Why We Can’t Itemize Taxes

Kitty PoP was getting a little cuddly while I was typing this post. Apparently he loves talking about taxes. =)

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 taxesour 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?

 

55 comments to Why We Can’t Itemize Taxes

  • We have been since we bought a house, but next year I think we won’t be paying enough mortgage interest anymore.

    http://nicoleandmaggie.wordpress.com/2012/12/03/december-mortgage-update-a-thought-about-mortgages-and-itemization/
    nicoleandmaggie recently posted..Answering questions posed by Christmas carolsMy Profile

  • I nailed it! As I started reading I predicted you couldn’t itemize mainly because your mortgage was probably too small.

    Sherlock Holmes here…I thought you were a responsible individual with a small mortgage and I was correct! Gold star to me. Ah…nap time.
    AverageJoe recently posted..Year End Business Tax Planning – Stop Uncle Sam From Eating Your LunchMy Profile

    • Nap time? It’s 8:26 in the morning! =)

      FWIW, even if our mortgage was double the size we’d barely be hitting the standard deduction level in year 1, and as the mortgage gets paid off, that interest is only going to decrease as we’re on a 15-year note.

  • Jacob

    Is your rental property under a separate tax entity? If not, what about depreciation on the rental, as well as any business expenses incurred related to the rental (repairs, maintenance, as well as cost of marketing the units &c.)?

    • Those are all expenses that we can count against the passive income that the rental property brings in. They are counted outside of the standard deduction, so we get to take them whether or not we use the standard deduction or itemize our personal expenses.

  • We itemize taxes, and have for several years. Last year, we itemized about 30k in deductions. VA has state income tax (about $7000/yr), we have a big mortgage ($18,000/yr), and high property taxes ($5000/yr). This year I donated a car and half of my guest room (decluttering) to Goodwill, and ItsDeductible estimates I can deduct ~$5000 extra this year. We also have a kid, which nets us a nice deduction on daycare (which I believe you can take whether you itemize or not…)

    Even once we pay the mortgage off (which is still 10yrs down the road, we will probably still be able to itemize and do better than the standard deduction)
    Mom @ Three is Plenty recently posted..Selling used stuffMy Profile

  • We do itemize our taxes but barely. In a few years, we won’t be able to anymore.
    Holly@ClubThrifty recently posted..The VIP Club Roundup – 14th EditionMy Profile

  • Brian

    Since we own our house free and clear we don’t itemize. I guess it is a good problem to have.

    • I think being forced to take the standard deduction isn’t a bad problem at all. In general, it’s a sign that your spending is pretty low, which is definitely a good thing in our book.

  • We do itemize. It’s a combination of our mortgage, charitable giving and business expense. We’ve had quite a bit of the last this year so it’ll definitely work out to itemizing. In regards to year end & the Cliff we’re trying to bring as much income forward to 2012 and putting off the expenses to next year.
    John S @ Frugal Rules recently posted..Frugal Friday: Posts That Ruled This Week, the Clark W. Griswold EditionMy Profile

    • The business expense is definitely something that we don’t get to take advantage of because our employers are pretty good about reimbursing business expenses for both of us. Glad you guys take it if you are due!

  • Jonathan

    The accountant’s son in me requires me to point out that you’re discussing itemizing DEDUCTIONS, not taxes.

    My wife and I have itemized our deductions every year we’ve been married. Living in California we have very high state income and sales taxes, but if I’m reading my Schedule A correctly you can only deduct one or the other but not both. So we got about $6,500 deducted for state income tax. Beyond that we had over $30k in charitable giving to deduct, so overall the deductions save us close to $10,000 a year. However, it is worth noting that the first $11,600 would be deducted regardless as the standard deduction, so our itemization only saves us an additional $7,000.

    • Touché. You are right, that we are counting deductions not taxes. I hope you forgive my use of the terms fairly interchangeably. =) I think you’re right on the income tax or sales tax that only one is allowed – though the IRS’s website could afford to be a bit clearer in reminding readers of that point.
      That’s a boat-load of charitable giving to deduct. I’m sure the charities that you support are very appreciative of your contributions.
      From another perspective, would you continue to donate that much if the charitable donation tax deduction were taken away? (It’s another argument that gets thrown around that I’m always curious about.)

      • Jonathan

        Well, we give primarily to one particular charity which we also sit on the board of. We are very supportive of its missions and know firsthand how and where the money is spent and how it helps people. When it comes to their missions, we find it easy to justify the financial “cost.” However, I suspect that if suddenly those dollars were no longer only costing us 75 cents each (actually probably 65 cents when we consider state tax too) then we would not be able to give as much. We save a large percentage of our income (around 50% of net) for investing, so if giving suddenly became more expensive then we’d probably have to balance that with investing a little.

        On the whole, I guarantee that charitable giving would be hit hard if the deduction went away. Big donors who can give tens or hundreds of thousands of dollars at a time only pay 50 cents on the dollar (if they live in California anyway) for charitable giving – it is easy to see that they would not have as big of a pot to pull from if their dollar only went half as far.

        • Sitting on the board would definitely give a new perspective when it comes time to donate because you know precisely how effectively those funds are being spent.

          Thanks for the perspective on the tax deduction for your giving. I guess the closest thing I can compare it to is when different charities have matching funds grants. I know that’s always been a motivation for me to donate more than I might otherwise since it feels like your dollar is stretching further.

  • PK

    I think this covers it: “State, local and foreign income taxes – we have no state or local income tax”, heh. In California, a lot of people get a ‘head start’ on itemizing due to the onerous income tax (going up next year). There is no relief for capital gains either – so every mortgage, charity, and property tax dollar gets deducted for people in that bucket!
    PK recently posted..Is Social Security a Good Investment?My Profile

    • Yup. While Florida taxes weren’t at the top of our minds when we were choosing where to live, they have certainly worked out well with the lifestyle that we’re choosing since Florida taxes are consumption based not income based.

  • We don’t itemize. There was only one year when I was single that itemizing made sense, and just barely. Our main deduction, if we itemized, would be charitable giving. We don’t have a mortgage, major medical bills, a business, or anything like that. I’m so grateful for the standard deduction! If I was resolving the fiscal cliff I would take that away and make everyone itemize every year (oh, and take away a lot of those, too) but I haven’t heard that the standard deduction is on the table.
    Emily @ evolvingPF recently posted..Blog Statistics Update November – December 2012My Profile

  • I don’t itemize, because I am renting an apartment and I don’t come close to the standard deduction.
    Thanks for posting this detailed analysis. I’ve always had a suspicion that the mortgage interest deduction isn’t as great as most people seem to think it is. Even if your mortgage was twice it’s current size, you still wouldn’t itemize, right?
    Ross recently posted..Give assets, not liabilities this XmasMy Profile

    • You’re right, doubling our mortgage would barely get us to hit the standard deduction in year 1, and would probably be less than the standard deduction in later years. Realtors and mortgage brokers will try and sell you more house based on this *giant* tax deduction, but you’ve got to remember – in order to get the deduction, you still have to spend way more than you’re getting back as a deduction. Kindof a bad motivation to get a tax deduction in my book.

  • Can I ask where you live that you have no state or local taxes? (Sorry if it is on your blog, a quick look didn’t net the info) When you filed your state tax return last year, you had $0 tax liability? You have no state and/or local taxes deducted from the paychecks your employer writes to you?

    Do you have a home office where you do any work for your job when not at work? If so, Form 2106, Unreimbursed Employee Business Expenses would allow a percentage to be taken as a deduction of your mortgage interest, property taxes, any repairs done to the home during the year, all utility bills, cable bill, trash, homeowners insurance, HOA fees, security alarms, etc. This percentage is in direct correlation to the space allotted to the home office – if there is one.

    And I’d like to comment to Ross: Ross, a home mortgage deduction does quite a lot for people – many people pay a much lower rate of income tax due to that deduction. It’s a great thing :-)
    Wendy recently posted..Give Your Money Away – Tax Free!My Profile

    • Sure, Wendy… in our post on our RE taxes http://www.plantingourpennies.com/2012/11/16/local-tax-time-property-taxes/
      we pointed out that we live in Florida, which happens to be one of 7 states that have no state income taxes. So when you’re asking about state and local income tax returns, they don’t exist for us. There are no forms that we have to submit every year except the federal tax return – and all of our W2′s have $0 for the state and local tax boxes. Check out the prop tax post for more details.

      As for expenses for a home office, the IRS states “you cannot deduct business expenses for any part of your home that you use for both personal and business purposes”. While we work from home occasionally, there is no portion of our home that is exclusively for business purposes, so I do not believe we’d be able to have any deduction here following the letter of the law. Even if we could devote 10% of our home strictly to business purposes (110sqft – which is actually smaller than my office at work), then, the deductible portion would still have to be over the 2% AGI limit… I just really don’t see that happening.

      With charitable deductions, there are also many charitable groups that we donate to that aren’t 501c3 organizations or the IRS does not allow our in-kind donations to be deducted even if they are – like my recent donation of over $1000 worth of hair to the 501c3 Locks of Love. http://www.plantingourpennies.com/2012/11/07/irs-double-standard-how-much-is-hair-worth/

      We hired an accountant to do our taxes for the first time ever last year to make sure we weren’t missing anything, especially associated with the duplex, and he came to the same conclusion that we did. We’re not missing anything, we just flat out don’t spend enough to qualify for more tax deductions by itemizing. (Although he was the one that told me we could double up our property tax bills in one year *if* it would benefit us. But since it doesn’t, it’s moot.)

  • Oh, and I meant to add – Charitable Contributions are not just cash contributions made to a qualifying charity. Any hard goods you donate to Goodwill, Disabled American Veterans, Little Sister’s of the Poor, etc., etc., also count as Charitable Contributions. Take the deduction for those as a “thrift store price” – meaning what you could get out of the item selling it at a garage sale.

    Many states have “extended” charitable contributions when it comes to donations made to domestic abuse or women’s shelters. In my state, a donation to Hope House (women and children shelter) will get me a Federal Charitable Contribution, which passes through to my State return – but in addition, the State allows ANOTHER charitable deduction for that SAME contribution, over and above what is claimed on my Federal return.
    Wendy recently posted..Give Your Money Away – Tax Free!My Profile

  • This was really informative. My aunt does our taxes and I would get mad at her every year because I couldn’t do itemized deductions It wasn’t until I realized that we get more back with a standard deduction that I finally got it. We will probably keep doing standard deduction and totally buy a house because property taxes in Southern California are really high.

  • Nice breakdown. I was planning on itemizing for the first time this year due to it being my first year with a mortgage. Like you I worked out some quick calculations to see what my deduction would be and even with my mortgage interest I don’t think I’ll break $5800 because I don’t have many other qualifying deductions. Maybe once I actually do my taxes I’ll be surprised, but it’s looking like a standard deduction for me.
    The First Million is the Hardest recently posted..2013 Maximum Contribution Increasing For 401(k) and IRAMy Profile

    • Did your mortgage broker or realtor talk up all the tax savings buying a house was going to net you? It seems to be one of their big sales pitches!

    • Did you have any closing costs for that mortage loan? What about pro-rated property tax? All deductible.
      Wendy recently posted..Give Your Money Away – Tax Free!My Profile

      • Maybe I’m misunderstanding you, but I’m not sure that’s 100% true. http://www.irs.gov/publications/p530/ar02.html This IRS document suggest that points (which are prepaid interest) and taxes are deductible, but other settlement (closing) costs are worked into the cost basis of the sale, and don’t come into play until you sell the property and capital gains are being determined. I would recommend that anyone who is not 100% comfortable with their interpretation of what is or isn’t deductible talk to a professional.

        • My apologies – as a member of the accounting profession and a professional tax preparer for the last 25 years, when those of us working on tax filings talk to each other about things like this we say “closing costs”, meaning an array of things associated with the sale and not just one thing. I should have used different verbiage :-) :-)

          Any new home buyer, anyone refinancing, or anyone buying a 2nd or 3rd home, or a vacation home, should always – always – give their tax preparer the complete package of papers signed at closing. The preparer will go through the list of line items and determine what is deductible and what is not.

          As an aside, depending on what is claimed as tax deductions on Sch A in a home purchase, and depending on how soon that home is then re-sold, those deductions may have to be recouped in a later filing year. In other words, you have to give the deductions “back” in certain cases.
          Wendy recently posted..Give Your Money Away – Tax Free!My Profile

          • haha, no apologies needed! I blame the IRS for all tax confusion. I’m of the theory that we shouldn’t need degrees and certifications to understand how to calculate our tax bills each year. And yet, here we are!

            I wish I could find the article, but I think it was WSJ that did a side-by-side comparison of various softwares and tax prep chains using the same person’s return and none of them ended up with the same amount of tax owed. Which I thought was insane.

            Anyhow, thanks for all your input and comments! They are greatly appreciated =)

      • @Mrs. Pop – No, my mortgage broker/Realtor didn’t talk up the savings at all. It didn’t factor in to my decision to buy, but I figured it would be a nice added bonus come tax time.

        @Wendy – I closed in Dec. 2011 so closing costs wouldn’t apply.

        I’ll just have to see how it all works out when it actually comes time to do my taxes, but my rough guess is that I won’t have the deductions
        The First Million is the Hardest recently posted..2013 Maximum Contribution Increasing For 401(k) and IRAMy Profile

  • We have itemized mainly due to my business. Last year our itemized deductions were just over $18K and in 2010, it was $23K. I’m sure when I sell the business, we won’t be able to itemize. I didn’t realize that Florida didn’t have state income tax until talking to one of the public health service doctors I work with. He lived there for a short time but still claims it as his primary residence. PHS is like being in the military and you are able to do that. I think the only better state is Alaska, where there is no state tax AND you get a pretty large annual stipend for living there. If is just wasn’t so cold!
    Kim@Eyesonthedollar recently posted..My Best Financial Tip: Stop Being AfraidMy Profile

  • I’m able to itemize every other year by paying my property taxes early. It adds just enough to put me over the limit. The next year I take the standard deduction.
    JP @ 20′s Finances recently posted..Do Americans Spend More Money on Christmas Gifts?My Profile

    • That’s what our accountant thought we might be able to take advantage of, but even with two years worth of property taxes, we’re still not close to getting over the standard deduction for two people.

  • I’m wondering if my recent refinance will drop me under the standard deduction next year… It’s been close, and I might now be under. I’d rather have a small tax burden and tiny mortgage than be able to deduct more on my taxes!
    kudy recently posted..Move Closer to Work? Commute Cost Savings & Rental Income PotentialMy Profile

  • [...] PoP from Planting Our Pennies presents Why We Can’t Itemize Taxes, and says, “There seem to be big assumptions out there in all of the pending fiscal cliff [...]

  • Our property tax is over the standard deduction. So everything above that is a real write-off.
    I don’t have the mortgage for the deduction any more than I donate to the local shelter for homeless vets for the deduction.
    But – the numbers matter. I make $100 in interest, and after federal tax, clear $72. I pay say $10,000 in mortgage interest, but it’s $7,200 after tax. Now, a $10,000 gain is going to net me $8,500. My 3.5% mortgage is like a 2.5% mortgage with no deduction. It’s still debt, just put in perspective.

    By the way – you are right that bunching deductions won’t really help you. But those who are closer to the standard deduction, say just at $11,000, may be able to ‘bunch’ their property tax, an extra mortgage payment, and all charity to swing between $16K and $6K every other year. The $4K above the standard deduction will be $1000 back in their pocket if they are in the 25% bracket. A bit of effort, but worth $1000, in my opinion.
    JoeTaxpayer recently posted..A 2013 Fiscal Cliff Round UpMy Profile

    • Wow, those are some serious property taxes, especially if you’re married.

      I definitely agree that “bunching” can help people who are more borderline take advantage of itemizing evert other year. My only question is – I thought extra mortgage payments were typically applied directly to the principal, so wouldn’t add any additional interest deductions. At least that’s our lender’s default. I’ve never explored other payment options in much depth.

      For you – If you are under the standard deduction when you exclude your property taxes, do you take advantage of pre-paying there? If that made you swing between 6K and 30K instead of two years at 18K in deductions… Just a thought.

  • [...] PoP from Planting Our Pennies presents Why We Can’t Itemize Taxes, and says, “There seem to be big assumptions out there in all of the pending fiscal cliff [...]

  • [...] Why We Don’t Itemize Our Taxes – Itemizing isn’t always the way to go. Sometimes taking the standard deduction is the best option on your tax return. [...]

  • Julie

    I must be in tax hell because my property taxes on my $160k suburban home are $4,000 a year, my car taxes are $400 a year and my sales tax rate is 7.5%. State income tax also applies. Oh, and the restaurant tax from 2011 is not only on the food but the sales tax on the food (so it’s not an offical tax because you can’t tax on a tax but a ‘fee’).

    I need to move.

  • [...] It’s above-the-line tax deductible when we deposit the money (great because we can’t itemize our tax deductions), and exempt from taxes when we take it out later as long as the money is spent on qualified health [...]

  • [...] get the full benefit of your tax deduction from mortgage interest despite the fact that many people cannot itemize tax deductions .  (The PoPs included.)  If you get the spreadsheet you can toggle this [...]

  • This is exactly why I think the mortgage deduction is so overrated, especially with rates so lot. Even if you can itemize, you’re probably not saving that much money because of the standard deduction. It seems that a lot of people aren’t aware of this.

    I also argue with people all of the time about what the deduction means. If you can deduct $20,000, a lot of people think you’re literally saving 20K. Not true. You’re just saving the money you’d pay in income taxes on the 20K.
    Mr. 1500 recently posted..Every Little Bit HelpsMy Profile

Leave a Reply

  

  

  

You can use these HTML tags

<a href="" title="" rel=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

CommentLuv badge