How Itemized Deductions Work

The IRS has identified dozens of different types of expenses that you can claim as itemized deductions. And if you're the kind of person who enjoys reading poorly translated instruction manuals, check out the full IRS.gov entry on itemized deductions. Otherwise, here are some of the most common itemized deductions claimed by American taxpayers [source: IRS]:

Mortgage interest: The mortgage interest deduction makes home ownership more affordable for millions of Americans. If you buy a home using a traditional 30-year mortgage, the majority of each monthly mortgage payment – at least for the first 15 years – is pure interest on that loan. This generous deduction lets you subtract all of that mortgage interest from your taxable income. You can also deduct premiums paid for mortgage insurance.

State and local taxes: Federal taxes are not the only taxes you pay each year. Most folks pay state and local income taxes, plus local property taxes. Since all of those taxes come out of your gross income, it seems only fair to subtract those totals from your taxable income when calculating federal taxes. Tax reform laws mean that starting in 2018, this deduction is capped at $10,000 [source: Perez]. Note that you can choose to deduct the amount you paid in state and local sales taxes instead of income taxes. This is particularly useful if you live in a state without state and local income taxes (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) or you made a large purchase (car, boat, plane) for which you paid a lot of sales tax.

Charitable gifts and donations: You are allowed to deduct the cash value of any gift you made during the tax year to a qualified charitable institution. Gifts can be made in the form of cash donations, property, stocks or anything of real value. Charitable institutions are tax-exempt organizations that include most churches, synagogues and mosques; most nonprofit community organizations like the Boy Scouts, Girl Scouts and Goodwill; most nonprofit colleges and universities; and nonprofit hospitals. For gifts worth $250 or more, you will need a statement from the organization. Note that you can even deduct certain expenses incurred when volunteering for a nonprofit organization. Charitable donations are subjects to limits, which we'll talk about on the next page.

Medical and dental expenses: You can deduct out-of-pocket medical and dental expenses, but only the amount that exceeds 10 percent of your adjusted gross income (there is no longer a lower percentage if you or your spouse is over 65). So if your AGI is $50,000, you can only deduct the expenses that exceed $5,000. If you spent $6,000 on doctor's visits, hospital stays and prescriptions, you can deduct $1,000. You cannot deduct health insurance premiums that were withheld from your paycheck using pretax dollars, but other out-of-pocket premiums are deductible.

Again, these are only the most common deductions. Others include unreimbursed job expenses, theft and casualty losses, tax preparation fees and gambling losses. But before you attempt to write off your entire life, read on to learn about the limits on itemized deductions.

Here's where itemizing deductions gets a little tricky and where a qualified tax preparer or accountant becomes essential. Congress has generously created many categories of itemized deductions, but there are limits on that generosity. Those limits come in the form of floors, ceilings and phase-outs.

Floors set a minimum amount at which you can start to deduct and ceilings put a cap on how much you can deduct in certain categories.

Common deduction floors:

Common deduction ceilings:

The flip side of the elimination of some of these deductions is that itemized deductions are no longer phased out (gradually decreased) when Adjusted Gross Income is above certain thresholds, (for instance it used to start phasing out at $313,800 for married filing jointly, and $261,500 for single filers.)

Despite the potential tax savings, relatively few Americans itemize their deductions. Read on to find out who does and why.

Only 30 percent of all federal income tax filers itemized their deductions in 2014, the latest data at the time of publication [source: Greenberg]. For the majority of Americans, the standard deduction offers a better deal than itemizing. They simply don't have enough deductible expenses to add up to more than $12,000 for an individual or $24,000 for a married couple filing jointly.

It's likely that the number of people itemizing will fall since the standard deduction increased so much for tax year 2018 (up from $6,500 for single filers and $13,000 for married filers). One reason Congress gave for doing this was to simplify the tax return, so there would be less need to itemize [source: Tax Foundation].

Itemizing deductions probably makes the most sense to higher-income earners who generally pay more for deductible expenses like mortgage interest, state and local taxes, charitable donations and medical expenses.

A 2017 report by the Congressional Research Service found some interesting data on who itemizes in America:

Perhaps not surprisingly, the highest income earners claimed an outsized number of deductions in 2014.

For lots more information on income taxes and personal financial planning, check out the related HowStuffWorks articles on the next page.