only claim a deduction for medical and dental expenses to the extent that they exceed 7.5 percent your adjusted gross income, or AGI – the number you’re left with after you claim any above-the-line adjustments to income you might qualify for. You can find your AGI on line 11 of the 2021 Form 1040 tax return.
The 7.5-percent AGI rule works out like this: You can only claim an itemized deduction of $4,375 if you have $10,000 in qualifying expenses and your AGI is $75,000: 7.5 percent of $75,000 is $5,625, and you can only claim a medical expense deduction for the amount of your expenses that exceeds this amount.
The Deduction for Charitable Giving
The IRS encourages generosity, and the Internal Revenue Code lets you deduct tangible gifts or cash you give to charity, subject to several rules. But here's some good news for the 2020 and 2021 tax years only: You can claim a $300 adjustment to income rather than itemize this deduction if you're single, or $600 if you're married and file a joint return. This provision was enacted in response to the COVID-19 pandemic, so it's unknown if it will continue in tax year 2022.
You must give to a “qualified” charity to qualify for either the itemized deduction or the adjustment to income, and you must get a statement/receipt from the organization if your gift exceeds $250. The IRS provides a search tool on its website so you can check if the charity you’re considering giving to is listed as qualified. You’re typically safe with religious institutions and nonprofit organizations, however.
You can’t deduct gifts made to political or foreign organizations. You can only claim a deduction for the portion over its fair market value if you receive anything in exchange for the gift, such as if you pay $750 for a $500 television because the money goes to charity. Your deduction would be $250 in this case. Each mile you drive to do volunteer work will earn you a 14-cent deduction in 2021, but you can’t deduct the value of your time.
Back to That AGI Again
Your AGI played a part in this deduction, too, through 2019. You could only claim a deduction for your generosity for up to 60 percent of your adjusted gross income, at least for gifts made in cash or by check. Special rules applied to capital gains property. Your deduction would be capped at $45,000 if your AGI was $75,000 a year, , but that’s a pretty big deduction and a whole lot of generosity.
Then came the CARES Act in 2020. This legislation lifted the 60-percent rule in response to the coronavirus pandemic. The IRS has announced that you can claim a deduction equal to 100 percent of your AGI beginning in 2020 and continuing in 2021. Again, there's been no indication if this provision will last into the 2022 tax year.
The State and Local Tax Deduction
You can also claim up to $10,000 of what you spend on property taxes and state income taxes, or $5,000 if you’re married and you file a separate return.
You can opt to deduct sales taxes you pay instead of income tax if the sales taxes turn out to be more, but keeping track of all the qualifying sales taxes you pay during the year might be quite a headache, and it might not amount to more.
You used to be able to deduct taxes paid on foreign properties, but that provision has been eliminated from the tax code. You can’t claim an itemized deduction for taxes paid on foreign income, either, or for some excise taxes or for federal income taxes.
The Mortgage Interest Deduction
You can claim a deduction for the interest you pay on up to $750,000 of the amount you borrowed if you took out a mortgage after Dec. 14, 2017. You can claim the deduction for property you purchased before this date, too, and it's even more generous if you did: up to $1 million in indebtedness. But you’re limited to $375,000 or $500,000, depending on the date you took out the mortgage, if you're married and file a separate return.
Interest on home equity loans doesn’t count unless you use the proceeds of the loan to build, improve or purchase property. In other words, forget about using the proceeds on your dream vacation unless you want to forego the tax deduction.
Effect of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act made many changes to itemized deductions when it went into effect in 2018, not all of them favorable. The $10,000 cap on state and local taxes was introduced – this deduction used to be limitless –and the mortgage interest deduction was reduced by $250,000 in indebtedness. The ability to deduct interest on home equity loans was corralled.
The TCJA also delivered a death blow to a few other itemized deductions, most notably miscellaneous deductions. You can no longer claim a deduction for work-related expenses that aren’t reimbursed to you by your employer, or for tax preparation fees, both of which used to be included here.
The itemized deduction for theft and casualty losses isn’t entirely gone, but it might as well be for many taxpayers. These losses are only deductible now if they result from a federally declared disaster. And you must first subtract $100 for each loss even if they do, then you can deduct only the portion that exceeds 10 percent of your all-important AGI.
Some Favorable Changes
You used to be able to claim an itemized deduction for mortgage insurance premiums, then this deduction expired at the end of 2017. But you can take heart because this one has come back. The Further Consolidated Appropriations Act has reinstated it effective with the 2020 tax year.
And the TCJA threw a bone back to some taxpayers. It used to be that those who earned too much weren’t permitted to itemize, or at least they couldn’t claim the full value of some itemized deductions above certain income thresholds. The more they earned over those thresholds, the more their itemized deductions were reduced until the deductions finally became off-limits entirely for some very high income levels.
These provisions were known as “Pease limitations,” named after Donald Pease, the lawmaker who initiated them back in 1991. But the TCJA repealed Pease limitations from the tax code, at least while the law remains in effect through 2025. The TCJA is slated to sunset or expire at that time unless Congress takes steps to renew it in its entirety or any of its provisions.
Read More: How to Calculate Income Tax Deductions
So, Should You Itemize?
These deductions cover a lot of expenses, and calculating them all according to the applicable rules can admittedly be a challenge. It might not even be worth your while thanks to the increased standard deductions provided for under the TCJA. You’d end up paying tax on an additional $2,550 in income if you claim $10,000 in itemized deductions in 2021 and you’re a single taxpayer entitled to a standard deduction of $12,550 – the difference between $10,000 and your $12,550 standard deduction.
Tax experts suggest that you might want to prepare a rough draft of your tax return both ways to see which results in the greater deduction if you think your itemized expenses are even close to your standard deduction.
And here’s one last important rule: If you’re married and your spouse decides to claim the standard deduction, you must do the same if you’re filing separate married returns. The IRS doesn’t allow married-filing-separately spouses the option of one of them itemizing and the other taking a different route.
How Do You Itemize?
Itemizing involves completing and filing Schedule A with your tax return. As far as tax forms go, this one is reasonably clear-cut. It’s broken down into sections for each itemized deduction, and each section comes with instructions. For example, the section for medical expenses clearly explains that you must multiply the total by 7.5 percent of your AGI on your 2021 tax return.
Enter the totals for all your deductions on the right side of the page, then add them up and transfer the total to line 12a of your 2021 Form 1040 tax return in lieu of claiming the standard deduction.
And for what it’s worth, Schedule A also asks you to check a box at line 18 if you’re itemizing even though you know that your standard deduction would be more.
- IRS: Adjustments to Income
- IRS: Tax-Exempt Organization Search
- Kays Financial Advisory Corporation: Pease Limitation Explained
- IRS: Form 1040
- IRS: IRS Provides Tax Inflation Adjustments for Tax Year 2021
- IRS: Form 1040 U.S. Individual Income Tax Return
- Congressional Research Service: Individual Tax Provisions (Tax Extenders) Expiring in 2020
- IRS: Standard Mileage Rates
- IRS: Charitable Contribution Deductions
- Bankrate: Private Mortgage Insurance (PMI) Federal Income Tax Deduction Returns
- IRS: Expanded Tax Benefits Help Individuals and Businesses Give to Charity in 2021
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.