Dictionary of Tax Deductions

Home | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z |

Edward A. Lyon, JD
TaxTuneup.com, Inc.
3416 Shaw Ave #5
Cincinnati OH 45208
513.321.2821
elyon@taxtuneup.com

Illegal Income

Illegal income is taxable as ordinary income. The IRS doesn't care how you make it. They just want their share. And requiring you to pay tax on it gives the government another way to catch you if you don't. Remember who finally nailed Al Capone!

The good news is, you can deduct most business expenses directly related to illegal income (except for illegal expenses or expenses "contrary to public policy," such as prostitutes for clients or the costs of rubbing out "Tony the Tuna"). If you're a bookie, for example, you can deduct the cost of phone lines you install to take bets.

Immediate Annuity (See Annuity)

Incentive Stock Option (See Stock Options)

Index Funds

Index funds are a category of mutual funds that aim to passively track a particular index, such as the S&P 500 or the Russell 2000. The largest funds do it by buying every security tracked in the index. Smaller funds do it by buying a representative sample, or by buying options on the index. Index funds have exploded in recent years, with more than 200 index funds tracking large-cap, mid-cap and small-cap indexes, foreign indexes, and fixed-income indexes. There's even a fund that purports to track an index of "tombstone" stocks: funeral homes, cemeteries, and casket makers.

Index funds offer these advantages over their actively managed competitors:

• Index funds deliver consistently superior returns. Critics accuse them of guaranteeing mediocrity. But, considering that index funds beat the majority of their actively-managed rivals, indexing is actually more like guaranteeing par. Index proponents aren't likely to score the knockout punch proving indexing unbeatable. But the evidence suggests that in taxable accounts, the rewards of trying to beat the index just aren't worth the cost.
   

• Index funds are cheap. Since they don't actively try to beat the market, they don't pay the costs of trying: manager's fees, research, and trading costs. Index funds as a group have the lowest expense ratios in the business. The average stock fund, for example, costs 1.47% per year. The average index fund costs just 0.62%, with some funds ranging below 0.20%. That means the average actively managed fund has to beat the average index fund by 0.85% just to break even before paying extra taxes.
   

• Index funds are the most reliable way to implement asset allocation choices. They don't hold large cash reserves, so performance isn't diluted. And they don't make big bets outside their published objectives. For example, in the spring of 1997, Fidelity Magellan's Jeffrey Vinik, fearing a stock market downturn, made large bets on bonds. He was wrong--and he lost billions for investors who thought they were buying stocks.

True index funds--those that buy the entire index, and hold it--enjoy a huge tax advantage over actively managed funds. Low turnover means low realized Capital Gains, therefore, low taxable gains. Each time an active fund manager sells a stock at a profit, she generates a capital gain to be distributed and taxed to shareholders. Index funds sell only when necessary to redeem exiting shares or when the index itself changes. Index funds can also hold less cash than active funds since index investors redeem their shares less often. In fact, many index funds limit transfers just to hold down this sort of expensive turnover.

Some index funds don't actually buy their underlying index. Instead, they buy a representative sample to track it. Some funds may use options or futures to track the index or even beat it. These options and futures generate short-term gains--and lots of them. They don't give you the tax advantages of true index funds. So, be careful when you index. Hold true index funds in taxable accounts. Buy proxy index funds, enhanced index funds, and leveraged funds in your IRA or retirement accounts.

Be especially careful before you buy "leveraged" index funds. These are funds that use options or futures to return a multiple of the index's return each day. For example, a leveraged fund might aim to earn 150% of the S&P 500's daily return. This leverage can be a double-edged sword. In down markets, the funds fall faster than the index. This means your future gains build back from a lower base. University of Chicago professor Richard Polson has calculated that leveraged funds can lag their index and even lose money when the index rises.

The S&P 500 includes over 70% of the U.S. stock market, by market capitalization. But it's far from the only index available:

• You can track growth and value indexes for large-cap, mid-cap, and small-cap stocks. Growth indexes are more efficient because of lower dividends, but also more volatile. This makes sense considering the underlying characteristics of growth and value stocks themselves.
   

• You can track smaller stocks with the Russell 1000 (the largest 1000 companies by market capitalization), the Russell 2000 (the next-largest 2000 stocks by market capitalization, often used as a proxy for small stocks), the Wilshire 4500 (the entire U.S. stock market minus the 500 largest companies), and the Wilshire 5000 (the entire U.S. market). You can also track small-cap growth and small-cap value indexes. Some advisors believe indexing is less effective with small stocks because this market is less efficient and there is more room for an active manager to add value. These indexes also have more substitutions, which boosts turnover and realized capital gains. But the evidence suggests that indexing these markets still adds value by cutting costs and reducing turnover.

• International investors can track over two dozen developed-market, emerging-market, and individual country indexes.
   

• You can even track indexes for real estate, socially-conscious stocks, and Commodities.

Finally, buying index funds and holding them for long-term returns lets you sleep late and ignore the hype of mutual funds marketing. Magazine covers tout "Hot Funds to Buy Now"; market gurus fill newsletters and airwaves with tips. The hype implies that the key to making money is picking the right horse. But as we've seen, most active portfolio management falls short of its promise. Buying an index fund lets you bet on every horse.

Individual Retirement Account

Individual retirement accounts, or IRAs, are tax-deferred retirement savings accounts. There are several different types of IRAs, including ordinary deductible IRAs, Nondeductible IRAs, Spousal IRAs, and Roth IRAs.

Ordinary IRAs, the most common type, let you deduct your contribution (subject to certain qualifications) and compound your earnings tax-deferred for retirement:

• Anyone with earned income (salary, self-employment income, etc.) can contribute to an IRA.

• You can contribute 100% of your earned income up to $5,000 (2008). If you're age 50 or older, you can make an additional $1,000 "catchup" contribution.

• If you don't actively participate in an employer retirement plan, you can deduct your contribution as an adjustment to income regardless of how much you make. If you do participate in an employer retirement plan, you can deduct your contribution if your adjusted gross income falls within these limits:

• You have to deposit cash. You can't transfer securities from another account.
   

• You can put almost any investment in an IRA: bank deposits, stocks, bonds, mutual funds, real estate, mortgages and other loans, private placements, even limited partnerships. About the only things you can't buy are most collectibles (rugs, wine, stamps, etc.), and certain options and futures investments.
   

• It pays to contribute early. You can put your money in as early as January 1 or as late as April 15 of the following year. If you contribute on January 1 and earn a steady 10.5% return, your contribution will already be worth $2,276 by the April 15 deadline.

• If you withdraw money before age 59½ you'll owe ordinary income tax plus a 10% penalty tax on withdrawals. See below for exceptions to this rule.
   

• Once you reach age 59½ you can withdraw money as ordinary income. Your trustee will report your withdrawals on Form 1099-R. The entire withdrawal is taxed as ordinary income, unless you've made nondeductible contributions (see below).
   

• You have to start taking money out by April 1 of the year after you reach age 70½.

• When you die, your IRA passes to your designated beneficiary and avoids probate. If your beneficiary is your spouse, he or she can take over the account as his or her own.

• IRA account fees are a Miscellaneous Itemized Deduction subject to the 2% floor. You have to pay the fee out of your own pocket to take this deduction; you can't claim it for fees you pay directly out of your account.

• IRA sponsors report contributions to the IRS, so if you fail to make your contribution by the April 15 deadline, don't just take the deduction and hope for the best. IRS computers can cross-check your return against contributions to verify the deduction.

Spousal IRA

A spousal IRA is an ordinary IRAs for a nonworking spouse. The contribution limit is the same $5,000 as for ordinary IRAs. Your combined income, minus the working spouse's own IRA, has to be enough to cover the nonworking spouse contribution.

If the working spouse doesn't actively participate in an employer retirement plan, the nonworking spouse can contribute $5,000 regardless of your income. If the working spouse does participate in an employer retirement plan, the nonworking spouse can contribute so long as your adjusted gross income is $150,000 or less. Otherwise, the rules are the same as with ordinary IRAs.

Penalties on Early Withdrawals

IRAs are intended as long-term retirement accounts, not merely tax-deferred savings accounts, so the IRS imposes a 10% penalty on most withdrawals before age 59½. Here are the exceptions:

• There's no penalty for withdrawals due to death or disability.
   

• There's no penalty to withdraw money from a regular IRA (but not a Roth IRA) to pay for unreimbursed Medical Expenses (up to the amount allowed as a medical expense deduction).
   

• There's no penalty for withdrawals of up to $10,000 (lifetime maximum) used within 120 days of the withdrawal for qualified acquisition costs of a "first-time homebuyer." To qualify, neither you nor your spouse may have owned a primary residence for two years before the withdrawal.
   

• There's no penalty to withdraw money for higher education expenses (including tuition, room and board, fees, books, supplies, supplies, and required equipment).
   

• There's no penalty to withdraw money if you're retired and over age 55.
   

• There's no penalty or tax to transfer money to a divorcing spouse under a qualified domestic relation order. 
   

• You can take money from your IRA and deposit it in a different IRA within 60 days. The redeposit qualifies as a rollover and there will be no tax due at all. You can use this strategy once within a 12-month period.

If you need to withdraw funds from a regular IRA (but not a Roth IRA), code section 72(t) lets you avoid the 10% penalty if you "annuitize," or take the funds in a series of substantially equal payments over your life expectancy. You'll owe ordinary tax on each withdrawal, but you'll avoid the 10% penalty. You'll also have to keep withdrawing funds for five years or until you reach age 59½, whichever is longer. The IRS has identified three safe harbor methods for calculating withdrawals:

• The "life expectancy" method lets you divide the balance of your IRA account by your life expectancy (or the joint and last survivor expectancy of you and your designated beneficiary) as shown in IRS Table VI. You can recalculate this amount each year, or simply reduce your life expectancy by one for each year you make withdrawals. This method yields the smallest annual payment because it doesn't consider future earnings in the account.

Example: You are a 50-year-old man and your IRA balance is $100,000. IRS Table VI shows your life expectancy as 33.1 years. You may withdraw $3,021 without penalty.

• The "amortization" method lets you amortize your IRA like a mortgage (using your single life expectancy or the joint and last survivor life expectancy of you and your designated beneficiary) and a reasonable long-term interest rate. This method yields larger withdrawals because it lets you withdraw anticipated future earnings as well as your current principal. The IRS suggests that a reasonable rate is 120% of the "federal midterm rate," which is a figure the Treasury publishes monthly to value gifts and annuities. You could also use a local bank's rate for long-term fixed-rate mortgages. You can even include an annual inflation factor to increase withdrawals each year.

Example: You're a 50-year-old man, your IRA balance is $100,000, and you set an 8% interest rate for amortization. $100,000 amortized at 8% for 33.1 years yields $8,679 per year. You may withdraw $8,679 without penalty.

• Finally, the "annuity factor" method lets you amortize your account balance as with the amortization method, above, but with insurance company mortality tables. These tables generally project shorter life expectancies, which let you withdraw more per year.

You can take your withdrawals any time throughout the year so long as your annual total satisfies the requirements. Your IRA custodian will send you a Form 1099-R describing the withdrawal as an "early distribution, no known exception." In this case, you'll have to file Form 5329 with your return to avoid the 10% penalty.

Section 72(t) can be a useful escape hatch. But, if you start taking withdrawals according to plan, you're locked in! If you deviate from schedule, you'll lose your safe harbor, triggering the 10% penalty plus interest on all your withdrawals. This is true even if you make an extra penalty-free withdrawal. For example, you can't start withdrawals under Section 72(t), then take extra money for college tuition or medical expenses. The only exceptions are death, disability, and perhaps divorce. (The IRS has ruled privately that an individual taking withdrawals under 72(t) could transfer part of the account to a divorcing spouse with a Qualified Domestic Relations Order; however, the IRS did not explicitly state that the individual could continue withdrawals according to the smaller account balance.) So be careful before you start down this road; no detours are allowed.

         Minimum Required Distributions

Since IRAs are intended as retirement savings plans, not wealth-transfer vehicles, you have to start taking money out of your ordinary IRA, nondeductible IRA, or spousal IRA by April 1 of the year after you reach age 70½, the "required beginning date." This led to a some of the tax code's most Byzantine rules. Previously, you were required to choose a beneficiary and a distribution schedule by age 70½ -- and once you made your choice, you were locked in. Those rules are gone!  On January 11, 2001, the IRS issued new proposed regulations, effective retroactively to January 1, 2001, that let you create a stretchout IRA with virtually no advance planning. If you blew your chance under the old rules, you get another crack under the new. The new regulations outline a simplified set of rules and a uniform life expectancy table that let you withdraw less than under most previous methods. 

Of course, there's a catch. It used to be that you calculated your own minimum required distribution and reported it yourself. Now, your IRA  custodian or qualified plan administrator can calculate your minimum required distribution for you -- and helpfully report that amount to the IRS. This lets the IRS cross-check your return with your plan sponsor's report. just as they do with interest and dividend income reported on Form 1099.

To calculate your minimum required distribution, simply divide your account balance by your distribution period determined according to your age. If you have more than one IRA, you have to calculate a required minimum distribution for each separate account. However, you can withdraw the required total from a single account.

You have to take your first distribution by April 1 of the year after the year in which you reach age 70½. That distribution counts for the calendar year in which you reach age 70½. You must take your next distribution by December 31 of the same year. That second distribution is based on the same December 31 account balance, minus the amount of your first distribution. This will raise your adjusted gross income for figuring your deductions and credits, and may bump you into a higher tax bracket. If this will be the case, consider taking your required minimum distribution in the actual year in which you reach age 70?, rather than waiting until the required beginning date.

Example: Husband reaches age 70? on August 1, 1998, and rings out the old year with $100,000 in his IRA. Husband's distribution period at age 70 is 26.2 years. Husband must withdraw 1/26.2 of his December 31, 1998 account balance, or $3,817, by April 1, 1999. His December 31, 1999 withdrawal will be based on a $96,183 account balance.

If your spouse is your beneficiary, and your spouse is more than 10 years younger than you, you can withdraw funds over your joint life expectancy as presented in IRS Table V. The process works the same as above, except that you use your joint life expectancy to figure your withdrawals.

When you die, your IRA passes to your designated beneficiary without passing through probate (unless you designate your estate as your beneficiary). After your death, the distribution period is based on the remaining life expectancy of your designated beneficiary. This is calculated using the age of the beneficiary in the year following the year of your death, minus one for each subsequent year. 

• If your spouse is your sole beneficiary at the end of the year following the year of death, the distribution period during your spouse's life is his or her single life expectancy. For years after the year of your spouse's death, the distribution period is your spouse's life expectancy calculated in the year of death, reduced by one for each subsequent year. 
   

• If you have more than one designated beneficiary -- such as happens when you leave your IRA to your children -- the distribution period is based on the beneficiary with the shortest life expectancy.
   

• If there is no designated beneficiary at of the end of the year after your death, the distribution period is five years.

You can designate a trust as your IRA beneficiary without blowing up the account. It's usually done to take advantage of the full unified credit exemption equivalent ($2,000,000 in 2008) in estates consisting largely of an IRA (by leaving the IRA to the marital deduction bypass trust). You can designate an irrevocable trust as beneficiary if it meets these five requirements:

• The trust has to be valid under state law.

• It has to be irrevocable as of April 1 following the year the owner reaches 70½.

• It can have only people as beneficiaries, not corporations, estates, other trusts, or charities.

• The individual beneficiaries have to be specifically identifiable from the trust document.

• Finally, you need to give the IRA sponsor a copy of the trust document before the required beginning date..

You can also name a living trust as a beneficiary so long as the trust becomes irrevocable at your death. If you name a trust as your IRA beneficiary, the distribution period will be based on the life expectancies of the underlying trust beneficiary or beneficiaries.

You can leave part of your account to charity. If you do so, be sure to split your IRA assets into separate accounts so that you can take advantage of the new stretchout provisions with the part you plan to leave to your family.

For more information on IRAs in general, see IRS Publication 590, "Individual Retirement Arrangements."

Inheritance

Inheritances you receive are nontaxable income. However, 13 states impose an inheritance tax on the amount that you receive. This is a separate tax that doesn't affect federal or state income taxes.

Installment Sale

Installment sales let you defer tax on Capital Gains until you actually receive the installments. Tax is divided among the actual installments and due as you receive them. No payment is necessary the year of the actual sale; you have to receive at least one payment in a year after the year of the sale. Installment sales are especially good for "big ticket" sales like businesses and real estate. 

The installment sale concept is simple. First, figure your gain on the sale. Next, figure what percent of your total sale price consists of gain. Finally, multiply each installment by your profit percentage to figure taxable gain from that installment. For example, if you buy a building for $600,000, then sell it for $1 million, 40% of your sale price is gain, so 40% of each installment is taxed as capital gain. Here are some rules:

• You have to charge interest on future installments or a portion of each installment will be treated as interest, taxed as ordinary rates, rather than capital gain. The minimum rate you have to charge is the "applicable federal rate," (published monthly by the Treasury) or 9%, compounded semiannually, whichever is less. Interest you earn on unpaid installments is taxed as ordinary income.

• If you sell a property on which you've claimed Depreciation, the entire depreciation is "recaptured" the year of the sale. Recapture is taxed as ordinary income, except for real property, which is taxed at no more than 25%.
   

• You can't make an installment sale of depreciable property to a business you control or a to trust with you or your spouse as a beneficiary.
   

• If you sell property with no fixed price--as with an "earnout" sale of a business or rental property for a fixed percentage of sales or rent--divide the property's basis into the term of the installments, then pay tax on any gain above that amount. (If the total of installment payments owed to you in any year tops $5 million, you'll owe interest at the federal underpayment rate on the balance exceeding $5 million. We should all have this problem.)
   

• If your buyer assumes a mortgage, subtract the mortgage amount from the gross sale price before figuring gain on the sale.

• If you elect installment treatment on a sale to a relative (spouse, child, grandchild, parent, grandparent, sibling) and the relative resells the property within two years of the original sale date, you'll owe tax on the entire remaining unpaid balance the year the relative sells the property.
   

• If you sell stock or other securities on an established exchange, you have to pay tax for the year in which you make the trade, even if the settlement date falls in a later tax year.

Example: In 1999, you buy a rental duplex for $50,000. Over the next eight years, you Depreciate $7,180. In 2008, you sell it for $100,000, payable in five installments of $20,000 plus 9% interest on the unpaid balance. Your gain is $50,000, or 50% of the sale price. Each $20,000 installment includes $10,000 of taxable gain. You'll "recapture" your $7,180 in depreciation in 2007. And you'll pay tax at ordinary income rates on the 9% interest as you earn it.

Report installment sale income on Form 6252, then carry it forward to Schedule D. For more information, see  IRS Publication 537, "Installment Sales."

Insulin Treatment

Deductible Medical Expense subject to the 7.5% floor.

Interest

Interest you earn on bank deposits, bonds, loans, and even tax refunds is generally taxable in the year you receive the interest. (Interest on Municipal Bonds is generally tax-free.) Original issue discount and zero-coupon bond interest are taxable in the year accreted or accrues. See Original issue discount and Zero-coupon bonds.

Interest you pay on a variety of loans may be deductible depending on the source or the purpose of the loan:

• Interest on up to $1,000,000 of "acquisition indebtedness" to buy your primary residence and one additional residence is deductible as Mortgage Interest on Schedule A.

• Interest on up to $100,000 of Home Equity Interest may deductible on Schedule A.
   

• Interest you pay to buy or carry investment property, including stocks, bonds, mutual funds, and other securities (margin interest), is deductible as Investment Interest.

• Interest you pay on behalf of your trade or business is deductible as a Business Expense on Schedule C, Form 1065, or your corporate return.
   

• Interest you pay to buy or carry tax-exempt securities, single-premium life insurance, endowment, or annuity contracts, is nondeductible.

• Prepaid interest isn't deductible until the year the interest is actually due. You can't prepay a year's worth of mortgage interest, for example, to claim a higher interest deduction in a year with unusually high income.
   

• There's no deduction for credit report fees, service charges, or account fees you pay to secure a loan. However, you can include these in the Basis of whatever asset you buy with the borrowed funds.

Inventory

Inventory is property you manufacture or buy for later resale in the course of your trade or business. Gain you earn from selling inventory is taxed as ordinary income, not capital gain. 

Investment Expenses

Investment expenses you pay to generate taxable income are deductible up to net investment income subject to the 2% floor on Miscellaneous Itemized Deductions. Deductible expenses include:

• asset management fees you pay to money managers or financial planners

• legal and accounting fees relating to investments

• fees for investment advice (fees paid to money managers or financial planners)

• bookkeeping and secretarial fees relating to investments

• books and subscriptions relating to investments

• IRA custodial fees, if paid separately from the account

• account fees for dividend reinvestment plans

• safe deposit box fees for storing investment information

• investment-related travel (mileage to and from your broker, trips away from home to meet with investment advisors and manage investment property, etc.)

• 50% of investment-related Meals and Entertainment (lunch with your financial advisor, members of your investment club, and the like)

• Investment Interest you pay on an unlimited amount of debt used to buy or carry investment property, including stocks, bonds, mutual funds, and other securities

• computer costs for a computer you use to manage your investments.

Commissions you pay to buy and sell investments aren't deductible. Instead, include them in your Basis for figuring Capital Gain or loss when you sell. However, if you pay your broker or investment manager an asset management fee that includes commissions on investment trades, you can deduct the fee the year you pay.

There's no deduction for costs you pay to manage tax-exempt securities or Passive Activities. And there's no deduction for the cost of investment seminars or the Travel costs for shareholder meetings.

Report investment expenses on Schedule A. For more information, see IRS Publication 550, "Investment Income and Expenses."

Investment Interest

Investment interest you pay to finance most taxable investments is deductible, up to your "net investment income." If your investment interest exceeds your net investment income--a real possibility in flat or declining markets--you can carry forward the excess against future investment income. Here are the rules:

• "Investment income" includes gross income from property held for investment, such as interest, dividends, royalties, and annuities. It doesn't include Capital Gains unless you choose to treat them as investment income; however, if you do so, you'll have to pay tax at ordinary income rates rather than preferential capital gains rates, on those gains. Investment income also does not include Passive Activity income.

• Investment expenses are expenses directly related to taxable investments allowable after figuring the 2% floor on miscellaneous itemized deductions.

Example: In 2007, your adjusted gross income is $60,000. Your miscellaneous itemized deductions include $1,000 for investment newsletters and other investment expenses, $600 for tax preparation, and $400 in employee business expenses. Your deductible investment expenses are just $800 ($2,000 in miscellaneous itemized deductions minus 2% of adjusted gross income, or $1,200).

• "Net investment income" is investment income minus investment expenses.

• You have to show that you actually use your investment debt to buy or hold taxable investments. You can't just borrow against your investments to finance personal expenses and deduct the interest, the way you can with most home equity interest. Safeguard your investment interest deduction by keeping separate accounts for investment borrowing. Don't use funds from your investment accounts for personal or business expenses.

• There's no deduction for interest that you pay to buy or hold-tax-exempt securities.

• There's no investment interest deduction for interest you use to buy or hold Passive Activities. Instead, deduct it directly from the passive activity's income to figure net passive income or loss.

• Investment interest is not subject to the phaseout of itemized deductions for adjusted gross incomes above $159,950.

Calculate your investment interest deduction on Form 4952, then carry the total to Schedule A.

Investment Management Fees

Investment management fees are generally a deductible Investment Expense, up to net investment income, subject to the 2% floor on Miscellaneous Itemized Deductions.

Fees you pay to manage Individual Retirement Account assets are not deductible because they don't offset taxable income.

Investment Newsletters (see Subscriptions)

Involuntary Conversion

Involuntary conversion is the loss or destruction of property through casualty, theft, seizure, condemnation, or sale under threat of condemnation. You'll be treated as selling the property at a price equal to whatever proceeds (including insurance) you receive. This can trigger tax on Capital Gain if your proceeds are more than your adjusted Basis in the property. However, you can postpone tax if you replace the property within a specified time.

IRA (See Individual Retirement Account)

IRA Custodial Fees

IRA account fees are a Miscellaneous Itemized Deduction subject to the 2% floor. You have to pay the fee yourself, out of your own pocket; you can't claim the deduction for fees you pay directly out of your account.

Itemized Deductions

Itemized deductions are the classic writeoffs most of us think of as "tax deductions." These include:

• Medical Expenses

• State and Local Taxes
   

• Property Taxes

• Mortgage Interest and Home Equity Interest

• Casualty and theft losses

• Charitable Gifts

• Miscellaneous Itemized Deductions

Itemized deductions grow more valuable as your tax increases. If you're in the 15% bracket, every dollar you deduct cuts your tax by 15 cents. If you're in the 35% bracket, that same dollar deduction cuts your tax by 35 cents.

The starting point for every taxpayer is the standard deduction: $5,450 for single filers; $8,000 for heads of households; $10,900 for joint filers; and $5,450 for married couples filing separately (2008). If your actual itemized deductions are higher than the standard deduction, take your itemized total; if actual deductions are lower, take the standard deduction. (Married couples filing separately must both itemize or both take the standard deduction; you can't have it both ways.)

Standard deductions are high enough that less than one out of three taxpayers itemize deductions. There's no magic to using them other than knowing what's out there. This Dictionary gives you the most complete, user-friendly list of deductions available.