Understanding Tax Deductions: Should You Keep Your Mortgage for the “Tax Deduction”?

Standard Deduction vs. Itemized Deductions

What is the difference between the standard deduction and itemized deductions?

Standard Deduction:

The standard deduction is a fixed amount that reduces your taxable income, and it varies depending on your filing status. Each year, this amount is adjusted for inflation. Additionally, if you are 65 or older, or visually impaired, you may qualify for an extra deduction.

Itemized Deductions:

If your eligible expenses exceed the amount of the standard deduction, you can choose to itemize your deductions. 

Common itemized deductions include:

• Mortgage Interest: On up to two homes
• State and Local Income or Sales Taxes
• Property Taxes
• Medical Expenses: Exceeding 7.5% of your Adjusted Gross Income (AGI)
• Charitable Donations: Cash or goods

When considering whether to take the standard deduction or itemize, compare your total eligible expenses against the standard deduction for your filing status. If your itemized deductions exceed the standard deduction, choosing to itemize could result in greater tax savings.

Above-the-Line Deductions: Reducing Your AGI

Above-the-line deductions reduce your gross income before calculating your adjusted gross income (AGI). These deductions apply to all taxpayers, whether or not they itemize, and they can also increase your eligibility for other tax breaks. 

A few key above-the-line deductions include:

• Retirement Contributions: Contributions to traditional IRAs or 401(k)s reduce taxable income.
• Self-Employment Retirement Plans: Contributions to SEP IRAs or SIMPLE IRAs are deductible for self-employed individuals.
• Student Loan Interest: Deduct up to $2,500 in interest payments annually. 
• Self-Employment Expenses: Includes health insurance, business costs, and half of one’s self-employment tax.
• Home Office Deduction: Available to self-employed individuals, allowing a deduction for home-related expenses, proportional to business use.
• Health Savings Account (HSA) Contributions: Contributions reduce taxable income and grow tax-free for qualified medical expenses.
• Alimony Paid: Deductible for divorces finalized before 2019.
• Educator Expenses: Teachers can deduct up to $300 annually for classroom supplies.

Below-the-Line Deductions: When Itemizing Makes Sense

Below-the-line deductions only apply after your AGI is calculated. These deductions are available only if you itemize, and your total exceeds the standard deduction. 

A few examples include:

• Charitable Donations: Deduct cash contributions and donated goods (keep the receipts).
• Mortgage Interest: Claim interest paid on qualified home loans.
• State and Local Taxes (SALT): Deduct up to $10,000 for a combination of state/local income, property, or sales taxes.
• Medical Expenses: Deduct unreimbursed medical costs exceeding 7.5% of your AGI.

Above-the-Line vs. Below-the-Line Deductions: What is the Difference?

• Above-the-line deductions reduce your AGI, which can impact your eligibility for certain credits and tax benefits. 
• In contrast, below-the-line deductions further reduce your taxable income but are only applicable if you choose to itemize.

Understanding this distinction can help you optimize your deductions and minimize your tax liability.

What Does Not Count as a Tax Deduction? Avoiding Common Pitfalls

While there are numerous ways to reduce your tax bill, not all expenses qualify as deductions. 

Some common non-deductible expenses include:

• Car inspection fees
• Customs duties
• Employee business expenses (eliminated under the 2017 tax law)
• Federal excise tax and federal income tax
• Gas taxes and license fees
• Gift tax
• Personal expenses
• Social Security, Medicare, FUTA, and RRTA taxes
• Real property improvements
• Taxes paid on someone else’s behalf

It is important to be aware of these exclusions, as misclassifying non-deductible expenses can result in penalties, delays, or increased scrutiny from the IRS. Knowing what is not deductible ensures that your tax return is accurate and compliant.

Take Control of Your Taxes

From retirement contributions that grow tax-free to home office deductions for the self-employed, leveraging the right tax deductions can help you keep more money in your pocket. Understanding when to itemize, when to take the standard deduction, and which expenses qualify can empower you to make smarter financial decisions and avoid costly errors.

To simplify the complexities of tax deductions, we invite you to connect with your Farther advisor. They can walk you through strategies that will help you make the most of your deductions, maximizing your savings and ensuring your financial success.