Insights + Resources

Personal Deduction Planning

Jan 22, 2024

Taxes, like death, are inevitable. But why pay more than you have to? The trick to minimizing your federal income tax liability is to understand the rules and make the most of your tax planning opportunities. Personal deduction planning is one aspect of tax planning. Here, your goals are to use your deductions in the most efficient manner and take all deductions to which you’re entitled.

Deductions lower your taxable income

Your first step is to understand how deductions work. You subtract certain deductions from your total income to arrive at your adjusted gross income (AGI); these deductions are commonly referred to as adjustments to income or as “above-the-line” deductions. Then, you subtract other deductions and exemptions from your AGI to determine your taxable income; these deductions are sometimes referred to as “below-the- line” deductions. Your tax liability is calculated based on your taxable income. Generally speaking, therefore, the higher your deduction level, the lower your tax liability.

You can either take a standard deduction or itemize

After you’ve computed your AGI, you’ll generally want to subtract the greater of either the standard deduction or the total of your itemized deductions. The standard deduction is a fixed dollar amount, indexed for inflation yearly, that is determined according to your filing status (e.g., married filing jointly, single) and certain circumstances. Itemized deductions are various deductions that are reported on Schedule A of your federal tax return (Form 1040). They involve certain personal expenses, such as medical expenses, mortgage interest, state taxes, and charitable contributions. If you have enough of these types of expenses, your itemized deductions may exceed your standard deduction. In that case, it would generally be to your advantage to itemize.

When filling out your tax return, how do you know whether to take the standard deduction or itemize? You should calculate your taxes (including any alternative minimum tax) using both methods, and go with the one that lowers your tax liability the most. Be aware that there are some limitations regarding who can use the standard deduction and who can itemize. Also, certain itemized deductions are available to you only if your expenses exceed a particular percentage of your AGI. For example, your medical expenses itemized deduction is allowed only to the extent that medical expenses exceed 7.5 percent of your AGI. So, if your AGI is $100,000, your first $7,500 of medical expenses won’t count toward your total itemized deductions.

There may be circumstances where it is better to itemize deductions even if the standard deduction is greater than itemized deductions. For example, if you are subject to alternative minimum tax, even a small amount of some itemized deductions may be preferable to the standard deduction, which is reduced to zero for alternative minimum tax purposes.

The medical and dental expenses deduction: what it is, and how it involves your income level

The medical and dental expenses deduction is an itemized deduction that you may take (within certain limits) for unreimbursed medical and dental expenses you paid during the year for yourself, your spouse, and your dependents. You may be surprised to learn which medical and dental expenses are deductible and which are not; the line is sometimes blurry. For example, you can’t deduct your expenses for nicotine gum, but you can deduct your fee for a smoking cessation program. Many expenses qualify for this deduction, including acupuncture treatments, crutches, eyeglasses, and prescription drugs. You should obtain IRS Publication 502, Medical and Dental Expenses, for an authoritative list of eligible and nondeductible expenses. If you don’t review this list, you may miss out on some important tax-saving opportunities.

You can take this deduction only to the extent that your unreimbursed medical expenses exceed 7.5 percent of your AGI. That might sound complicated, but here’s how it works. First, add up your eligible medical expenses. You can deduct only part of that total on Schedule A of your federal income tax return. The schedule will actually lead you through this calculation. On that form, you’ll multiply your AGI by 7.5 percent (0.075). The figure you come up with will represent the amount of your medical expenses that you cannot deduct. Subtract this figure from your total eligible medical expenses. The remaining amount is your medical deduction.

Proper timing of your deductions will minimize your taxes

For most people, income is reported in the year that it’s received, while deductions are generally taken for the year in which expenses are paid. In many cases, you can control whether you incur an expense this year or next. That means that you can control the timing of your itemized deductions to some extent. If you’re in a higher income tax bracket this year than you expect to be in next year, you may want to accelerate your deductions into the current year to minimize your tax liability. You can do this by paying deductible expenses before year-end and making charitable contributions before year-end. For example, if you have major dental work scheduled for January of next year, you can reschedule for December to take advantage of the deduction this year. Here are some tips:

  • If you pay a deductible expense by check, make sure it’s dated and mailed before year-end. It needn’t clear the bank by year-end, however.
  • If you pay by credit card, the expense is deductible in the year the charge is incurred, not when the credit card bill is paid.
  • A mere pledge or promise to make a charitable contribution is not deductible.
  • Along with your cash contributions to a charity, remember to deduct noncash contributions like clothes. You can also deduct mileage if you use your car for charitable purposes.

Tags: , , ,

More Insights

Apr 17, 2024

Following Iran’s missile and drone strikes on Israel over the weekend and the apparent escalation likely in any Israeli response, stocks fell sharply during Monday’s trading session. We examine the latest developments in the Middle East conflict, how stocks have reacted historically to geopolitical events, and the possible impact on markets moving forward.

Apr 15, 2024

Did you buy U.S. Savings Bonds decades ago? Or did your parents or grandparents purchase them for you? If they’re collecting dust in a drawer, you may want to take a look at them to see if any of your bonds have matured. If your bonds have matured, that means they are no longer earning … Continue reading “How US Savings Bonds Work”

Apr 12, 2024

In baseball, three strikes and you’re out. With inflation, a third straight month of hotter-than-expected consumer inflation data nearly ruled out probabilities for a June rate cut yesterday (now less than a 25% chance, according to fed funds futures). The core Consumer Price Index (CPI) rose 0.4% in March, or 3.8% when compared on a … Continue reading “Market Update – Assessing the Prospect for a Pullback”

Apr 10, 2024

You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you’ll need to fund your retirement. That’s not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your … Continue reading “Estimating Your Retirement Income Needs”

Apr 8, 2024

Let’s talk seasonality. For those that are unfamiliar, seasonality is the tendency for markets to perform better during some calendar periods and worse during others in a somewhat predictable way. One of the more amazing things about 2023 and part of the first quarter of 2024 is how well U.S. equity markets have been following … Continue reading “Can Pre-Election Market Trends Survive This Attention?”

Insights + Resources >