3 Ways to Maximize Itemized Tax Deductions
Bundle Expenses To Maximize Itemized Tax Deductions
There are two types of deductions, standard or itemized. You should choose the one that lowers your taxes the most. Two out of three people claim the standard one because they don't have enough deductions to itemize - or because they aren't aware of how itemized deductions work.
Here are the three ways you can potentially increase your itemized deductions.
1. Bundle Medical Expenses to Maximize Itemized Tax Deductions
When you incur medical expenses that are not covered by health insurance, you are only allowed to deduct them from your taxable income to the extent that they exceed 10% of your adjusted gross income if you are 64 and younger, or 7.5% of your income if you are 65 and older. (Note: prior to 2013 it was 7.5% for all ages.)
Let’s say you are age 60 and make $50,000 a year. 10% of $50,000 is $5,000. If you have out-of-pocket medical expenses of $5,250, only $250; the amount that exceeds $5,000, would be eligible as an itemized tax deduction.
To maximize the use of this tax deduction, you need to do three things:
- Each year calculate an estimate of what 10% of your adjusted gross income will be.
- Keep a running total of your out-of-pocket medical expenses each year.
- If you have a year where you are nearing your threshold, determine if there are expenses you can bundle into the current calendar year.
2. Pre-Pay State Taxes
State income taxes paid are an itemized tax deduction on your federal return. Many people can benefit by paying their state income taxes before year end in order to maximize their deductions for federal taxes.
Be careful, as this strategy can possibly throw you into AMT (alternative minimum tax). If you plan on prepaying a substantial amount of state tax, consult with a tax advisor to make sure this strategy will work for you.
3. Bundle Investment and Tax Prep Related Expenses
Expenses such as tax preparation fees, safety deposit box fees, and investment fees are deductible to the extent that they exceed 2% of your adjusted gross income.
Let’s say you make $50,000 a year. Two percent of $50,000 is $1,000. If you have out-of-pocket investment and tax preparation related expenses of $1,500, only $500; the amount that exceeds $1,000, would be eligible to be listed as an itemized tax deduction.
If it would allow you to exceed the 2% threshold and if you work with advisors you trust, you may consider prepaying for tax preparation and investment advisory services. There are limits, of course, to how much you can pre-pay, so you can't pay years worth up front.
You can also pay investment management fees for an IRA from the IRA account balance thus paying fees with pretax dollars.
As with all tax-related advice, seek professional assistance and/or do additional research on the IRS itemized deductions topic site to determine what is legal, and what will work best for you.