As a quick refresher, a deduction reduces the amount of taxable income you report. Itemizing means that you take specific expenses that were paid throughout the year that theoretically should not have been taxed and mention them specifically to the IRS to reduce your taxable income. I'm going to focus on the filing single numbers, but the concept behind married filing jointly and the other categories is the same (just different limits). For the current year, the standard deduction is $5,950. This means when you look at the total deduction you would get if you itemize, it should be higher than $5,950. Otherwise, you can just take the standard deduction and be better off.
How do you calculate your deduction if you were to itemize? You would fill out a 1040 Schedule A form. Here is an example for 2011. You can quickly see the categories of expenses that are deductible if you itemize on the left hand side. These include medical and dental expenses, taxes you've already paid, interest you've already paid, gifts to charity, casualty and theft losses, job expenses and miscellaneous deductions. Now before you automatically assume that all your expenses throughout the year that fall into these categories can just be written off your taxable income, there are certain rules that apply to each one. I won't go over everything but I hope to hit the most common buckets.
First on the list is medical expenses. These include visits to the doctor, drugs, and insurance. In order to use these, however, your total expenses for the year must add up to more than 7.5% of your adjusted gross income (AGI). AGI is your income minus some automatic deductions on the first page of the 1040. These deductions are taken whether or not you itemize or take the standard deduction. If your AGI is $50,000, you would need to spend $3,750 ($50,000 * 7.5%) before any deduction is allowed and only the expenses after the $3,750 limit are deductible. This means that you should make sure you keep a good record of all your medical expenses throughout the year (keep those receipts!). Most of the time, this 7.5% floor makes it difficult to claim this deduction because most people have insurance which keeps the expenses below this hurdle. More specific details can be found on this IRS page.
The other taxes paid section allows you to deduct state and local taxes from your federal tax return. You can choose between deducting your income taxes or deducting your sales taxes (some states have low income tax rates but earn revenue by having a higher sales tax rate such as Tennessee and Arizona). Pick whichever bucket of taxes is higher for you. You can also deduct real estate taxes. If you are in a high state tax area, such as New York, this section alone may make it worth it to itemize your deductions since you can go above the $5,950 limit pretty quickly.
I am going to skip the section on interest because the rules with this are fairly complicated. However, I will return to it in another post. In general, you can deduct most forms of mortgage interest and business interest. However, you cannot deduct interest on personal expenses (such as for a car loan or credit cards).
Next we have charitable contributions. Many wealthy individuals who donate a lot to charity often reduce their effective tax rate through this method. The news which often highlight how low the tax rates are for the top 1% are often attributable partly to the wealthy donating money to charity and taking full advantage of this itemized deduction. This also means that you can donate to charity as well and not need to pay tax on that amount. If you donate more than $250 at a time, make sure you keep a copy of the letter or receipt which you should receive from the institution. Most charitable institutions qualify for this deduction and we use an easy up to 30% of AGI limit on these deductions but the full rules are pretty lengthy. You can find out more information on the IRS page if you are interested.
I am also going to skip casualty and theft partially because I didn't learn much about it in class so I am assuming it isn't a big part of itemizing your deductions.
The final section is job expenses and miscellaneous deductions. Unreimbursed job expenses can also be itemized and deducted. These include job travel (such as traveling to a client, does not include commuting), union dues, education for your job, etc. 50% of meals and entertainment expenses are also deductible from your work. Also, any expenses incurred in the production of income are included such as a Wall Street Journal subscription, tax preparation fees, investment fees, safety deposit box fees. With miscellaneous deductions, there is a 2% of AGI floor that has to be hit before any deduction can be taken. With the same $50,000 AGI example, miscellaneous deductions would have to be greater than $1,000 ($50,000 * 2%) before you can start taking a deduction.
So try itemizing your deductions for the year, see if it is greater than $5,950 or whichever limit if you aren't filing single, and choose whether to itemize or not when filing your tax return.