Written by:
Menu
Written by:
For many, tax planning is not a simple filing every April. Many Americans seek a more proactive approach and coordinate their tax planning with their full financial picture. On that note, it is common for many to seek deductions and credits to lower their taxable income, ultimately reducing their tax liability to the federal government. The most common deduction available to each taxpayer is the option to either take the standard, allowable deduction, or itemize their deductions. This blog seeks to break down these two options to help the taxpayer determine the deduction that allows the most on a case-by-case basis.
Before determining whether the standard deduction or itemized deductions make sense, adjusted gross income is calculated on one’s tax return.
One must first calculate the household’s total gross income to determine taxable income. Gross income comprises all wages, dividends, capital gains, rental payments, and pension payments, among many others. The two notable exceptions to gross income are any gifts or inheritance received. Once gross income is pooled together, it is important to note any above-the-line deductions which lead to the adjusted gross income. Examples of above-the-line deductions include Traditional 401(k) / Traditional IRA (if income allows for deduction) / SEP IRA contributions, Health Savings Account contributions, deductible self-employment taxes, and student loan interest (if income allows).
For example, let’s assume a client has a gross income of $500,000 (part is W2, and part is 1099 from their own business). If they contribute $22,500 to a Traditional 401(k) through their W2 income and $66,000 to a SEP IRA through their 1099 income in the same year, this client’s adjusted gross income would be calculated as $411,500.
Once the adjusted gross income is calculated, one can take the standard deduction or itemize their deductions.
The standard deduction is what the IRS allows as a dollar-for-dollar reduction to one’s taxable income. For single filers or those married filing separately in 2023, this equals $13,850. If married filing jointly, the standard deduction currently sits at $27,700. For those filing as head of household, the 2023 standard deduction is $20,800. There are additional standard deductions if one is over 65 or legally blind of $1,850 if filing single, or $1,500 if married filing jointly.
A taxpayer can choose the standard deduction or the sum of their itemized deductions– whichever is higher.
Itemized deductions include, among others:
For example, let’s assume a household is filing jointly for the 2023 tax year. Further, for 2023, they have state and local taxes due of $8,000, mortgage interest of $10,000, and make charitable contributions of $6,000. In this example, their itemized deductions for 2023 would equal $24,000. This is less than their standard deduction amount of $27,700, so this household would be better off taking the standard deduction. This couple may have thought they were getting tax breaks from their mortgage and charity (as an example), but in this case, they did not help with their tax return because of electing the standard deduction.
However, let’s assume the household is charitably inclined and wants to “batch” all their donations for the next few years in one donation (all in 1 year). By utilizing a Donor Advised Fund, the household could batch future donations into one year’s worth of contributions. Taking the previous example, let’s assume the household batches $6,000/year of donations for five years ($30,000 total all in 1 calendar year), along with their state and local taxes of $8,000 and mortgage interest of $10,000. Now, in 2023, their itemized deductions would equal $48,000.
In this case, $48,000 outweighs $27,700, and the household would itemize their deductions in 2023 before taking advantage of the standard deduction in subsequent years.
Being strategic in choosing the standard deduction vs. itemizing can lead to significant tax savings for households. Further, it can lead to a more proactive tax planning approach better coordinated with one’s entire financial plan. Before deciding on any tax deduction or credit, it would be wise to consult with a tax professional.
Please see the following resources of videos created around tax planning:
In just 15 minutes we can get to know your situation, then connect you with an advisor committed to helping you pursue true wealth.
Add me to the weekly newsletter to say informed of current events that could impact my investment portfolio.
Important Disclosures:
Securities and advisory services offered through EWA LLC dba Equilibrium Wealth Advisors (a SEC Registered Investment Advisor).
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
* All indexes referenced are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
* Gold represents the afternoon gold price as reported by the London Bullion Market Association. The gold price is set twice daily by the London Gold Fixing Company at 10:30 and 15:00 and is expressed in U.S. dollars per fine troy ounce.
* The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* The Dow Jones Industrial Average (DJIA), commonly known as “The Dow,” is an index representing 30 stock of companies maintained and reviewed by the editors of The Wall Street Journal.
* The NASDAQ Composite is an unmanaged index of securities traded on the NASDAQ system.
* International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage is often obtainable in commodity trading and can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
* There is no guarantee a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
* Asset allocation does not ensure a profit or protect against a loss.
* Consult your financial professional before making any investment decision.
In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.
EWA, LLC dba Equilibrium Wealth Advisors, is an SEC-registered investment advisory firm providing investment advisory and financial planning services to clients.
Investments in securities and insurance products are not insured by any state or federal agency.
To view EWA’s public disclosure, registration, Form ADV and Part 2B’s, click here.
To view EWA’s Client Relationship Summary (CRS), click here.
*See reference 1 and reference 2 for more information about the above-mentioned statistic.
COPYRIGHT 2024 EWA, LLC. ALL RIGHTS RESERVED
In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.