Should I itemise my deductions?

When you file a federal income tax return, you must choose between taking the standard deduction or itemising your deductions. These are the main two ways of reducing your adjusted gross income (AGI), so making the correct decision is important for reducing the tax you owe (or maximising a potential refund).

 

What is the standard deduction and how much am I entitled to?

The standard deduction, as the name suggests, is a flat amount that the IRS lets you deduct from your gross income to lower the amount that is taxable regardless of any expenses. How much you are entitled to will depend on your filing status.

For the 2023 tax year, the standard deduction amounts are as follows:

  • Single (Or Married filing separately) – $13,850
  • Married filing jointly – $27,700
  • Head of Household – $20,800

These figures are adjusted yearly and usually increase with inflation.

As a non-resident alien (any individual who is not a U.S. citizen or U.S. national and does not pass the substantial presence or green card test) you are not entitled to any standard deduction at all. Unless you are a student or business apprentice from India, in which case you may be eligible to claim the standard deduction.

 

What does it mean to itemise deductions?

When you choose to itemise your deductions, you are making a list of expenses that will be deducted from your gross income. The catch here is that they need to be qualifying expenses approved by the IRS.

A brief overview of some of the most common deductions that can be claimed on Schedule A:

  • Mortgage interest (on up to $750,000 of principal for mortgages incurred after December 31st, 2017 and $1m for those incurred before)
  • State & local income tax, sales tax and property tax (capped to $10,000)
  • Medical and dental expenses (over 7.5% of AGI)
  • Charitable donations made to US public charities
  • Gambling losses (only to extent of gambling winnings reported)

This is not an exhaustive list but should give you an idea on the type of expenses which are available to claim.

 

So, should I Itemise?

Once you have gathered all the necessary documentation and receipts for the qualifying expenses you would be claiming, the decision becomes quite trivial. Generally speaking, you should itemise your deductions if they exceed the standard deduction. And you should take the standard deduction if your qualifying expenses are below the standard deduction.

If you are a US taxpayer living abroad, it may be more beneficial to itemise your deductions even if they fall short of the standard deduction.

This situation often arises when you are paying a high foreign tax rate on all sources of income. Without itemising, the standard deduction will be rateably allocated between US and foreign sourced income. The foreign income is already offset by foreign tax credits, so much of the deduction is lost or has little to no impact on your tax liability.

To counter this, you can itemise your deductions and specifically allocate certain amounts directly against US sources of income. The most common deductions that can be specifically allocated are state & local taxes and US charitable donations.

Additionally, claiming the Standard Deduction can inadvertently lead to a small “alternative minimum tax” liability. Claiming a smaller amount of itemised deductions can reduce this liability for UK based taxpayers without any increase in net tax because of the availability of foreign tax credits.

 

Since personal circumstances change from year to year, reassessing whether to itemise or take the standard deduction every year is crucial to optimise tax savings. On top of your individual tax situation, you will need to consider any changes to the standard deduction or any tax law changes.