Welcome back to the Deep Dive. Our mission is
always to take a stack of sources, articles,
research papers, government reports, and really
extract the most crucial knowledge, turning all
that complexity into clarity. And today we are
wading into some pretty dense territory. We are.
We're looking at one of the most fundamental
financial decisions faced by every single U .S.
taxpayer. How do you reduce your taxable income?
It sounds like it should be simple math, right?
But as soon as you open up the tax code, you
realize it's, well, it's anything but. We're
looking specifically at that great annual strategic
choice. Do you opt for the fixed, simplified
path? That's the standard deduction. Or do you
dive deep into the receipts and the record keeping
with itemized deductions? Exactly. Our mission
today is to unpack the rules, to analyze the
massive seismic shift caused by the Tax Cuts
and Jobs Act of 2017, the TCJA. A huge change.
A huge change. And crucially, to break down exactly
which specific expenses actually qualify for
that intricate itemizing process. We want to
give you, the listener, the knowledge to understand
why you're making the choice you make every April.
And this choice is paramount because it really
determines the final amount of tax you owe. The
core goal, you know, mathematically is to choose
whichever option results in the lesser amount
of tax payable. Simple enough. But the meta lesson
here, which our sources really emphasize, is
that the very existence of such a large and frankly
complicated number of deductions is a direct
result of policymakers preference to pass policy
through the tax code. That's the key takeaway
right from the jump, isn't it? Yeah. Deductions
aren't just arithmetic. They are deeply ingrained
incentives. Exactly. I mean, we don't just deduct
mortgage interest because it feels fair. We deduct
it because historically the government wanted
to incentivize homeownership. And charitable
deductions because we want to incentivize private
philanthropy. Right. But the TCJA completely
changed the cost benefit analysis for millions
and millions of people when it was enacted. It
absolutely did. And understanding that policy
context is really key to understanding your current
tax situation. So I think we should start with
the fixed, simplified path that most taxpayers
now take. OK, let's do it. Let's unpack this,
starting with the standard deduction, which for
a lot of people means their taxes are now, you
know, a one page form and a quick calculation.
A huge simplification. So the standard deduction,
if you don't have enough expenses to make itemizing
worthwhile or you just want to avoid the administrative
headache. This is your friend. Define it for
us. What is it exactly and how does it function
in practice? So the standard deduction is a fixed
dollar amount that taxpayers who choose not to
itemize subtract directly from their income.
OK. This number is applied to your gross income.
And after other adjustments are made, it reduces
your adjusted gross income or AGI. And AGI is
a crucial number. We're going to be saying that
a lot. Before we go further, we should probably
define it because it's going to come up constantly.
Great point. Yeah. AGI is the baseline for almost
every deduction limit we're going to discuss
today. So what is it? Think of AGI as your total
income. So wages, interest, dividends, business
income minus specific above the line adjustments.
Above the line. Right. These are deductions you
can take before you even get to the choice between
your. itemized or standard deduction. What are
some examples? Things like contributions to traditional
retirement plans like an IRA, maybe student loan
interest payments or alimony payments for agreements
before 2019. So you subtract all that first.
You subtract that first to get your AGI. Then
from your AGI, you subtract either the standard
deduction or the total of your itemized deductions.
The number you're left with is your taxable income.
And it's vital to note, this deduction only impacts
your income tax. It doesn't affect other federal
taxes, like payroll tax, which is calculated
based on your total earnings, regardless of your
standard deduction choice. Precisely. Now, eligibility
is pretty wide, but it's not universal. It's
available to U .S. citizens and resident aliens.
Okay. However, non -resident aliens are generally
not eligible to claim the standard deduction.
But wait, I see that word generally. That word
always suggests there's a specific exception,
which our sources love to highlight. I see a
fascinating little nuance mentioned here about
F1 students from India. That's a perfect example
of how specific and, frankly, weird the tax code
can be. Right. While the default rule excludes
nonresident aliens, certain tax treaties and
agreements create these narrow little exceptions.
For instance, specific visa holders, like F1
students from India, can sometimes use the standard
deduction because of treaty provisions. Huh.
These exceptions... though rare, they really
illustrate that you can never assume a universal
rule in the tax code. You always, always have
to check the specific context, or in this case,
the treaty itself. OK, let's get into the history,
because the TCJA didn't just tweak this standard
deduction. It created an earthquake. The Tax
Cuts and Jobs Act of 2017 implemented an immediate
dramatic increase starting in the 2018 tax year.
The jump was designed to achieve legislative
simplification, and it was. It was truly stunning.
For many Americans, it eliminated the incentive
to itemize overnight. Literally overnight. Let's
just look at the contrast for a married couple
filing jointly, for example. In 2017, the standard
deduction was $12 ,700. $12 ,700. In 2018, just
one year later, that amount nearly doubled, jumping
to $24 ,000. That is an immediate gain of over
$11 ,000 in untaxed income. I mean, if you're
a young couple or someone who rents and doesn't
have major medical costs, your itemized deductions
would almost never exceed 24 grand. Exactly.
You instantly switch to the standard deduction
and your tax preparation complexity just plummeted.
Yeah. And that floor for itemizing has been raised
significantly ever since, and it continues to
grow with inflation adjustments. If we look ahead
at the projected figures, this trend just keeps
going. What are we looking at? For a single filer
in 2025, the standard deduction is projected
to be $15 ,750. $15 ,750. For a married filing
jointly couple in 2025, it's projected to reach
$31 ,500. $31 ,500. That's a high bar. A very
high bar. And for head of household, it's $23
,625. So the message is clear. Yep. The barrier
to entry for itemizing is now dramatically higher.
I mean, if your total qualified expenses don't
hit nearly $32 ,000 as a married couple, you're
taking the fixed path. You are. And this is a
massive simplification for the majority of the
country. But it also means that many people who
used to benefit from certain smaller deductions,
which we'll get into later, they no longer get
any benefit at all. That's the tradeoff. However,
the basic deduction isn't the final number for
everyone. We need to introduce the nuance of
additional standard deductions. Right. It's not
just one fixed amount for your filing status.
The government adds amounts for specific conditions.
Exactly. Additional amounts are tacked onto the
standard deduction for two key conditions. Age,
so being 65 years or older, and blindness. And
this applies to both the taxpayer and, if you're
filing jointly, their spouse, right? Correct.
And it's cumulative. So if you meet four conditions
between the two of you, say you're both over
65 and one of you is blind, you could get four
extra increments. You get all four. Correct.
Let's quantify this using 2023 data for clarity.
For most filers, an additional $1 ,500 is added
for each applicable condition. Okay. $1 ,500.
But here's a typical example of tax code complexity.
The source specifies that for unmarried individuals
who are not a qualifying surviving spouse, that
additional amount is higher. It's $1 ,850 per
condition. Why the higher amount for the unmarried
filer? Is that... like an attempt to balance
out the benefit that a married couple gets from
having two people who could potentially qualify.
It's an attempt to provide slightly more targeted
relief to single seniors who don't have a spouse
to share expenses or deductions with. The code
is trying to distribute the financial relief,
you know, equitably, even if the resulting numbers
feel a little arbitrary. Let's run the numbers
on those illustrative examples to really drive
home how significant this elderly and blindness
bonus can be. Let's stick with 2023 figures.
OK, take. Like a 70 -year -old single individual,
their basic deduction was $13 ,850. $13 ,850.
Because they're over 65 and single, they get
to add that higher amount of $1850. So plus $1
,850. Which brings their total standard deduction
to $15 ,700. That's a healthy guaranteed deduction.
It is. Now, for the married couple example where
the effect is compounded, let's say we have a
couple filing jointly. ages 78 and 80 and one
spouse is blind okay so we start with their married
filing jointly baseline which was 27 700 in 2023
27 7. then we just count the conditions that
are eligible for that 1500 increment the 78 year
old qualifies for one condition age right the
80 year old qualifies for one condition also
age And the couple gets an additional condition
because one spouse is blind. So that's three
conditions total. Three conditions. So it's $27
,700 plus three times $1 ,500. Which is another
$4 ,500 in additional deduction. Right. That
brings their grand total standard deduction up
to a huge $32 ,200. Wow. This policy is a really
clear example of the government passing direct
financial assistance through the tax code to
help specific... you know, vulnerable demographics.
It's predictable and very substantial assistance.
Absolutely. OK, before we leave the standard
deduction, we have one more layer of complexity
to peel back, and that involves dependence. Because
if you're a parent claiming your child is a dependent
and that child earns money. Their standard deduction
rules are highly specialized. They are. The dependent's
deduction rules are designed to prevent the dependent
from claiming that massive full single deduction
when their actual income might be very limited.
But you also want to give them some benefit if
they do earn wages. Exactly. So the calculation
is based on their earned income wages, salaries,
tips, plus a certain fixed amount, which was
$400 in 2023. So it starts with their earnings,
but then it's subjected to these high and low
limits. What are the caps? So the standard deduction
for a dependent cannot exceed the basic standard
deduction for a non -dependent single filer.
That's the maximum. In 2023, that was $13 ,850.
And there's a minimum, too. Right. And it cannot
be less than a certain minimum, which was set
at $1 ,250 in 2023. This tiered system is really
essential to grasp because it covers every possible
dependent earning scenario. Let's illustrate
this using those 2023 figures. Okay, scenario
one. A dependent who babysat a few times and
only earned $200 all year. Okay. Their earned
income plus $400 is only $600. But since the
standard deduction cannot be less than the minimum.
They get the minimum. They take the minimum,
$1 ,250. The system guarantees them a floor.
Okay, scenario two. A dependent earning a modest
income, say a high schooler working a part -time
job and earning $6 ,000. Here the calculation
applies. $6 ,000 plus $400 equals $6 ,400. $6
,400. Since this amount is above the minimum
and far below the maximum, they take the calculated
amount of $6 ,400. Simple enough. And the final
scenario, designed to enforce that cap, a high
-earning dependent, maybe a college student with
a lucrative internship, making $18 ,000. Their
calculated amount, $18 ,000 plus $400, would
be $18 ,400. But that's more than a regular single
person gets. Exactly. It exceeds the maximum
deduction for a single person in 2023, which
was $13 ,850. Therefore, they are limited to
the maximum of $13 ,850. The system makes sure
that a dependent can't claim a deduction that's
larger than a standard adult single filer. Correct.
Okay. We've thoroughly established the baseline.
Now, for the final distinction in this section,
standard deduction versus the personal exemption.
It's an old point of confusion that the TCJA
sort of resolved. By just getting rid of one
of them. It did. The standard deduction is distinct
from the personal exemption. Historically, the
personal exemption was a deduction based on the
number of people in the household. Right. You
got one for yourself, your spouse, each kid.
But as a key component of the TCJA, this exemption
was set to zero dollars for tax years 2018 through
2025. So it's gone. For now. It's gone for now.
This change shifted even more significance onto
the now doubled standard deduction, really reinforcing
it as the primary fixed simplification mechanism.
That sets the stage beautifully. We understand
the fixed baseline and the strategy behind taking
it. Now let's pivot to the complex side of the
equation. itemized deductions, and the strategic
thinking you need to use them. All right. So
itemized deductions are specific eligible expenses
that you claim on your federal tax return to
decrease your taxable income, and they are used
in place of the standard deduction. So after
you calculate the total amount of all your specific
itemized expenses, your medical bills, your charity,
your mortgage interest, you arrive at one single
number. This brings us to the core comparison.
Correct. You just compare the total of your itemized
deductions to your applicable standard deduction
amount, and you choose the greater of the two.
That's a straightforward calculation. It is.
But the decision involves a number of practical
and strategic considerations that go way beyond
just simple arithmetic. The first, and maybe
the most frustrating one for the average person,
is substantiation. Itemizing is a real commitment
to record keeping. It absolutely is. Itemizing
requires maintaining records receipts, canceled
checks, donation letters to substantiate all
claimed expenses. This is a massive administrative
burden. If your calculated itemized total is,
say, only $1 ,000 more than your standard deduction,
many financial advisors would just tell you to
choose the standard deduction. Just to avoid
the headache. Just to avoid the complexity and
the time cost of tracking all those records for
seven years. And then the simplicity factor is
huge. Choosing the standard deduction avoids
the complexity of preparing the longer. Form
1040 and the associated Schedule A. That's where
you list all these itemized details. For taxpayers
who are trying to file quickly and efficiently,
this avoidance of Schedule A is often worth more
than a minimal tax reduction. Absolutely. But
we also have to discuss a critical strategic
trap related to filing status that catches a
lot of married couples off guard. Ah. The married
filing separately trap. This is a preventative
measure by the IRS. If you file as married filing
separately and your spouse chooses to itemize
their deductions, you are automatically locked
into itemizing as well. You're stuck. You are.
If your spouse itemizes, you must either itemize
or claim zero as your standard deduction amount.
So why do they do that? This rule exists specifically
to prevent a couple from, you know, shifting
all their high deductible expenses onto one.
buys to hit that itemization threshold, while
the other spouse simultaneously claims the large
standard deduction. I see. So you can't double
dip. You can't. You have to coordinate your strategy
if you file separately. That is a classic example
of the tax code closing a loophole before it
can be exploited. Now, what about the audit factor?
The sources highlight that the certainty provided
by the standard deduction is really invaluable.
The amount of the standard deduction generally
cannot be changed following an audit unless your
underlying filing status changes. This is solid.
It's a fixed, secure number. Itemized claims,
however, are inherently subject to scrutiny because
the IRS can challenge the legitimacy or the substantiation
of any expense you claim. So choosing the standard
deduction. Drastically reduces your audit risk.
And your adjustment exposure. Yes. Okay. Here
is where we hit the high income aha moment that
often gets glossed over. The alternative minimum
tax or AMT. This is a parallel tax system that
throws a huge wrench into the itemization versus
standard deduction comparison. The AMT consideration
is crucial for those in higher income brackets.
The AMT is a separate tax calculation designed
to ensure that high income taxpayers pay at least
a minimum amount of tax, regardless of how many
deductions or credits they claim under the regular
tax system. And the massive problem here is that
the standard deduction is not allowed when calculating
the alternative minimum tax. It just disappears.
That is a critical distinction. So if you take
the standard deduction for your regular income
tax calculation, that deduction simply vanishes
when you calculate your liability under the AMT
system. Exactly. a potentially huge tax liability
under the amt with zero deduction wow furthermore
the amt calculation disallows many itemized deductions
too like the entire salt deduction and most miscellaneous
items however there are some that are allowed
yes certain deductions are allowed under the
amt notably qualified home mortgage interest
and medical expenses that exceed 10 percent of
agia higher threshold than the regular tax calculation
but still something So if you choose the standard
deduction, you don't even have the opportunity
to claim the few deductions that the AMT allows
because you never documented them on a Schedule
A. Exactly. For taxpayers subject to the AMT,
itemizing may be strategically better, even if
the total itemized amount is slightly less than
the standard deduction. That seems counterintuitive.
It does. But by itemizing for regular tax purposes,
they generate a Schedule A that documents their
deductible expenses. This documentation is then
available for the AMT calculation, potentially
allowing them to deduct those few permitted items,
like mortgage interest, which then lowers their
AMT liability and reduces their overall final
tax bill. Wow. So choosing the lower deduction
could actually be the optimal strategy if you
fall into the AMT trap. It can be. That perfectly
illustrates the tax strategy isn't always about
maximizing the number. Sometimes it's about having
the right documentation available for a secondary
parallel calculation. That's the subtlety the
tax code enforces. And finally, let's quickly
reiterate the timing rule. Right. Deductions
are reported in the tax year the expenses were
paid, not when they accrued or when the service
was rendered. That's right. Whether it's an annual
membership fee you paid in December for the following
year or a property tax installment, the year
the check cleared or the payment... processed
dictates the deduction year. It's simple, but
it's often overlooked. That strategic overview
is complete. Now let's get specific and tackle
the major categories of itemized deductions,
starting with the two largest drivers for most
Americans, housing and health. For decades, the
ability to deduct expenses related to your home
has been the number one reason taxpayers itemize.
We start with the mortgage loan interest expense,
which is a classic example of passing policy
incentivizing homeownership through the tax code.
And this deduction covers interest paid on debt
you incurred to purchase, build, or substantially
improve up to two homes, a primary and a second
residence. But the limits are where the TCJA
drew a heavy line in the sand, based entirely
on when the loan was originated. That cutoff
date, December 15th, 2017, is crucial. For loans
taken out on or before that date, the rules were
far more generous. Taxpayers could deduct interest
on up to $1 million in acquisition debt. A million
dollars. That was a massive subsidy, particularly
for those with very expensive homes. It was.
And the pre -TCJA rules were even more generous
because they allowed for home equity loan interest
deduction without restriction. That's right.
Before the cutoff. You could deduct interest
on up to $100 ,000 in home equity debt, regardless
of how you use the funds, a car, a vacation,
paying off credit cards. But if you took out
a new mortgage after December 15, 2017, those
limits tightened considerably. The deduction
is now limited to interest paid on up to $750
,000 in acquisition debt. That's a 25 % drop
in the deductible principal amount. And critically,
for post -TCJA loans, the ability to deduct interest
on home equity loans was generally eliminated
unless those funds were used specifically to
substantially improve the property securing the
debt. So if you take out an HELOC to pay for
college tuition today, that interest is no longer
deductible. It is not. This was a targeted move
to reduce tax expenditures related to expensive
housing, particularly in high -cost areas. It
effectively means the government decided it would
no longer subsidize borrowing against home equity
for general consumption, only for further investment
in the home itself. That's a very clear policy
signal. And within this category, we also have
to detail discount points. These are prepaid
interest fees you pay to the lender at closing
to secure a lower interest rate. What's the accounting
difference here? The key is immediate deduction
versus amortization. Points paid upon the acquisition
of the home are immediately deductible in the
year the home is purchased. So you get a big
benefit right away. A significant cash flow benefit,
yes. However, if you pay points on a refinance
of an existing loan, the IRS views that as a
cost incurred over the new life of the loan.
Therefore, the points must be amortized. Meaning
you have to spread them out. Deducted in equal
parts over the entire lifetime of the new loan,
which could be 15 or 30 years. That is a staggering
difference. An immediate write -off of, say,
$5 ,000 in points versus spreading that same
$5 ,000 out over three decades, it really changes
the math when deciding whether to refinance.
It does. Okay, moving from housing to local government
taxes, we encounter the state and local tax deduction,
or SALT. This is the itemized deduction that
generated the most political heat after 2017.
The SALT deduction used to be unlimited. But
post -TCJA, it faced a very, very significant
restriction. This is the second major driver
pushing people away from itemizing. Starting
in tax year 2018, the entire sum of this category
state and local taxes paid is capped at $10 ,000.
Just $10 ,000. So if you're a high -income earner
in California or New York, where your property
taxes alone might exceed $10 ,000. This cap essentially
eliminated the benefit of this deduction for
you entirely. And does the source material suggest
this was purely about revenue generation or was
there an element of targeting high tax, typically
Democratic -leaning states woven into the TCJA?
The sources report that the cap was definitely
seen as a means to fund other tax cuts in the
bill. It generated significant revenue by restricting
a benefit that was disproportionately used in
high tax states. While politically charged, its
immediate effect was to equalize the tax treatment
of high tax versus low tax state residents in
a way that had not occurred before. So what exactly
goes into that $10 ,000 cap? It's composed of
two parts. First, you can deduct your property
taxes, which can include vehicle registration
fees if those fees are assessed based on the
vehicle's value. Okay. Second, you get a choice.
You can deduct either the state income tax you
paid during the year or the state and local general
sales taxes you paid. You have to choose one.
You can't claim both. So if I live in Texas,
which has no state income tax, I'm clearly choosing
the general sales tax route. Yeah, absolutely.
The IRS actually provides tables and calculators
to help taxpayers in low or no income tax states
estimate their general sales tax deduction because,
you know, keeping receipts for every single purchase
is impractical. So the calculator helps you get
an equitable deduction. Exactly. Compared to
those claiming state income tax. And just as
important, what is explicitly not deductible
under SALT? This category does not include use
taxes, excise taxes on specific goods, or any
fines or penalties. Traffic tickets, for instance,
are not deductible, even if they're levied by
a local municipality. Okay, let's transition
now to health, which is another major itemized
category, but one with a notoriously high barrier
to entry, medical expenses. This deduction is
designed not for routine costs, but specifically
to provide relief for those facing catastrophic
medical costs. The hurdle is that only expenses
that exceed 7 .5 % of the taxpayer's adjusted
gross income, AGI, are deductible. The sources
noted that TCJA temporarily reduced this floor
from 10 % back down to 7 .5 % starting in the
2018 tax year. Why do they set the floor so high?
It's a policy choice to limit the tax subsidy
to genuine hardship. The government's essentially
saying they expect you to absorb your first 7
.5 % of AGR in medical costs yourself. So it's
for extraordinary circumstances. It ensures that
the tax benefit is focused on acute, extraordinary
financial burdens, not the deductible or copayments
that most people budget for. Let's walk through
the calculation example because it shows how
much of your actual expenses are absorbed by
that floor. Okay, consider a taxpayer with an
AGI of $20 ,000 and total medical costs paid
of $5 ,000. First, the floor calculation. 7 .5
% of $20 ,000 is $1 ,500. $1 ,500. That first
$1 ,500 of expenses is entirely non -deductible.
It just disappears. Therefore, the taxpayer can
only deduct the amount that exceeds the floor.
$5 ,000 minus $1 ,500, which leaves $3 ,500 as
the actual deduction. And if their AGI were higher,
say $100 ,000, 7 .5 % would be $7 ,500. If they
only had $5 ,000 in bills, their deduction would
be zero. Precisely. That's a stark illustration.
Now, what specific expenses are allowable once
you clear that high bar? The list is surprisingly
comprehensive. It includes payments to a wide
range of medical professionals, doctors, surgeons,
dentists, chiropractors, psychologists, even
home health care nurses and physical therapists.
And prescriptions. Also covered are prescription
drugs and insulin and necessary devices like
wheelchairs, hearing aids and prescription eyewear.
And insurance premiums, but only if they are
out of pocket post -tax payments. Exactly. And
qualifying long -term care insurance premiums
are also deductible, though the allowable amount
is limited. based on the taxpayer's age. We also
shouldn't forget transportation costs. Right,
mileage. The mileage accumulated for travel to
and from treatment is deductible at a specific
rate set by the IRS. But the real deep dive here
is the rule regarding capital expenditures. This
is one of those highly specific rules where the
tax code acknowledges severe long -term necessity.
it's a fantastic nuance expenditures advised
by a physician can be allowable if the expense
is reasonable and the facility or equipment is
used primarily by the patient the examples are
telling installing a swimming pool specifically
for therapeutic use for a degenerative disease
or an elevator for heart disease exactly wait
you can deduct the cost of a pool or an elevator
how does that work without letting people just
deduct general home improvements you don't deduct
the full cost you only deduct the portion of
the expense that exceeds the increase in the
value of the property. Oh, I see. For example,
if an elevator costs $20 ,000 to install, but
it only increases the home's market value by
$15 ,000, the remaining $5 ,000 is recognized
as a necessary medical expense and is deductible,
provided you clear that 7 .5 % AGI floor. So
it's an adjustment recognizing the necessary
accommodation over the property appreciation.
That distinction is key. And to finish this section...
What are the common items people assume are deductible
but actually aren't? Over -the -counter drugs,
unless they're prescribed. General health club
memberships for general fitness. And cosmetic
surgery, unless that surgery is restorative,
like after an injury, or to correct a congenital
anomaly. So there's a strict line between medical
necessity and discretionary choices. A very strict
line. That gives us a robust look at housing
and health. Let's shift our focus to the moral
and the accidental. Charitable giving and losses.
Charitable contributions are highly incentivized
by the government, a clear public policy objective.
The deduction allows taxpayers to reduce their
taxable income by supporting qualified organizations.
What are the main limitations we need to be aware
of here? The primary limits are based on your
AGI, typically falling between 30 and 60 percent
of AGI, depending on the recipient characterization.
So public charities versus private foundations,
things like that. Exactly. But the crucial rule
is that the recipient must be a qualified entity.
So we're talking churches, government entities,
veterans organizations, registered 501c3 charities.
Correct. You cannot deduct contributions to non
-eligible recipients, which would include individuals,
political campaigns or political action committees,
PACs. The money has to go to a tax exempt entity
that the IRS recognizes as serving a public benefit.
Now, let's talk about the non -cash donation
rules, goods or services. If I volunteer my time,
which is valuable, can I deduct that? This is
a common point of confusion. The value of your
donated services, your time, your labor, your
professional skills cannot be deducted. So if
you spend 100 hours doing pro bono accounting
for a charity. You can't deduct the value of
those hours. You cannot. But the expenses necessary
to provide those services are deductible. Precisely.
You can deduct reasonable expenses necessary
to provide those services, like mileage driven
to and from the site, the cost of special uniforms
required for the volunteering, or maybe the cost
of materials you purchased for the charity to
use. And for non -cash gifts like clothing or
property, the substantiation rules kick in pretty
fast. They do. If the non -cash donation is valued
at more than $500, you need special substantiation
on a separate form. And when you're valuing the
goods, the rule is generally to deduct the lesser
of the donor's cost or the current fair market
value. So you can't buy a used jacket for $10
and then claim a $50 fair market value deduction.
You cannot. Now, let's talk about the exception
that high net worth individuals absolutely rely
on. Appreciated stock. This is a massive aha
moment in charitable strategy. This is a textbook
example of how the tax code incentivizes a specific
type of giving. If you donate appreciated stock
that you have held for longer than a year, the
deduction is the full fair market value of the
stock on the date of the donation. That's amazing
on its own. You get a deduction based on the
high current value, not your lower purchase price.
But here is the massive tax benefit that is so
often overlooked. The taxpayer completely avoids
ever having to pay capital gains tax on the inherent
gain. Right. Had you sold the stock first, you
would pay capital gains tax on a profit and then
donate what's left. By donating the stock directly,
you get the full market value deduction and you
completely sidestep the capital gains liability.
A double benefit. A huge double benefit that
makes giving long term appreciated assets highly
strategic. It's the ultimate win -win scenario.
for tax efficiency. OK, moving on to the less
voluntary category, casualty and theft losses.
This covers sudden, unexpected losses to property.
And this deduction is incredibly hard to utilize
now because of the high financial floors imposed
on it. It's essentially limited to declared disaster
level events. That's the practical reality. The
loss has to exceed a double threshold. First,
there is a per event floor. which was set at
$500 starting in tax year 2009. Second, and much
higher, the aggregate loss must exceed 10 % of
the taxpayer's AGI. You have to clear both. So
if I have an AGI of $150 ,000, 10 % is $15 ,000.
If I lose $16 ,000 worth of property in a theft
or fire, the first $15 ,000 is non -deductible
because of the AGI floor. Correct. Then of the
remaining $1 ,000, I subtract the $500 per event
floor. I am left with a mere $500 deduction,
even though I lost $16 ,000. That's the severity
of the restriction. The source mentions the specific
context of Hurricane Sandy facilitating amendments
to 2011 tax returns for taxpayers in declared
disaster areas of Connecticut, New Jersey, and
New York. So when the president declares a major
disaster area, these strict limitations are sometimes
eased. Or the timing rules are adjusted, reinforcing
that this category is primarily geared toward
federal disaster relief, not routine insurance
deductibles or common losses. Our final category
is the strangest itemization rule because it's
entirely dependent on whether you won money.
Gambling losses. This rule is highly specific
and often misunderstood. Gambling losses are
only deductible to the extent of gambling income.
You can itemize losses, but they can never reduce
your other forms of income, like your salary,
investment returns, or business profits. This
prevents a taxpayer from claiming they are gambling
their way to a zero tax bill. Exactly. Let's
look at the cap using the examples. Scenario
one. A person wins $1 ,000 in various lotteries
and games during the year and loses $800 playing
poker. Okay. They report the $1 ,000 income,
and they can deduct the $800 loss, resulting
in $200 of net gambling income. Perfectly fine.
Scenario two. The taxpayer wins $3 ,000 but loses
$3 ,500 over the year. They report the $3 ,000
income. They can only deduct $3 ,000 of the losses
against that income. And the other $500. The
remaining $500 excess loss is not deductible.
It cannot be used against other income, and it
cannot be carried forward. It simply vanishes
for tax purposes. That is harsh. The only exception,
sources note, is if you are deemed a professional
gambler. Yes. For a professional gambler, the
activity is treated as a business. They can deduct
losses from other income, but they have to treat
the activity like a business, including deducting
relevant business expenses like travel and training.
It's a completely different legal and accounting
structure. We've covered the major categories
that survive the TCJA with their benefits intact.
or mostly intact. But now we have to turn to
the category that was almost entirely eliminated,
which heavily contributed to the success of the
new higher standard deduction, the curious case
of miscellaneous itemized deductions. This category
used to be a source of immense complexity and,
frankly, frustration for the upper middle class,
particularly salaried professionals. It was defined
by a severe limitation known as the 2 % floor,
or as we called it, the 2 % haircut. That name
perfectly describes the feeling of losing part
of your deduction before it even counts. What
exactly did the 2 % haircut entail for tax years
before 2018? It was a substantial hurdle. A taxpayer
could only deduct the total amount of miscellaneous
itemized deductions that exceeded 2 % of their
adjusted gross income, AGI. That initial 2 %
of AGI was the non -deductible floor, the haircut.
Let's quantify the real cost of that floor using
the provided example. A taxpayer has an AGI of
$50 ,000 and $4 ,000 in miscellaneous itemized
deductions. First we calculate the floor. 2 %
of $50 ,000 is $1 ,000. $1 ,000. That $1 ,000
is non -deductible, wiped out immediately. Therefore,
the taxpayer could only deduct $3 ,000. That's
the $4 ,000 in expenses minus the $1 ,000 floor.
So even with $4 ,000 in costs, they only get
a deduction for $3 ,000. And that's only if they
clear the higher standard deduction threshold
anyway. Exactly. The combination of the 2 % floor
and the standard deduction meant that this entire
category was often useless for the average employee.
And that's precisely why the entire category
became a major target for simplification. So
the TCJA didn't just trim the hair. It scalped
the entire category. Per the law, miscellaneous
itemized deductions were completely suspended.
They are not deductible for tax years 2018 through
2025. This is a massive change because it eliminated
expenses that many people viewed as necessary
costs of employment. Who was hit hardest by this
suspension? Primarily salaried employees who
incurred unreimbursed work -related expenses.
Think of the traveling salesperson, the consultant,
or the teacher who buys supplies out of pocket.
Before 2018, they could potentially deduct those
costs. Now they get zero benefit. Let's look
at some of the key now suspended deductions because
these are expenses people still incur, but now
without any relief. The list is long, but here
are the most impactful. First, unreimbursed work
-related expenses. This was a huge one, covering
job -related travel, professional continuing
education. But with a big caveat. Right, provided
the education didn't qualify the taxpayer for
a new line of work. For instance, an engineer
taking a course in advanced coding was deductible,
but a teacher going to law school was not. Okay,
what else? Job related clothing or equipment.
This covered necessary items like steel -toed
boots, safety goggles, hard hats, and specific
uniforms. But not a suit. The key distinction
was that the uniform had to be unsuitable for
social wear. Nurses, scrubs or police uniforms
were deductible. A standard suit or office attire,
even if required by the boss, was not. And a
few others. Union dues were previously deductible
in this category. Fees paid to tax preparers,
books or software used specifically to calculate
taxes owed and subscriptions to professional
journals or periodicals directly related to one's
job. That is a long list of legitimate business
costs that for. eight years offers zero tax benefit
to the employee. It really reinforces the TCJA's
goal of pushing the vast majority of taxpayers
out of itemizing and into the simplified standard
deduction. That was the clear legislative intent,
trade complexity for certainty. Now... To add
a final layer of esoteric nuance, the sources
remind us that while the general category was
suspended, there are 12 very specific deductions
listed in the U .S. code that were never subject
to the 2 % floor and were not suspended by the
TCJA. Why were these 12 exceptions treated so
specially? They are generally related to very
specific non -employee business costs or adjustments.
For instance, expenses of an impaired employee,
the deduction for amortizable bond premiums,
or certain costs. related to generating rental
income. So they were seen as more fundamental.
They were considered fundamental adjustments
to income rather than elective expenses, and
they were left untouched, highlighting the surgical
yet often arbitrary precision required when you're
drafting major tax legislation. OK, we've covered
the mechanics, the numbers and the specific items.
Now let's zoom out and discuss the why, the legislative
intent and the massive policy implications of
all these changes. As we've established, the
U .S. tax code is a reflection of social engineering.
Before 2017, the system often added complexity
by trying to claw back deductions from the very
highest earners. Right. We talked about the itemized
deduction phase outs, often referred to as the
P's limitations that existed for tax years before
2017. Exactly. P's limitations phased out itemized
deductions for high income taxpayers based on
their AGI. But the TCJA eliminated these phaseouts
and limitations entirely. That's interesting.
It's fascinating. While the TCJA restricted deductions
for the upper middle class through the high standard
deduction, the SALT cap, and the miscellaneous
suspension, it simultaneously removed the income
-based restrictions on the remaining itemized
deductions for the highest earners. So it created
a cleaner, less complicated system for the very
top earners, while restricting the ability of
upper middle earners, particularly those in high
tax states, from even reaching the itemization
threshold. That's the legislative outcome. It
reinforces the core observation that the U .S.
has such a complicated system because policymakers
prefer to pass policy through the tax code. Every
deduction is a deliberate choice to provide an
incentive. We see that so clearly. with the incentives
for homeownership through mortgage interest and
the encouragement of charitable giving. These
are public policy goals achieved by sacrificing
tax revenue. But the TCJA dramatically shifted
the field with what we're calling its grand bargain.
It was a tradeoff aimed squarely at simplification.
The combination of the dramatically higher standard
deduction, the hard $10 ,000 SALT cap, and the
suspension of the miscellaneous deductions led
to a critical mass. The result is that significantly
fewer taxpayers are now itemizing, the vast majority,
in fact. For taxpayers with average expenses,
filing taxes became vastly simpler because they
could take the high standard deduction and avoid
Schedule A entirely. The simplification was real
for the majority of Americans. But this bargain
came at a cost that was concentrated on two groups.
Right. High tax state residents who lost the
vast majority of their state and local tax deductions
and salaried professionals who lost the ability
to deduct unreimbursed business expenses. The
tax landscape became flatter, but the pain was
concentrated on those groups who previously relied
on those specific deductions. And finally, a
reminder on timing before we conclude. Deductions
are always reported in the tax year the expenses
were paid. A simple but critical detail. Whether
it's that annual membership fee or a property
tax installment, the payment date dictates the
deduction year. If you prepaid your January 2025
property taxes in December 2024, you claim them
on your 2024 return. That brings us to the end
of our deep dive into the standard versus itemized
choice. What's the final synthesis for you, the
learner? I think the most important takeaway
is that your annual tax choice is not just an
arbitrary calculation. It is a profound strategic
decision dictated by federal policy. The TCJA
made the standard deduction the default for most,
but understanding the intricate rules of itemization
remains crucial for those with high expenses
in housing, health, or charity. And for anyone
who might fall into that alternative minimum
tax calculation. Especially them. It's the difference
between taking the wide, fast highway and navigating
the complex but sometimes rewarding back roads.
The highway is now much wider. But we can't forget
that many of these itemized deduction rules,
including the high standard deduction amount,
the sole cap, and the suspension of the miscellaneous
deductions, have sunset provisions. They are.
They're set to expire at the end of 2025. Which
leads to our provocative thought for you, the
listener. If the suspension of the miscellaneous
deductions expires in 2025, how might a future
Congress use these expiring levers to rewrite
the economic landscape again? Think about the
implications. If Congress simply lets the current
rules expire, the 2 % haircut instantly returns,
making all those unreimbursed business expenses
matter again. And if they let the $10 ,000 SALT
cap expire, what happens to property values and
state budgets in high -tax areas? Will they see
a sudden cash infusion from high earners moving
back to the itemizing column? What public policy
objectives might they try to achieve by adjusting
just one of these figures? Will they prioritize
simplification again? Or will they use the tax
code to re -incentivize specific behaviors that
have been dormant since 2017? maybe by lowering
the AGI floor for medical expenses or restoring
a larger home mortgage deduction? This choice
is far more than a line on your 1040. It's a
direct barometer of U .S. legislative priorities.
It really is. Thank you for joining us for this
deep dive into decoding the tax deduction choice.
We'll see you next time.