This is the second post in my “Taxes for Your Family” series.
Back when you were a young and fancy-free, your taxes were simple as pie. You probably rented a place to live (or these days, lived with your parents), had no kids, and didn’t make that much money anyway. Maybe you could figure out how to file online for free on April 14th and even get a refund. You took what is called the Standard Deduction.
The standard deduction is a fixed amount that reduces your taxable income. This is the income you get to completely keep before the remainder of your income is taxed.
Your age and filing status, along with several other factors, determines your standard deduction amount. Here are the basic standard deduction amounts for 2012:
If your filing status is… Your standard deduction is:
- Single or Married filing separately $5,950
- Married filing jointly or Qualifying widow(er) with dependent child $11,900
- Head of household $8,700
Source: IRS Pub 501
Your standard deduction is increased if you are over age 65 or blind, and may be decreased if someone else can claim you (or your spouse if filing jointly) as a dependent.
Life tends to grow more complicated over time. Your tax situation becomes more complex as you earn more money, buy property, or start a business. In such cases, your tax deductions may be greater than the standard deduction noted above. This is where it typically makes sense to itemize.
Common federal tax deductions include:
- Mortgage interest
- State & Local taxes
- Property tax
- Charitable contributions
There are many more, but those tend to be the “biggies”. Mortgage interest on a big mortgage or state taxes on a high income can easily be greater than the standard deduction.
If your total deductions are greater than the standard deduction, you should most likely itemize. Your taxable income is reduced by each dollar that exceeds the standard deduction. Lower taxable income means lower taxes.
Joe and Sue are married and file their taxes jointly. They own their home and paid $11,000 in mortgage interest last year. (This information comes from the 1099-INT form received from their mortgage provider). That’s not enough to put them over the top, but they also paid $5,000 in state taxes. Since the standard deduction is $11,900, itemizing their deductions reduce their taxable income by another $4,100.*
It can get more complicated, but that’s the basic concept.
How Does this Fit into Your Financial Plan?
If you are “on the border” between itemizing (or not), it may make sense to do some tax planning.
In some cases, you can choose the calendar year in which you take a deduction. This is obviously the case for charitable contributions, but other possibilities may be things like paying your January property tax bill in December if you want to accelerate the deduction. Consult your tax advisor.
Please note, changes in tax laws may occur at any time and could have substantial impact upon each person’s situation. You should discuss tax or legal matters with the appropriate professional.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.
*This example is for illustrative purposes only. Every investor’s situation is unique and you should contact a qualified professional regarding your particular situation before making any investment or withdrawal decision.