The general concept
Every year when you file your taxes, the government allows you to deduct some things prior to calculating your tax liability. This is done on schedule A, which lists “itemized deductions.” So we basically add up all of your taxable income (W2’s, investment income, etc.), then subtract your deductions to get to your taxable income. Taxable income is then plugged into tax tables and out comes your tax liability. So the lower your taxable income is, the lower your tax liability will be, which is what motivates people to gather as many itemized deductions as possible each year around tax time. It is also the reason I often end up with a giant shoebox of medical receipts on my desk during tax time (which I love, in case you were wondering).
By the way – I’d like to make it clear that I don’t have some magic way of adding these up when you give them to me. I still have to unfold the receipt, find the stupid faded number at the bottom, and type it into a spreadsheet. And you are WAY overpaying me to do this for you. In the future, make your kids do it. That’s why you had them!
An important thing to note is that not everyone takes itemized deductions. In fact, MOST people don’t at this point. Every year, you either take itemized deductions or you take the standard deduction. The standard deduction is just a number that the IRS adjusts for inflation each year, and everyone gets to deduct AT LEAST that much from their income on their tax return. You basically take whichever deduction is higher. For 2023, the standard deduction is $13,850 for single filers, $27,700 for married filers, and $20,800 for heads of households. These numbers are MUCH higher than they used to be under pre-Trump tax laws. After adding up all of your itemized deductions, you compare the number on the bottom of schedule A to the standard deduction and simply go with the higher number.
Itemized deductions include medical expenses, taxes paid, interest paid on real estate, and charitable donations. We’re going to dive into all of these further over the next few weeks, so stay tuned for that. Or don’t. It really doesn’t matter.
Many people assume that because they are taking the standard deduction, they are worse off than they were under previous tax laws. The phrase I always hear is, “I can’t write anything off anymore.” While it may be true that you are not technically “writing off” your itemized deductions anymore, the reason is usually just because they are now giving you a much higher deduction for free. This higher deduction, in general, saves people more money in taxes than being able to take itemized deductions under previous tax laws did. I certainly understand the frustration that most people have when I explain this to them though. They used to get a big tax benefit for having a home, paying a mortgage, and giving to charity. Now, there is little motivation for most people to do these things from an income-tax perspective.
Over the next few weeks, I’ll do a dive into each of the itemized deductions and how the calculations work. It will be a truly riveting experience for all of us. Then come tax time, you can decide whether or not it’s worth digging up your medical expenses or charitable contributions for the year.