How to decide whether to itemize (if you need to do the same in state tax return as federal)

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Counterpoint
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How to decide whether to itemize (if you need to do the same in state tax return as federal)

Post by Counterpoint » Fri Jan 05, 2018 8:58 pm

This applies to taxpayers living in states where you have to do the same thing on your state return (itemized vs standard deduction) as what you do on your federal return. This is true in our instance, plus our state’s standard deduction is much lower than the federal ($4000 for MFJ in our state). In these circumstances, it may make sense to itemize even if your deductions are less than the standard federal deduction ($24K for MFJ). This is because your benefit from itemizing on your state return may exceed what you give up on the federal return.

So it would make sense for you to run your tax software to see what you should do. However, since the software is not yet available for the new tax rules, in order to help with tax planning (e.g. deciding on bunching) I’ve provided below my thinking on how to figure out whether you should itemize or not. If my logic is correct (would appreciate any feedback on that), perhaps it will help some folks in their tax planning.

For this example, I’m assuming a state standard deduction of $4000, a marginal Federal tax rate of 24% and a marginal (State+Local) tax rate of 9%.

If X in itemized deductions is the breakeven point where it makes sense to start itemizing, then the amount you gain on your state return is (X - 4000) x 9%. What you lose on the federal return (by itemizing compared to taking the standard deduction of $24000) is (24000 - X) x 24%. If you equate the two, i.e. (X - 4000) x 9% = (24000 - X) x 24%, you can solve for X which is $18,545.

So in this situation it would make sense to itemize if your deductions are above $18,545 rather than waiting till $24,000. You can put in your specific marginal tax rates and state standard deduction (and federal standard deduction if you’re not doing MFJ) into the equation above to see at what level you should start itemizing.

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Re: How to decide whether to itemize (if you need to do the same in state tax return as federal)

Post by grabiner » Fri Jan 05, 2018 10:49 pm

Remember only to count deductions which are allowed on both returns. In most states, you cannot deduct state income tax. Thus, if you pay $3000 in property tax and at least $7000 in state income tax, your state itemized deductions will be $7000 less than your federal itemized deductions.
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Counterpoint
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Re: How to decide whether to itemize (if you need to do the same in state tax return as federal)

Post by Counterpoint » Sat Jan 06, 2018 11:28 am

grabiner wrote:
Fri Jan 05, 2018 10:49 pm
Remember only to count deductions which are allowed on both returns. In most states, you cannot deduct state income tax. Thus, if you pay $3000 in property tax and at least $7000 in state income tax, your state itemized deductions will be $7000 less than your federal itemized deductions.
Excellent point, grabiner.

For anyone wants to whack through the arithmetic weeds to figure out their situation: If we take grabiner’s example ($3K in property taxes and $7K in state taxes to make up the $10K max in SALT deductions), then what I mentioned earlier would have to be adjusted as follows. If X is still the amount that can be deducted for federal purposes, then X-7000 becomes the lower amount that can be itemized for the state return. So the savings on the state return are (X-7000 - 4000) x 9%. And when you equate it to what’s given up on the federal return, which is still (24000-X) x 24%, X is solved to be $20,450. So in this example it would be worth it to start itemizing with total federal deductions of $20,450.

In any case, for folks in the above situation it would be worth running the tax software when available to see if they should itemize even if their total itemized federal deductions are below $24K.

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