Claiming itemized tax deductions has become less common since the passing of the Tax Cuts and Jobs Act (TCJA) that went into effect in 2018. In fact, the IRS now reports that almost 90% of tax filers use the standard deduction instead, which allows married, joint filers to deduct $25,900 from their adjusted gross income (AGI) and additional $1,400 per person if they are over age 65 (for tax year 2022).
But don’t put away your tax notebooks and spreadsheets just yet. There’s a potential opportunity to save money on income taxes that’s too often missed here by many taxpayers — especially those who own a home with a mortgage and donate to charitable organizations.
Today we’ll talk about what itemized deductions are and how to potentially use them to maximize your tax savings (work with a CPA and/or your tax advisor for best results) before it’s time to file your taxes.
What are itemized deductions?
The most common itemized deductions follow an acronym I’ll call the “TMMD,” which stands for:
Taxes such as property taxes and state & local sales/income tax up to the $10,000 annual limit,
Mortgage interest on your home or second home,
Medical expenses above 7.5% of your AGI, and
Donations to charitable/religious organizations
Is it Better to Itemize or Take the Standard Deduction?Add these four groups of expenses – the “TMMD” — together. If these itemized deductions total more than the standard deduction for your tax filing status ($12,950 for single filers and $25,900 for married filers under age 65 in 2022), then you will be able to use itemized deductions instead of the standard deduction and therefore deduct more of your income to save additional money on taxes.
For example, let’s say you’re a married, joint filer under age 65 earning $250,000. During the tax year you paid $10,000 in property taxes, paid $20,000 in mortgage interest on your home, and donated $10,000 to charity/church. That adds up to $40,000 in itemized deductions.
Because the standard deduction would be $25,900 for 2022, the IRS allows you to take the more tax favorable option — in this example you would claim the $40,000 in itemized deductions.
The extra $14,100 in itemized deductions compared to the standard deduction at a 24% tax rate would save $3,384 for the year in taxes ($40,000 – $25,900 = $14,100 difference x 24%) in this example.
Next, let’s talk about the four main itemized deductions and how to use them to potentially shrink your income tax bill.
Itemized Deduction Category #1: Property Taxes and SALT Taxes
If you have a property tax bill of $8,000 per year, it may not be difficult to add your state sales tax or state income tax to reach the annual limit of $10,000 you may count toward your itemized deductions total. Don’t have receipts for sales taxes? That’s okay, as the IRS gives you a table that allows you to deduct sales taxes equal to a percentage of your income.
Tip: You may claim property tax on your second home if you choose to itemize, provided you don’t rent the property out to others more than 14 days of the tax year.
Itemized Deduction Category #2: Mortgage Interest
Many taxpayers who have a mortgage with a balance of more than $200,000 may be paying $5,000 to $15,000 or more per year in potentially deductible mortgage interest depending on their interest rate.
Tax form 1098 Mortgage Interest Statement (which comes out in late January) will show you the amount of mortgage interest you paid on your home during the tax year.
In addition to the mortgage interest on your main home, don’t forget to look for these commonly missed items when calculating this itemized deduction:
- Mortgage interest on second homes (note: If it’s a rental property, taxpayers may deduct part or all of the mortgage interest under Schedule E instead of itemizing).
- If you got a new mortgage during the tax year, you also may itemize the amount you paid for prepaid mortgage insurance premiums or any points or used to lower your interest rate. You can find these amounts on your 1098 Mortgage Interest tax statements from your mortgage lenders.
- If you refinanced during the year, look for two of these 1098 tax statements in your mailbox or email during tax season.
- And if you were one of millions of Americans who took out a home equity loan or home equity line of credit for home renovations to “buy, build, or substantially improve the home” during the tax year, you may include that in your mortgage interest paid total.
Keep in mind there is a $750,000 mortgage debt limit to this deductibility (or up to $1,000,000 if the debt was acquired before December 2017), so if you have mortgage balances totaling more than that you may not be able to claim a deduction on the full amount of interest.
Itemized Deduction Category #3: Medical Expenses
This is perhaps the most difficult itemized deduction to utilize, because if you itemize, you may not begin counting your unreimbursed medical expenses until they add up to more than 7.5% of your AGI.
For example, if your AGI was $100,000 for the year and you paid $10,000 in medical expenses (e.g., for doctors, dentists, lab fees, contact lenses, prescriptions, or other medical-related expenses) that weren’t paid for by the insurance company or HSA funds, you’d only be eligible to itemize $2,500 of those medical expenses because that’s the amount you spent above 7.5% of your income.
Additionally, the IRS only allows you to itemize medical expenses that you have paid for during the tax year rather than unpaid bills yet to be collected.
Still, if you had sizeable medical bills this year and/or you were unemployed and paying for health insurance out of pocket, itemizing these expenses are worth checking into.
Some commonly missed unreimbursed medical expenses include:
- Premiums paid for Medicare Parts B & D, COBRA, non-subsidized ACA marketplace plans, private dental insurance, and Medigap coverage.
- Travel-related expenses to the hospital, including: Personal-car miles driven for care, taxi/bus/ambulance expenses, hospital parking fees, tolls to medical care, airfare and lodging expenses (up to $50 per night) for those needing to travel to a distant medical center.
- Disability-related equipment including wheelchairs, ramps, supporting handrails and other modifications made to your car or home for a disability.
- Caregiver’s medical services and even their meals that you paid for
- Certain weight loss program expenses, acupuncturists, mental health services and chiropractors
- Long-term care premiums up to a certain amount determined by age
- Any unreimbursed care you paid for out of pocket for a spouse or dependent on your tax return
Tip: If you have trouble tracking your prescription expenses or in-office expenses, try asking your pharmacy and medical centers directly for a printout of all the expenses you incurred during the tax year.
Itemized Deduction Category #4: Donations to Charity
The IRS allows you to deduct contributions or gifts made to charitable, religious, educational, scientific, anti-cruelty, or literary organizations. Most qualifying organizations will send you verification of their charitable status and oftentimes a receipt of your donation totals for the tax year. You can also use the IRS’ Tax-Exempt Organization Search tool to check an organization’s status.
Tip for future tax years: While many people donate a regular amount each year, an even better way to give since the 2018 tax law passed is to combine your donations together in a year you choose to itemize. For example, instead of giving $5,000 each year for the next five years to your favorite charity, considering giving $25,000 in a single year you choose to itemize in instead, so a larger portion of your donation counts in the itemization calculation.
Bonus Tip: if you have appreciated stocks in a taxable account, you can give those securities to a Donor Advised Fund (DAF) to get a full deduction* today and not have to choose a charity until later.
FMP advisor John Hixson, CFP® writes about these charitable donation strategies and one more that seniors don’t need to itemize to take advantage of in 3 Ways the 2018 Tax Law Can (and Will) Affect Your Charitable Giving.
*Note: This charitable deduction is limited to 30% of AGI for long-term appreciated securities and limited to 60% of AGI for short-term appreciated securities or cash. Donations exceeding those limits can be carried forward for up to five tax years.
The Bottom Line
It’s important to look at the big picture and try and plan for taxes this year as well as several years into the future. The key is to concentrate your efforts on individual tax years to fully take advantage of itemized deductions in some years, while claiming the standard deduction in others. But keep in mind everyone’s financial situation is different.
Before following any ideas on this list, consult with a tax professional and learn more about itemized deductions on the IRS’ Instructions for Schedule A. While many of you will choose to prepare your own federal income taxes, it may be wise to work with an experienced tax professional and/or your financial advisor to potentially use itemized deductions and maximize your tax savings.
For More Ways to Save Money on Taxes:
- Tax Planning for the Self Employed
- 3 Ways the 2018 Tax Law Can (and Will) Affect Your Charitable Giving
- Our Notes on the Tax Cuts and Jobs Act of 2017
*The information presented here is not specific to any individual’s personal circumstances. FMP Wealth Advisers is not providing investment, tax, legal, or retirement advice or recommendations in this article.
**To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
***These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Outside sources for more information:
When Can I Deduct Health Insurance on my Taxes? (Forbes)
Standard Versus Itemized Deductions: Which is Better? (Turbotax)
1040 Schedule A Instructions (IRS)