Remember the old days when you could gain a tax benefit for paying your property taxes in December, generously donate to qualified charities and deduct your mortgage interest? Those deductions from the good old days are still available, but you must have a significantly greater amount of them to itemize and gain a benefit on your personal income tax return.
The standard deduction for married filing joint taxpayers for 2021 is $24,800 and $25,900 for 2022. For most families, the standard deduction threshold is far higher than they would normally have claimed as itemized deductions. One of the purposes for such a level of standard deductions is to simplify the tax filing for millions of Americans.
Within the itemized deductions additional limits exist. For example, to claim a deduction for your healthcare expenses for 2021, you are required to consider a “floor” of 7.5% or 10%, depending on your adjusted gross income. To create a deduction, consider maximizing your medical expenses by combining qualifying expenses in one year. Another, and more effective method, is to take advantage of any medical employer benefits offered to you.
Some companies offer their employees a “cafeteria” plan or IRC §125 plan that allows for pre-tax contributions to an account that the employee controls and utilizes for co-pays, deductibles, etc. By contributing to this plan in a pre-tax manner, you have avoided the limits caused by the “floor” mentioned above. This means you gain full benefit from the first dollar spent on your qualified medical care.
Income, property and other taxes are allowed as itemized deductions for individuals. The best method of taking advantage of these expenses is to maximize the deductibility of your income tax withholding. For example, let’s assume you are self-employed and the company you own is a partnership, limited liability company taxed as a partnership or an S corporation. These entities distribute the profits to the partners, members or shareholders for taxation at the individual level. Known as conduit returns, all income, losses, gains, credits, etc. will be reported by the owners on their individual returns and taxed for federal and state purposes.
However, some states have enacted legislation that allows the entity to pay the tax on behalf of the owners. By paying the state income tax at the entity level, the owners will receive full benefit of the taxes paid without concern for the $10,000 limitation otherwise required to compute their itemized deductions. Depending on the taxpayer’s income, these savings could be sizeable.
Charitable contributions are another important itemized deduction. Many people do not think about non-cash charitable deductions when preparing their returns. For example, let’s assume you donate your old living room furniture to a qualified charity in 2021. The value of the furniture, determined by IRS-approved methods, would be a deduction on your 2021 return. Proper receipts and other procedures must be followed to deduct the non-cash donation.
You can claim a greater amount of itemized deductions by reducing your adjusted gross income. One of the easiest methods of reducing your income is to contribute to your employer-provided retirement plan. Consequently, this is a great way to increase your future savings since most employers match the contributions you defer from your paycheck.
Another method of lowering your adjusted gross income is to contribute to a Health Savings Account (HSA) if your health insurance qualifies. This is another form of “have your cake and eat it, too!” By contributing to your HSA, unlike the previously mentioned cafeteria plan, you may accumulate the account for many years and utilize for other medical payments after retirement. For example, if a doctor orders rehabilitative therapy in a nursing facility, the funds in your HSA may be utilized to pay these out-of-pocket medical expenses.
The simple act of itemizing your deductions for personal income tax preparation has become more difficult but not impossible. With a little planning and thought throughout the tax year, you may save your family significant federal and state income taxes. This area of tax law is complex. Seek out the assistance of a Certified Financial PlannerTM professional to help guide you through the maze of tax laws to gain the most benefit for your family.
It is truly an honor to share with you each week. This Holiday Season, consider the true wealth you possess in your life – family, friends and faith.