Category: Taxes

Posted on

Reducing Taxes – Standard vs. Itemized Deductions

What’s the difference and why should you care?

So it is tax filing time. You have all your income documents and withholding ready to go.  You are cranking through ready to wrap this up and get back to the things you like doing, which taxes are definitely not a part of, and you get to this question: Would you like to use the Standard Deduction or Itemize your Deductions?

via GIPHY

You may be tempted to select whichever option gets you done the fastest.  Stop! Unless it is April 15th (or October 15th) at 11:59pm, the fastest choice may not be the best choice.  Why you ask? Have no fear, faithful reader, I am here to set you down the right path.

Why it Matters

The short answer is that either one of the options save you money.  Deductions reduce your taxes.  How? They reduce the amount of money on which you have to pay tax.  If you make $50K, a tax deduction of $10K would have you pay tax on $40K, which might save you $1,000 in tax if you didn’t have the deduction.  Tax Credits work a little differently and I have dig into that in this fancy post here.

The Standard Deduction

So what is the “standard” deduction.  Your mama always said you were special, and you are.  The standard deduction is a base level tax deduction offered to all taxpayers.  The amounts fluctuate primarily based on your filing status. We can cover filing status in another post.  Often your age can increase the standard deduction you are eligible to claim as well.  You  are permitted to claim the standard deduction no matter how much money you make.  The amount changes from year to year.  The 2017 Tax Cuts and Jobs Act basically doubled the standard deduction amounts and reduced a lot of the need for itemized deduction filing.

Itemizing Deduction

The alternative to utilizing the standard deduction is to itemize out your deductions.  The IRS Code allows taxpayers to deduct 5 broad categories of deductions, when combined, are your Itemized Deductions: Medical Expense, State and Local Taxes, Interest Expenses, Charitable Contributions, and Miscellaneous.  There are nuances and details to all of these deductions that would need to be covered in separate posts like Explaining the Mortgage Interest Deduction. When Itemizing your deductions, you add the totals of each of these five categories and the total is your deduction.  With itemizing deductions, your income matters.  With the passage of the One Big Beautiful Bill, it reintroduced certain income limitations that factor into how much of your itemized deductions that you are permitted to deduct. 

Pros and Cons

The biggest benefit of the standard deduction is that it is the simplest which also means quickest.  You take the deduction allotted to your filing status.  The downside is that you could be leaving money on the table.  Conversely, the biggest benefit of itemizing your deductions is that you could save more tax dollars.  The con of itemizing is the additional time it takes to gather documentation of your expenses and calculate each deductible amount.  Depending on how you file your return, there could also be additional filing cost if your tax preparer charges extra to prepare Schedule A, the extra form you file to report your deductions, or your tax software may charge more to calculate it.

So How Do You Decide?

You may be feeling like you want to pull your hair out at this point. when comes to figuring out which deduction to you use. Usually, you just take the biggest…except when you don’t.

via GIPHY

 It doesn’t always come down to picking the biggest.  In most cases, it will. There are a couple of other items to keep in mind though.  If your filing status is married filing separately, you are required to use the same deduction method as your spouse.  You both have to either take the standard deduction or itemize.  You can’t split.  Another item to consider is state tax filings.  In some instances, it could provide a better combined federal and state result to take a lower itemized deduction on the federal return so that you can take a larger itemized deduction on the state return.  States generally follow IRS guidelines, but individual state standard deductions vary greatly, and they often have different thresholds for limitations on itemized deductions.

The IRS has tools to help you in calculating your itemized deductions and most tax softwares will help you optimize which is best on the federal return.  

Summary

Here is a quick checklist to help you in your decision:

Filing Status – to determine the amount of your standard deduction

Information for potential itemized deductions: 

Form 1098 for mortgage interest and maybe real estate taxes

W-2 for State income taxes paid

Documentation for major charitable deductions

How does your state standard deduction or itemized deduction vary from the federal?

There is your basic primer on taking the standard deduction or choosing to itemize.  As always, this is a blog post and not intended to be considered tax advice.  Taxes are highly dependent on your own personal situation and this post is just to point you in the right direction.  Please consult and engage with a tax professional for recommendations regarding your own personal specific circumstances.

Until next time…

Posted on

Estimated Tax Payments: What are they and How to be sure you aren’t behind?

One question that I get a lot from clients relates to confusion regarding estimated taxes. I get this question most often from taxpayers who have been employees for most of their careers and for whatever reason find themselves self-employed, either full-time or by just having a side gig.

Generally the questions fall around: “Do I have to pay quarterly estimates?”, “When are they due?”, and “How much do I have to pay?”

I’m going to lay down a “brief” primer on estimated taxes and why, primarily self-employed people, have to pay them.

Jimmy Fallon Lets Do This GIF by The Tonight Show Starring Jimmy Fallon - Find & Share on GIPHY

The Feds require all taxpayers to pay in both Income Tax and FICA taxes throughout the year as you earn your income.  Taxpayers who are classified as employees (those that work for “the man”) have both of these taxes withheld by their employer before they ever get paid .

Family Guy GIF - Find & Share on GIPHY

This is a pretty crazy development that we accept as the governed in that you agree to work with an employer for money and before you even receive it, the government carves out their share first.  I don’t want to stand too long on this soap box. So, employees have their taxes withheld and remitted to the government by their employer every pay period, generally.

For those who are self-employed, the government does not yet have a practical way to get their hands on the funds nor appropriately assess how much to withhold since self-employed taxpayers pay tax on their net income (income after expenses) rather than their gross income (cash that comes in the door).  Since self-employed taxpayers don’t have withholdings they are required to make tax payments every quarter for what they expect to owe. This is how we get the term “Quarterly Estimated Tax Payments”.  

Taxpayers are required to reasonably estimate how much tax they think they will owe when filing a tax return after the year closes.  Again this process is more difficult for a self-employed person rather than the employee.  A self-employed taxpayer may know how much gross income they have in a quarter, but the net income may be completely different depending on what expenses they incurred to generate that income.  These expenses reduce the amount of income they are required to pay tax on.  FICA taxes complicate matters further.  For employees, the FICA tax responsibility is shared between the employee and the employer, with each group remitting half of the tax.  In reality, the employee bares the cost of the full tax, they just don’t feel it. Therefore it is accepted.  One half of the tax is paid through direct withholding of the employee’s wages, the other half is indirectly paid by the employee in the form of suppressed gross wages that they never see because it is a cost of employment to the company. This unseen half is remitted to the Feds by the employer.   For the self-employed, they are directly responsible for both the employee and employer portions and this is reported to the IRS annually as a part of their income tax return. 

Since knowing what you are going to earn on a net basis may be difficult to predict, the IRS “offers” what are referred to as “safe harbor” calculations whereby, if you pay these safe harbors amounts, you will not be assessed any penalties for the underpayment of tax, even if you owe when you file your tax return.

The most commonly used safe harbor is related to the prior year tax.  If your adjusted gross income (a tax return calculation) is less than $150,000, then as long as your estimated tax payments total at least 100% of the tax owed in the prior year, you will not be assessed a penalty for underpayment of tax, even if you owe $1,000,000.  If your AGI for the prior year is over $150,000, then you have to pay 110% of the prior year tax to be eligible for this safe harbor.

The other safe harbor is much more subjective.  You have to pay in 90% of the tax for the current year to avoid penalties for underpayment of tax.

So, when are your quarterly taxes due?

Payments are due to be sent by calendar year taxpayers (most everyone) on the following schedule:

April 15th

June 15th

September 15th

January 15th (following year)

These dates are adjusted forward if they happen to fall on a holiday or weekend.

Underpayment penalties are assessed on a daily basis, for each day and amount of tax that you are underpaid.  When you file your return, the IRS generally assumes that you earned your income steadily throughout the year.  If you have a highly seasonal business where the bulk of your earnings occurs in the 3rd or 4th quarter, you can fill out the schedule as part of the Form 2210 for calculating underpayment penalties.  This will tell the IRS, “Hey, I didn’t earn my income evenly and I’m not underpaid.”

Still with me?

Good Morning Hello GIF by CBBC - Find & Share on GIPHY

I hope this helps you keep up with your tax payments when you start your own business or even a side hustle.  When you want more info on tax impacts of side hustles check out my prior post  HERE

Leave your tax questions or a personal story about estimated taxes down in the comments below.  We will what kind of future post I can cook to answer them.  Thanks for reading!