The IRS isn’t cruel. It doesn’t want to tax every last cent you earn. In fact, it offers a standard deduction — a gift! — to all taxpayers based on their filing status.
For the 2014 tax year, the standard deduction for a single filer under the age of 65 can automatically deduct $6,200 from their taxable income, and a married couple filing jointly can deduct $12,400 ($6,200 married filing separately).
But, depending on your finances, you may be able to lower your tax burden even further if you itemize deductions.
Written into the tax code are allowances for all kinds of deductible expenses.
When you choose to itemize deductions on your federal income tax return (the famous 1040), you attempt to claim legal deductions that add up to more than the standard deduction, giving you a bigger refund (or a smaller amount to pay).
This requires careful financial recordkeeping and a close reading of the tax rules, but it can pay off come April 15.
There are dozens of itemized deductions available, but here are a few of the most common deductions claimed by American families:
This is a real benefit for homeowners whose monthly mortgage checks include huge chunks of interest. By itemizing deductions, you can deduct 100% of the mortgage interest you’ve paid.
State and local taxes
This one makes sense; why should the federal government tax you on earnings that you’ve already spent on state and local taxes?
In the seven states that don’t have income tax, residents can choose to deduct sales tax instead.
Charitable gifts and donations
As a way of rewarding charitable giving, the IRS lets taxpayers deduct the cash value of donations given to charitable, tax-exempt organizations.
The total charitable giving deduction is capped at 50% of adjusted gross income (AGI).
Medical and dental expenses
The IRS recognizes the high cost of health care and allows a partial deduction of out-of-pocket medical expenses (not health insurance premiums).
The deduction covers the portion of medical expenses that exceed 10% of your income (7.5% if you’re over 65).
Other deductible expenses
You can also deduct certain unreimbursed job expenses, theft and casualty losses, tax preparation fees, and gambling losses.
The generosity of the IRS does have its limits, though. The tax code applies floors, ceilings and phase-outs for certain itemized deductions.
Floors set a minimum amount at which you can start deducting certain expenses, like medical expenses in excess of 10% of AGI. That 10% is the floor.
There’s a whole category of miscellaneous expenses that only count if they amount to greater than 2% of AGI.
Ceilings impose a limit on certain categories of itemized deductions, like the limit on charitable deductions to 50% of AGI.
You can only deduct 50% of the cost of business-related meals and entertainment, and gambling losses cannot exceed gambling winnings.
The phase-out of certain itemized deductions is reserved for the highest income earners.
For tax year 2014, the phase-out begins for individuals earning $254,200 or couples earning $305,050.
The phase-out applies to most of the popular itemized deductions, including mortgage interest, charitable donations and taxes paid.
If your income exceeds those thresholds, the total amount of itemized deductions you can claim is lowered by 3% of every dollar over the limit, up to a maximum 80% reduction.