With all the fiscal cliff talk bouncing around the media these days, there’s been a LOT of talk about the future of federal income taxes. One piece of the discussion that I find interesting is that there is a big assumption that if you’re making over $50K/year, you must be itemizing your taxes. And that just baffles me.
The PoPs are the perfect example of why that is just not true even though we might “look” like we’d be perfect candidates for itemizing (relatively high income, own our own home, have a mortgage, etc…).
Tax Basics Review
For your US federal income taxes, deductions are taken off a person’s taxable income, so they are basically income that is earned income tax-free. Each person is either allowed to take a standard deduction (in 2011 it was $5,800), or deduct based on their itemized spending in specified categories according to federal limits. Since the PoPs are married, our combined standard deduction is $11,600 for two people (Kitty PoP gets no deduction).
In order to benefit from itemizing, we’d have to come up with more than $11,600 in itemized expenses to deduct. Let’s see how close the PoPs can get…
IRS Itemized Deductions
For all of the IRS info here, I’m working from this page on the IRS website. For this exercise, we’re going to assume the PoP AGI (adjusted gross income) is $130K – which is a pretty fair assumption.
Medical And Dental Expenses – are only deductible for the portion which they exceed 7.5% of your AGI. For us, that would be $9.75K. Our medical expenses cost around $600-$800 most years, so we’re nowhere near being able to deduct anything here. PoP Deduction: $0
Deductible Taxes – are taxes you already paid to someone else. They are deductible if they fit into one of the following five categories:
- State, local and foreign income taxes – we have no state or local income tax
- State, local and foreign real estate taxes – our RE taxes are $1,846 for our home
- State, and local personal property taxes – we pay ~$130 in taxes to keep our cars registered each year, though I’m not 100% sure those count as taxes and not registration fees
- State and local sales taxes - our sales tax rate is 6%, and the IRS approved Sales Tax Deduction Calculator allots us $1,192 in approved sales tax deductions. That would translate to us buying about $20K in taxable merchandise each year, which I think is *probably* high when you exclude spending on the duplex. Gas taxes cannot be deducted here.
- Qualified motor vehicle taxes - This seems like a weird rabbit hole that has to do with buying an alternative fuel car during a certain window of time. It doesn’t apply to us.
PoP Max Deduction $3,168
Home Mortgage Points – are prepaid interest that come into play when you first begin (or refinance) a home mortgage. We didn’t refi in 2012 (and our refi in 2011 had no points). PoP Deduction: $0
Interest Expense – is limited to interest on your qualified residential loan or student loans. Our only deductible interest expense is the interest on our primary mortgage. Although I could use the cumint formula in Excel, a quick back of the envelope calculation will give us an over estimate of what we paid in home mortgage interest this year. Our rate is 3.25%, and we refi’d at the end of 2011 into a new loan with a principal of $111,000. So 3.25%*111K = $3607.50 is an over-estimate of what we’ll pay in interest this year. PoP Max Deduction: $3,607.50
Charitable Contributions – are limited to qualified organizations (such as 501c3′s) and the donation of my hair is not deductible. So as of right now, I think we’ve only got receipts for 501c3 donations for the year totally about $300 in donations. PoP Deduction: $300
Miscellaneous Expenses* – are only deductible inasmuch as your unreimbursed employee expenses and tax preparation fees exceed 2% of our AGI. We definitely didn’t have over $2,600 in miscellaneous expenses. PoP Deduction: $0
Business Use of Home & Car* – any part of your home that you use for work and play is non-deductible. Our work commutes are non-deductible, and employers pay us for mileage for any travel that we need to use our own car for. Since they are reimbursed, they are non-deductible. This is also subject to the 2% AGI limit. PoP Deduction: $0
Business Travel and Entertainment* – all of our business travel is reimbursed, as has been all of our business entertainment expenses to date, would be subject to the 2% AGI limit. PoP Deduction: $0
Educational Expenses* – are subject to the 2% AGI limit, but we don’t have any anyhow. PoP Deduction: $0
Employee Business Expenses* – commuting is not a qualified business expense, but gifts to business associates are, up to $25 per person. However, they are subject to the 2% of AGI limit, so there’s no way Mr. PoP would be gifting more than 100 clients gifts of $25 each. PoP Deduction: $0
Casualty, Disaster, and Theft Losses – are only deductible in the year the loss occurs and must be offset by any insurance reimbursements. We have had no losses like this (thank goodness since we’re self-insured on part of the house!), so we have nothing to deduct. PoP Deduction: $0
Maximum PoP Itemized Deductions: $7,075.50
Now, it’s possible to inch this up a little higher through some careful manipulation by pre-paying deductible expenses (like our property taxes). Since we can pay our property tax bill anytime between November and March each year, it would be totally feasible to pay property taxes for this year in January 2013, and the bill for next year in December 2013. Since they are both in the same calendar year, you can deduct them both in that year.
But, even if we double up on property taxes, that only adds another $1,846, bringing our tally to $8,921.50, still well under the $11,600 standard deduction that we get.
It’s also worth noting that we’re not expecting these deductible expenses to increase dramatically anytime soon. Increases in property taxes will likely be offset with decreases in the interest we’re paying on our mortgage as we pay down the principal.
So with our current situation, we don’t see a time where itemizing makes a lick of sense for the PoPs.
What about you? Do you itemize your taxes? If so, where do the bulk of your deductions come from? Did you make spending decisions based on your ability to itemize deductions? What’s your game plan if itemized limits change in the fiscal cliff negotiations?