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Itemizing vs. Taking The Standard Deduction

By: Investor Solutions

By: Investor Solutions, Inc.

This year, millions of do-it-yourselfers are going to prepare their own tax return for 2003. Are you going to miss out on the advantages of having a tax professional sitting in your corner? Although there’s nothing wrong with preparing your own return, which path you take should depend on your time available, how complicated your financial affairs are, and of course your willingness to sort through IRS forms. Are you keeping all the proper documentation to justify your deductions? Who is going to help you if you get audited? While your odds of being audited are quite slim (approximately only 1% of all returns submitted are examined by the IRS), you still need to carefully prepare your return. The deductions you take or fail to take can end up costly in the long run.

Once you’ve taken the steps to determine your Adjusted Gross Income (AGI), you’ll need to decide if it’s more advantageous for you to take the standard deduction or to itemize your deductions. In 2003 the standard deductions are the following:

Single $4,750

Head of Household $7,000

Married Filing Jointly $9,500

Qualifying Widow(er) $9,500

Married Filing Separately $4,750

**If you are age 65 and older or blind, you will qualify for additional standard deduction of $1,150 (single) or $950 (married).

You should itemize deductions on Schedule A if your deductions exceed the standard deduction for your filing status. Many individuals will find that mortgage interest alone can take them over the standard deduction amount. So, let’s take a look at some of the most common itemized deductions such as charitable contributions, interest expense, local & state taxes, medical & dental costs, casualty & theft losses, and job & investment expenses.

Charitable Contributions – By making charitable contributions, you help your favorite philanthropy and at the same time receive a tax deduction. If the cash contribution is less than $250 your canceled check or receipt from the charity will serve as your proof of a donation. If your donation is $250 or more, you’ll need a written acknowledgement from the charity (receipt) a cancelled check is not sufficient documentation. When gifting property or securities the fair market value is used for determining the value of the donation.

Remember that your public charities (churches, schools, hospitals, American Red Cross, etc…) will be deductible up to 50% of your AGI, whereas; private charities (veteran’s organizations, fraternal societies, and private foundations, basically those not listed in the 50% category), will have a 30% or 20% deduction ceiling, depending on the type of donation.

Interest Expenses – There are three types of deductible interest charges: Home Mortgage Interest, Points, and Investment Interest. Generally, you may deduct the qualifying mortgage interest on up to two residences, however; if your AGI exceeds $139,500 your mortgage interest is subject to the 3% reduction of itemized deductions. Mortgage interest is reported to you on IRS Form 1098. Although interest on consumer loans is not deductible, you can use a home-equity line of credit to pay off existing consumer debts and finance future consumer expenses. Interest on home-equity loans is deductible, up to qualifying home equity debt of $100,000.

Points are generally treated as prepaid interest that must be deducted over the period of the loan. The IRS does not allow a current deduction on points paid to refinance your mortgage; these points must be deducted over the life of the loan. In most cases, points paid to purchase your primary residence will be deductible in the year paid as long as the five-test rule is met.

Interest that you pay on margin accounts and other investment activities is deductible up to the amount of net investment income on Schedule. If you do not have investment income (dividends, income, etc…), you may not deduct investment interest.

State & Local Taxes- Payments for State, Local, Foreign, and Real Property Taxes are deductible. You may also deduct State & Local personal property taxes, however; state and local sales taxes are not deductible.

Medical & Dental Expenses – Medical expenses are deductible if you have expenses that exceed 7.5% of your AGI. Expenses up to the 7.5% of AGI are not deductible (self-employed health insurance premiums are an exception). You may not deduct the cost of over-the-counter drugs, just those prescribed by a physician. Starting in 2003, Stop-Smoking Programs and nicotine withdrawal drugs prescribed by a physician are now fully deductible. If your doctor has recommended a weight-control program to control a specific condition (heart disease, etc), the IRS allows a deduction for the costs incurred for that program as well. The IRS has held a firm position that the cost of cosmetic surgery without a medical purpose will not get you a valid deduction.

Casualty & Theft Losses – The deductibility of an unreimbursed casualty or theft loss depends on the purpose for which you held the asset. For property used for personal purposes, the casualty is subject to the sudden events test and the deduction is reduced by $100 and an additional 10% of your AGI. Because of the 10% floor, many casualty and theft losses are not deductible unless they are quite substantial. One of the most common home damages- termite damage is generally nondeductible since it often results from long periods of infestation. For theft losses, you should get statements from witnesses who saw the theft or police records documenting the break-in or theft.

Job & Investment Expenses (Miscellaneous Expenses) – These expenses are subject to the 2% of AGI floor (they must exceed 2% of your AGI to be deductible). They include such items as overnight business travel, meal & entertainment expenses, special work clothing, professional dues & fees, tax preparation fees, legal expenses, job-hunting costs, vehicle and investment expenses, only to name a few. In 2003 the business mileage rate was decreased to 36 cents per mile (down from 36.5 cents in 2002). Fees that you paid to an investment advisor are generally tax deductible provided that they are paid in cash or from a taxable investment account. Investment fees paid directly from IRA accounts are not treated as a taxable distribution, therefore; they are not tax deductible.

So remember, tax planning is a year-round job in itself. Since your tax bracket may shift from year to year because of fluctuations in your income and expenses, it’s important that you develop a strategy to help reduce your tax. Save all of your receipts and cancelled checks for anything that you may find deductible, then sort them according to the type of expense incurred. It’s your tax refund or tax bill due, so take the extra steps to prepare for your filing. If better preparation can get you an extra $1000 refund or tax savings, you’ll be glad you maximized on all the available opportunities.