Howdy, partners! I hope you’re all staying warm as this cold front sweeps across the U.S. When the temperatures drop, what better way to pass the time than by diving into taxes with Reasoned Reflections?

This week, we’re breaking down below-the-line deductions—also known as itemized deductions—and how they relate to the standard deduction.

TODAY ON REASONED REFLECTIONS:

• Personal finance articles 💰;

• Below-the-line deductions;

• Time to reflect;

• Quote of the Reflection.

Personal Finance Articles 💰

Time for a bit of R&R

• IRA tips and tricks

  My Take - IRAs are one of the most popular retirement tools, and we’ve covered them plenty of times in Reasoned Reflections. Whether it’s traditional vs. Roth, contribution limits, or withdrawal rules, there’s a lot to keep in mind. This resource pulls everything together in one place, making it easier to navigate the ins and outs of IRAs. 

• Rental properties and depreciation

  My Take - Rental properties are a popular way to generate passive income, but like everything in life, they come with their own set of complex tax rules. One key concept to understand? Depreciation recapture.

• Tax bracketology

  My Take - Next week’s Reflection will cover tax brackets and how they impact our overall tax bill. But if you can’t stand the anticipation, this article is a great resource to help you better understand how tax brackets work and how to manage your taxable income effectively. 

• Saver’s credit

  My Take - Last week, we covered the Saver’s Credit. Honestly, what could be better than getting a tax credit just for saving money? If you qualify, it’s a great way to reduce your tax bill while building your retirement savings.

• Saving for college?

  My Take - When it comes to saving for college, 529 plans are the cream of the crop thanks to their tax advantages. But if you’re looking for more flexibility in how the funds can be used, a custodial account can be a great complement. While 529s are designed specifically for education, custodial accounts allow you to save and invest for your child’s future without restrictions on how the money is ultimately spent.

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Looking ahead!

Whoa. Where did February go?! Next week marks the final Reflection on this month’s topic of taxes. We’ve covered deductions and explored tax credits. Now, to wrap things up, we’ll take a look at the progressive tax system and how tax brackets work.

Reflection No. 23: Below-the-line Deductions

I - Issue: What’s the difference between taking the standard deduction and itemizing? 

R - Rule: Below-the-line deductions reduce taxable income after above-the-line deductions. These deductions can either be itemized or taken as a standard deduction, and you should itemize only if your total deductions exceed the standard deduction amount.

A - Analysis: Let’s take a step back. When calculating your taxable income, you start with your gross income (typically found on your W-2), subtract above-the-line deductions to arrive at adjusted gross income (AGI), and then decide between the standard deduction or itemizing deductions.

Standard Deduction 

The standard deduction is the simpler option. It’s a fixed amount that lowers your taxable income without requiring you to track individual expenses. For tax year 2024, the standard deduction is $14,600 for single filers and $29,200 for married filing jointly. 

The Tax Cuts and Jobs Act of 2017 almost doubled the standard deduction. This change made it the better choice for most taxpayers..The increased standard deduction is set to sunset at the end of 2025, however, so tax rules could shift in the coming years.

One major benefit of the standard deduction is simplicity. Taking the standard deduction means there is no need to keep receipts or track every deductible expense. An added benefit is that the standard deduction also adjusts for inflation each year. 

Itemized Deductions

Certain expenses throughout the year can be deducted to reduce your taxable income. Itemizing deductions requires more effort but can be worth it if your eligible expenses exceed the standard deduction. Common itemized deductions include:

Mortgage Interest

In the same way the Tax Code rewards having kids, it also rewards—or incentivizes—homeownership. You can deduct mortgage interest on the first $750,000 of mortgage debt for a primary or secondary home. If you refinanced or purchased a home during the year, you can also deduct points paid at closing. Lenders will send Form 1098 to show the mortgage interest you paid.

Charitable Donations

You can deduct donations made to qualified charities, but the deduction can’t exceed 60% of your AGI. The IRS wants you to be generous but not so generous that you wipe out your entire tax bill.

State and Local Taxes (SALT)

Taxpayers can deduct state and local income taxes, sales tax, and property taxes but only up to $10,000 total. This cap was introduced by the TCJA and affects taxpayers in high-tax states. Unsurprisingly, many taxpayers in those states were SALT-y about this provision. Similar to the increased standard deduction, the SALT cap is set to expire at the end of 2025, though. 

Which Option Should You Choose?

Everyone qualifies for the standard deduction, but itemizing only makes sense if your deductible expenses exceed that amount.

For example:

• If your itemized deductions total $12,000, taking the $14,600 standard deduction is the better choice.

• If your itemized deductions total $18,000, then itemizing saves you more on taxes.

C - Conclusion: The standard deduction is the easiest and most widely used option, but itemizing makes sense if your deductible expenses exceed the standard deduction.

Time to Reflect…

As we’ve covered in a previous Reflection, everyone can take above-the-line (ATL) deductions, but only those with significant below-the-line (BTL) deductions should itemize. Otherwise, the standard deduction usually saves more money.

Here’s how taxable income is calculated:

• Income – ATL Deductions = Adjusted Gross Income (AGI)

• AGI – (Standard Deduction or BTL Deductions, whichever is greater) = Taxable Income

Quote of the Reflection