Itemizing Deductions When Standard is Higher

“We become what we think about.” – Earl Nightingale

According to Mr. Nightingale, I must be taxes.  As many of you who know me are aware, I became addicted to learning tax law in my senior year of college.  I went on to intern with, and later work for, PricewaterhouseCoopers in Atlanta and complete a Masters of Taxation degree.  The prospect of planning around taxes to minimize burdens and put cold, hard cash back into clients’ hands became a passion.  So why would I tell you to itemize your deductions even if the standard deduction is higher?

Tax Cuts and Jobs Act of 2017

Most of you know that the so-called “Trump Tax Cuts” law passed in late 2017, becoming effective for tax years beginning in 2018.  This law expanded the standard deduction for individuals by roughly doubling them (see chart below). 

The tax rules state that taxpayers get to take the GREATER of their standard deduction amount or their itemized deduction.  Along with the removal of various itemized deductions, the increased standard deduction amounts have caused a super-large majority of taxpayers (estimates of 90%+) to simply use the standard deduction.

Georgia State Income Taxes

All the above sounds well and good until you look at the Georgia Form 500 individual income tax return.  The rules state that if a taxpayer uses the standard deduction on their federal return, they must use the standard deduction for state.  Likewise, if they itemize their deduction for federal, they must itemize for state.  The state standard deduction is much less than federal (see chart below).

When deciding whether to file your federal taxes with the standard deduction or itemize, it is important to keep good records and enter all data into your tax software.  Most people will just assume if their deductions for medical, mortgage interest, state taxes, and charity don't exceed their standard deduction they can leave all their itemized deductions off.  This may be a mistake!

The Math

The basic breakdown is that federal tax rates are much higher than the state of Georgia, which quickly cap out at 6%.  So, you don't want to forgo much in federal breaks for the benefit of state deductions.  The formula I devised below provides the breakeven itemized deduction threshold where it would start making sense to itemize rather than taking the standard deduction.

Where SDF = Federal Standard Deduction; TRF = Federal Marginal Tax Rate; SDS = State Standard Deduction; and TRS = State Marginal Tax Rate

By utilizing this formula and the various situations taxpayer would find themselves in, I have created the following table as a quick reference guide.  You would simply determine your filing status, the range in which your taxable income for the year falls, and the “Itemized Deduction” column shows the minimum amount of total itemized deductions you need where itemizing provides a better benefit than claiming the standard deduction.

Example 1: Jaime and Alan are 60-year-old married taxpayers filing jointly.  Their income is $50,000, mostly from retirement accounts and interest.  They donate heavily to their church in the amount of $14,000 per year.  They also have real estate taxes of $3,500, state income taxes of $1,000, and mortgage interest of $2,500.  Their total itemized deductions equal $21,000 (simple sum of the above).  Their standard deduction is $24,400 for 2019, or $3,400 more than itemizing.  However, their itemized deductions are greater than the $18,267 shown in the chart above so it makes more sense if they opt to itemize.  Their net savings would be approximately $500 in this situation.

      • Higher Federal taxes = $3,400 in lower deductions * 12% federal tax rate = $408
      • Lower State taxes = $15,000 in higher deductions * 6% state tax rate = $900
      • Net = $492 less in taxes

Example 2: Tim is a single taxpayer making about $100,000 in total income from his job, interest and dividends on investments, and a few capital gains.  He has paid $4,000 in state income tax, $2,000 in real estate tax, $3,000 in mortgage interest, and donates $2,000 to charity each year.  His total itemized deductions are $11,000 (simple sum of the above).  Being single, his 2019 standard deduction is $12,200, or $1,200 more than itemizing.  However, his itemized deductions are greater than the $10,680 shown in the chart above so it makes more sense if he opts to itemize.  His net savings is about $100 in this situation.

Caution

As you age, the state of Georgia provides a "Retirement Income Exclusion," allowing a deduction against income of $35,000 per person once you reach age 62 or if disabled, regardless of age.  At age 65, the deduction increases to $65,000.  This allows taxpayers to offset up to $4,000 of earned income and all interest, dividends, capital gains, retirement plan distributions, pensions, annuities, etc. up to the stated limit.  This deduction is done on a per person basis according to income allocable to each person.  Unfortunately, it is not as simple as saying $65,000 * 2 for married folks.  Regardless, as you might imagine, this eliminates the state tax burden for many seniors and alters the arithmetic above.

The guide, shown above, should be utilized as a first step to get an idea if claiming itemized deductions will be better for you, even if the standard deduction amount is higher.  Additional calculations will likely be necessary to determine the true benefit.  Please consult with your tax advisor to make decisions for your specific situation.

Conclusion

Sometimes the best solution is to do what nobody thought rational: purposefully claim less in deductions to minimize your overall tax burden.  Because of the interaction between the federal and Georgia state tax laws, it is imperative to evaluate your decisions on a holistic basis.  As always, I strongly recommend discussing this and any other planning ideas with your financial advisor in addition to your tax advisor.

 

Bryan Strike, MS, MTx, CFP®, CFA, CPA, PFS, CIPM is a Senior Financial Advisor at Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at bstrike@scottkays.com.

Nothing mentioned in this article constitutes tax advice.  Please consult your personal tax advisor.