Money Girl answers 7 common questions about paying income tax that will help you comply with the law, minimize what you owe, understand tax deductions and credits, pay household workers or nannies properly, and avoid trouble if you can’t pay Uncle Sam on time.
Question 2: When should you itemize income tax deductions?
Money Girl listener Megan S. wants to know if she should itemize deductions and how to make it easier. Megan, thanks for sending in your questions.
Deductions are important because they reduce your taxable income and therefore the amount of tax you owe. Every year you’re allowed to choose between claiming a standard deduction or itemizing deductions.
I previously mentioned that for 2018 the standard deduction is $12,000 for singles and $24,000 joint filers. When your total itemized deductions exceed the standard for your tax filing status, you’ll come out ahead by itemizing.
The trick is to understand which expenses are deductible and to keep track of them carefully throughout the year. Then you can compare the actual value of your deductions to the standard deduction and choose the method that cuts your taxes the most.
Reform under the Tax Cuts and Jobs Act of 2017 significantly increased the standard deduction from 2017 to 2018 and changed or eliminated some popular deductions. So, if you itemized in the past, you may find that claiming the standard deduction save you more now.
Here are some of the most common and valuable deductions you should track:
- State and local taxes, including real estate taxes, up to $10,000
- Home mortgage interest and points paid on up to $750,000 of debt to buy, build, or improve a primary or secondary residence
- Medical and dental expenses that exceed 7.5% of adjusted gross income (goes up to 10% in later years)
- Charitable donations up to 60% of adjusted gross income
But what if you don’t have enough deductions to make itemizing pay off? Don’t worry, there are some deductions you can take even if you claim the standard deduction. For 2018, they include:
- Educator expenses up to $250
- Health Savings Account contributions up to a maximum of $6,900 when you have a high-deductible health plan
- Self-employment expenses, such as one-half the self-employment tax; contributions to a SEP, SIMPLE, or qualified retirement plan; and health insurance payments
- Alimony you paid
- Traditional IRA contributions up to a maximum of $6,000 (or $7,000 if you’re age 50 or older)
- Student loan interest up to $2,500 (if you meet certain income limits)
Megan, I recommend using a program such as Quicken or Mint to categorize these expenses throughout the year. Then you can simply run a report at tax time. For mortgage interest, your lender will send you Form 1098 for any year that your interest exceeds $600.
Question 3: Who can claim the home mortgage interest tax deduction?
And speaking of the home mortgage interest tax deduction, that’s a surprisingly complicated tax benefit. And, yes, the rules for claiming it recently changed with tax reform.
Here’s a voicemail question from Cassie B. who says: “My parents pay the mortgage and property taxes on my home, but my name is on it the title. I pay rent to my parents in order to reimburse them for paying the mortgage. So, can I claim the mortgage interest deduction on my taxes or is that only available to my parents since they’re officially paying the mortgage?”
Thanks so much for your question. (And by the way, if you want to leave your money question, just call (302) 364-0308.)
The interest you pay on a mortgage, a home equity line of credit (HELOC), or a home equity loan for your primary residence or second home can only be deducted from your income when these two conditions are met:
- You must file taxes on Form 1040 and itemize deductions on Schedule A.
- You must have a secured debt on a qualified home in which you have an ownership interest.
Be aware that the total amount of home debt that you (and a spouse if you file taxes jointly) can base this deduction on changed from $1 million to $750,000, for loans closed starting in 2018.
So, if you have an older loan, you can still deduct interest based on $1 million worth of debt, or $500,000 if you’re married and file taxes separately. But if you have a newer loan, the limit is now $750,000, or $375,000 if married filing separately.
I frequently get questions, like Cassie’s, about who is entitled to claim the deduction. The answer is that you can only claim the mortgage interest deduction for interest that you actually paid.
Since her parents make the mortgage payments, they are the only ones allowed to claim the interest deduction, in any year that they itemize. And if they don’t itemize, no one can claim the deduction.
The bottom line is that you need some form of written proof stating your ownership and the amount of mortgage interest you paid during the year in order to qualify for the deduction.
Another question comes up when you co-own a property and pay half of the mortgage. In that case, each person would be eligible to deduct 50% of the interest. Even if your name isn’t listed on a Form 1098, if you have an ownership interest in a primary or secondary residence and paid mortgage interest, you can deduct the portion you paid.
If you’re like the caller and own a home, but are not listed on the mortgage, one tip is to make payments directly to the lender, instead of paying rent. When you reimburse someone else’s mortgage debt so they can make the loan payment, you can never claim the interest deduction.
So, if the caller’s parents allowed her to pay the lender directly, she could claim the mortgage interest deduction. Another option is for the caller and her parents to create a written contract that spells out her ownership interest. In that case, I would still recommend that she make payments directly to the lender for a clear paper trail.
Another situation is paying someone else’s mortgage out of the goodness of your heart because they’re unemployed or facing foreclosure. Again, if you don’t have an ownership interest in the property, you’re not entitled to claim the interest deduction.
The bottom line is that you need some form of written proof stating your ownership and the amount of mortgage interest you paid during the year in order to qualify for the deduction. If you have a more complicated situation, be sure to speak with an accountant or a legal professional who specializes in real estate.
Question 4: If my raise puts me in a higher tax bracket, will I get less pay?
When you get bumped into a higher tax bracket, pat yourself on the back! The U.S. tax system is progressive, which means that not all your income is necessarily taxed at the same rate.
A tax bracket is a range of income that’s taxed at a certain rate. Each bracket gets assigned a progressively higher rate, which means only a portion of your income is taxed at the highest rate.
There are seven tax brackets for 2018: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. If you’re in the 24% tax bracket, your entire income is not subject to 24% tax—that’s just the highest rate that’s applied to your top range of income.
Let’s say you’re a single taxpayer who made $80,000 in 2017. That amount of income put you in the 22% tax bracket. But for 2018, you got a raise and made $83,000.
You realize that the cut-off between the 22% bracket and the next highest, 24% tax bracket is $82,500. So, should you worry about getting bumped from the 22% bracket into the 24% bracket? Absolutely not!
You should be thrilled to get a raise because your income won’t be taxed any differently—except for the amount that falls within the top 24% tax bracket, which is $500. Again, $500 is the only amount that will be taxed at 24%, the top rate for your bracket.
No matter your tax bracket, getting a raise always means that you take home more money. Use the IRS Tax Rate Schedules to find out your bracket and calculate how much tax you may owe based on your income. Depending on where you live you may also have to pay state income tax.