Itemizing deductions is difficult, but yields clear rewards.
As the tax deadline looms, many Americans are rushing to prepare returns and avoid penalties for late filings. In this rush, however, money owed to a filer by the government may be left on the table.
Tax law is complicated and penalties for filing an incorrect return are stiff. Because of this, many don't realize just how many deductions and credits are available, or are simply afraid to claim what they are entitled to.
The result? Money owed is often lost. U.S. News spoke with several tax experts to determine the most common missed deductions and to clarify exactly what tax filers are eligible for.
Deduction vs. credit. In order to maximize returns, the difference between a deduction and a credit must be clear. A tax deduction is taken from taxable income. A tax credit is a dollar-for-dollar reduction.
"A credit is a dollar-for-dollar tax saving, so it reduces your tax bill dollar per dollar," says Melissa Labant, director of tax for the American Institute of Certified Public Accountants (AICPA). "If you're paying $15,000 in taxes and have a $2,000 credit, you're only paying $13,000."
A tax deduction, on the other hand, is based on one's income. For instance, assume someone is in the 35 percent marginal tax bracket, the highest income bracket in the U.S. tax code. This means a $1,000 tax deduction only lowers the tax bill by $350, or 35 percent of the $1,000.
In other words, a tax credit is better for the filer, because it provides dollar-per-dollar relief. A deduction only provides relief from a percentage of income.
Standard vs. itemized deductions. Most tax filers take the standard deduction, an amount set by the Internal Revenue Service each year. For 2011, these deductions are:
• Married, Filing Jointly: $11,600
• Single: $5,800
• Married, Filing Separately: $5,800
• Head of Household: $8,500
An individual or couple can elect to forgo the standard deduction and
instead claim itemized deductions. According to Labant, many deductions are only available if deductions are itemized.
But itemizing deductions is a complicated science. First, you have to calculate how much itemized deductions will be. According to the website MoneyUnder30.com, one must tabulate how much was spent on the following things:
• Home mortgage interest
• Property, state, and local income taxes
• Investment interest expense
• Medical expenses
• Charitable contributions
• Miscellaneous deductions
If this amount adds up to more than the standard deduction, the filer should opt for itemized deductions to maximize their return.
Overlooked deductions. Taking the standard deduction is by far the easier route. But it also allows the government to keep a large amount of taxpayer money. According to Kiplinger 's Personal Finance. about 45 million Americans itemize deductions annually, claiming more than $1 trillion in deductions. On the other hand, the 92 million Americans who take the standard deduction claim only $700 billion in deductions.
In other words, approximately one-third of all filers claim $300 billion more in deductions that the other two-thirds. The math is obviously in favor of itemized deductions.
These deductions come from some across the financial spectrum. For example, large charitable donations are easy to track. But the costs of preparing a meal for a nonprofit homeless shelter are also eligible.
Job hunters also get a tax break. Costs associated with finding a job, including travel, materials like paper and envelopes, phone bills associated with the search, and fees paid to recruiters are all eligible. And if you move more than 50 miles from home for your first job, you can write off expenses associated with the move.
Ironically, the cost of preparing taxes is eligible for deduction. According to the IRS, the "cost of preparing that part of your tax return relating to your business as a sole proprietor or statutory employee" is qualified. So it might pay to have a professional prepare your taxes.