Should you itemize deductions?

 

AGI - very important number

Finally, after adding your income from all sources and subtracting the adjustments to your income, you come to your adjusted gross income. This number, frequently called AGI, is an important number and is usually at the bottom of the front side of Form 1040.

Because many deductions are based on your AGI, you want to have an AGI that is as small as possible. Note that you can decrease your AGI by having small business or rental losses, or by contributing money to your 401(k) or IRA account.

Deductions to your income which came before your AGI are sometimes called "above the line" deductions. They're more valuable than deductions you receive after calculating your AGI, especially if you itemize your deductions.

Above the line deductions reduce your AGI. By having a small AGI, you can get more from your itemized deductions because a smaller AGI lowers the floor for many deductions. I'll have more on this later.

Should you itemize?

After you've calculated your adjusted gross income, you're ready to subtract your deductions and exemptions to get your taxable income. Here the big question is whether to itemize or not.

The Tax Reform Act of 1986 made this question a lot easier to answer because it simplified the whole area of deductions. It increased the standard deduction, and reduced the number of itemizable deductions.

75 percent take the standard deduction

Because of this simplification, more people took advantage of the more generous standard deduction. In fact, about 75 percent of tax filers now take the standard deduction. This saves them record-keeping hassles, and probably reduces their chances for audit.

Still, you should do a little analysis to see if you should itemize or not. Here, the biggest factor for most people is home ownership.

Itemize if you own a home (probably)

If you own a home with a mortgage of over maybe $75,000, you're a good candidate to itemize. You also might want to itemize if you had very high medical bills, paid a lot in state and local taxes, donated a lot to charity, or if you suffered a major casualty.

Bunching deductions

If your deductions are only slightly more than the standard deduction, you still might want to itemize, but there's another strategy that might help you. You can take the standard deduction one year, and then shift expenses into the next year and itemize next year.

Let's say you normally give $1,000 each year to the Red Cross. You might be better off giving $2,000 to the Red Cross every other year, and itemize in the year when you give $2,000.

You also can look into bunching your other payments for medical services or state and local taxes to maximize your deductions.

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