Maximizing Tax Savings: Beyond the Standard Deduction

Published on Sunday, February 25, 2024

Filing your federal tax return often boils down to a straightforward decision: if your itemized deductions is more than the standard deduction, itemize; otherwise, stick with the standard deduction.

But is that the optimal answer?

Not always.

State Income Tax Considerations

Let's take a scenario: a couple residing in Virginia with a combined federal adjusted gross income (AGI) of $130,000 and itemized deductions totaling $27,000. For the tax year 2023 and a federal standard deduction of $27,700, itemizing seems less favorable. By opting for the standard deduction, their federal tax bill would be $154 lower than if they itemized.

But now consider their state income tax return. Virginia mandates using the same deduction method for state taxes as for federal taxes. With a state standard deduction of $16,0001, choosing the standard deduction means a state tax bill $632 higher compared to itemizing.

When we combine both tax bills, the couple would save $478 by itemizing their deductions. Yes, they'll pay more federal income tax, but the savings on their state income tax bill more than compensates for it.

To be clear, the fewer deductions our couple can itemize, the smaller the advantage of itemizing. At the extreme, if our couple itemized only $16,000 of deductions, then they’d pay $2,574 more in federal tax but their state tax would remain the same.

Discovering the Crossover Point

What is the point at which you should itemize your deductions even if they are lower than your standard deduction? By considering marginal tax rates and standard deductions at both federal and state levels, the following equation unveils the optimal strategy:

Deduction Crossover Point = (Federal Standard Deduction * Federal Marginal Tax Rate + State Standard Deduction * State Marginal Tax Rate) ÷ (Federal Marginal Tax Rate + State Marginal Tax Rate)

For our couple in Virginia with a Federal Marginal Tax Rate of 22% and a Virginia Marginal Tax Rate of 5.75%, their Deduction Crossover Point sits at $25,276. If their total itemized deductions exceed this amount, itemizing becomes the wiser choice.

The optimal point depends on your situation. For example a single person with a federal federal marginal tax rate of 24%, and a Maryland marginal rate of 4.75%, with standard deductions of $13,850 and $2,550 (respective), the crossover point is $11,983, nearly $2,000 less than their federal standard deduction.

You can use this simple calculator to find your crossover point:

Federal Standard Deduction:
Federal Marginal Tax Rate
%
State Standard Deduction:
State Marginal Tax Rate:
%
Itemize Crossover Point:
25275

Not So Simple

However, this simplified approach overlooks certain complexities. Federal taxable income can impact refundable credits like Maryland's Child and Dependent Care Tax Credit, altering the credit amount received. Moreover, taxpayers nearing marginal rate boundaries might require adjustments to find the correct optimum.

Ultimately, the most effective strategy involves completing both federal and state tax returns using both methods. Whichever method yields the lower overall tax bill should be adopted.

Conclusion

With the increase in the federal standard deduction, fewer taxpayers benefit from itemizing deductions. Yet, if your state imposes an income tax and its standard deduction falls short of the federal counterpart, itemizing could prove more beneficial, even if deductions are lower than the standard deduction.

Footnotes

  1. [1]: The MFJ standard deduction for Virginia is set to revert to $8,000 in tax year 2025.
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