Itemizing deductions can save money
By Sandra Block
USA Today
Americans have always griped about taxes. Yet every year, thousands give the IRS a little something extra when they file their tax returns.
The overpayments add up to nearly $1 billion a year, according to the General Accounting Office, the investigative arm of Congress. The problem: Taxpayers who could reduce their taxes by itemizing take the standard deduction instead.
Itemizing on your taxes requires more work. You need to keep good records and fill out a longer form. Taxpayers with just a few deductions may need to calculate their taxes twice, using the standard deduction and then itemizing, to figure out which is the better deal.
Still, the extra effort is worth it. The average overpayment for nonitemizers analyzed by the GAO was $438. For about 25 percent of tax returns analyzed, the overpayment topped $500.
A look at the most common deductions, and who qualifies:
• Mortgage interest. Most homeowners benefit from itemizing because interest on a home mortgage is deductible. The deduction is particularly valuable during the early years of your mortgage, when interest accounts for a big chunk of monthly payments, says Julian Block, a New York tax attorney and author of "Year-Round Tax Savings."
"Interest on a mortgage for a second home — such as a vacation retreat — is deductible as long as the combined balance of all your home loans doesn't exceed $1 million," says Randi Schuster, tax partner at BDO Seidman. You can also deduct interest on home equity loans of up to $100,000.
Your lender should send you a Form 1098 showing how much you paid in mortgage interest during the year. The lender will also send a copy to the IRS.
If you bought a home in 2002, you may qualify for additional deductions. Points, or the fees associated with getting a home mortgage, are deductible on a mortgage to buy your principal residence, says Jim Seidel, senior tax analyst for RIA, a provider of tax information and software.
You don't get an immediate deduction on points paid to buy a second home or to refinance, Seidel says. The cost of those points must be spread out over the life of the loan. However, if you refinanced a home for the second time last year to take advantage of falling interest rates, you can deduct the balance of points remaining on your old loan.
• Taxes. State, local and property taxes are deductible. If you rent and live in a state with no income taxes, you may be better off taking the standard deduction. But if you're a homeowner who already itemizes, don't overlook these deductions.
If you live in a high-tax state, itemizing may pay off even if you don't own a home. Block recalls preparing taxes for a single nurse who lived in New York City and earned a high salary. Her previous tax preparer had always taken the standard deduction, he says. "What she was paying in state and city taxes alone was greater than her standard deduction," he says.
• Charitable contributions. Unless you're extremely generous, your charitable contributions alone won't exceed your standard deduction. But if you're already itemizing, make sure you include your charitable gifts. For individual contributions of $250 or more, you need a receipt and written explanation from the charitable organization. You don't need to send the letter to the IRS, but you should keep it on hand in case you're audited.
• Medical and dental expenses. Medical and dental costs must exceed 7.5 percent of your adjusted gross income, or AGI, to qualify for a deduction. That hurdle prevents most itemizers from deducting their healthcare costs.
However, if your income plummeted last year, or someone in your family was seriously ill, you may be able to overcome the bar.
For example, if you lost your job and had to buy your own health insurance, the premiums are deductible medical expenses, says Donna LeValley, contributing editor for "J.K. Lasser's Your Income Tax". Given the rise in health insurance, those costs alone may top 7.5 percent of your AGI.
• Casualty and loss. You can deduct personal property losses caused by storms, fires or natural disasters, or theft. But your unreimbursed losses must exceed 10 percent of your AGI before you can take the deduction.
The event must be "sudden, unexpected or unusual in nature," Block says. You can deduct damage from a tornado, but not from termites, because the IRS assumes the bugs have been feasting on your house for a few years.
• Miscellaneous deductions. Deductions in this category must exceed 2 percent of your AGI before you can take them. These include job-hunting expenses, union dues, tax preparation fees and unreimbursed business travel costs.
