©2003 South-Western College Publishing, Cincinnati, Ohio CHAPTER 5 Itemized Deductions and Other...

©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio

CHAPTER 5

Itemized Deductions and Other IncentivesItemized Deductions and Other Incentives

© 2003 South-Western College Publishing Transparency 5-2

Objective

Understand the nature and treatment of itemized deductions


Itemized Deductions (Schedule A) Itemized deductions are generally personal expenses

If itemized deductions exceed standard deductions, use that number

Itemized deductions are phased out if AGI is over threshold amounts

Types of itemized deductions (Separate sections of of Schedule A)

Medical Expenses Charitable ContributionsTaxes Employee Employee Business ExpensesInterest OtherCasualty/Theft


Medical Expenses Taxpayers are allowed deductions for medical expenses

for spouse, self and dependents (in excess of reimbursements) but only if the total exceeds 7.5% of AGI Prepaids are generally not deductible but credit card charges

are deductible in year charged Prescription medication is allowed $.13/mile transport for medical care and $50/night lodging for

each individual (person needing attention plus one caregiver)

Capital purchases deductible all in one year (only in excess of value increase of home, for example wheelchair ramps and bathroom fixtures)


Medical Expenses (continued) Health, dental and optical insurance premiums

Health insurance for self employed is split: 70% is deductible for AGI30% is deductible on Schedule A

Long term care insurance premiums also deductible Medicare A premiums not deductible, but Medicare B

(supplemental) are deductible (SS Statement designates)

Psychiatric care, drug/alcohol treatment deductible, but not marriage counseling or smoking cessation

Nursing home costs (if entirely for medical benefit) deductible


Medical Savings Accounts(MSA) MSAs are designed to help employees of small businesses

with high deductible health insurance plans meet uncovered costs Also available to self-employed taxpayers

Employees can contribute 65% of annual deductible (if single) or 75% (family) as a deduction for AGI “High deductible” plan means deductible of $1,650-$2,500 for

individual or $3,300-$4,950 for familyOut of pocket expenses cannot exceed $3,300 ($6,500 for a family)

If employer contributes to MSA, not includable in income Earnings and distributions from MSA are then nontaxable if used for

medical expenses (15% penalty if used for other purposes)


Taxes Taxes are imposed by a government to raise revenue for

general public purposes; a fee is a charge with a direct benefit to the person paying. Taxes are deductible, fees not deductible.

Examples of deductible taxes State and local income taxes Real estate taxes Personal property taxes

Example of nondeductible taxes Sales tax Estate tax Social Security taxes Any federal tax


State Income Tax Deductibility Amount paid in current year is deductible. For example: What is

deductible in following scenario? Amend 2001 state tax return and pay additional $843 ($93 in

penalties/interest + $750 tax) State Income Tax (SIT) withholding for the current year is $660 Paid quarterly SIT estimates as follows:

4/15, 6/15, and 9/15 of current year and 1/15 of next year ($200/each) 1/15 of current year paid fourth quarterly estimate from prior year of $155

Answer: Deductible amount is $750 + $660 + $200 + $200 + $200 + $155 = $2,165

If taxpayer receives refund of SIT that was deducted in prior year, that refund is taxable income in year it is received. Report on Form 1040


Real Estate Taxes Property taxes on real estate are deductible (even on

second home); however, rental property real estate taxes are reported on Schedule E If paid into escrow, taxes are deductible when paid If taxpayer pays real estate taxes twice per year, doesn’t matter

which year it pertains to - deduct using cash method

When selling property, need to allocate based on number of days each owned; this is reported on closing documents Seller deducts taxes paid up to, but not including, date of sale

Assessments add to basis of property and are not deductible


Personal Property Taxes

Tax on personal property (such as autos, boats, trailer, etc.) are deductible, but only if ad valorem (amount that is based on the property’s value)


InterestExamples of deductible interest include

Qualified residence interest and points Amortized points on refinanced mortgage Investment interest, such as margin interest Student loan interest

up to $2,500 per year this deduction phases out when AGI > $50,000 (S) and

when AGI > $100,000 (MFJ)Loan must be used for qualified expenses including

tuition, room and board, and related expenses.


Mortgage Interest Qualified residence interest is interest on debt used to

secure/construct principal and second residence limited to acquisition indebtedness (up to $1,000,000) home equity loans (even if loan is for personal use) up to

$100,000

Loan origination fees and discount points (these are quoted as a percentage of principal) Refinancing points must be capitalized & amortized

(deducted) over life of loan (reported on 4562 and carries to A or E)

Other closing costs such as appraisal, title search, etc. are nondeductible, but are added to the property’s basis


Interest Limitations To be deductible, interest paid or accrued within tax year

must result from true debtor-creditor relationship Promissory note, market rate of interest

Investment interest (debt to purchase investment property, such as margin interest, but not if belongs on C or E) Can only deduct up to the amount of net investment income

carry forward to next year on 4952 any unused investment interest expense

Not allowed to deduct Investment interest on tax-exempt securities Interest on loans to pay life insurance premiums Consumer interest or prepaid interest


Charitable Contributions Deductions limited by type of donee organization and type of

contribution made Example of organizations that qualify for 50% AGI deductions:

Churches and educational institutions Hospital and medical research organizations Private operating foundations (defined as receiving 1/3 or more of

operating funds from grants) Private non-operating foundations if all contributions distributed to

public charities in the same year

Examples of organizations that qualify for 30% AGI deductions: Private non-operating foundations War veterans’ associations and fraternal societies


Charitable Contributions (continued) Can contribute cash or property If contribute appreciated long term capital gain (LTCG)

property (such as appreciated stock) To a 50% organization

can deduct appreciated value, but subject to 30% AGI limitation, or deduct the basis instead and then can take up to 50% AGI

to a 30% organization can deduct appreciated value but subject to 20% AGI limitation, or

deduct the basis instead and then can take up to 30% AGI

If the LTCG property donated is tangible personal property that is used for unrelated purpose, can only deduct FMV less potential LTCG


Charitable Contributions (continued)

50% Organization

Cash

50%

LTCGproperty,

see rules onprior screen

STCG or ordinaryincome property. Can deduct FMV less amount of gain that would’ve been recognized (i.e., the basis), then limited to 50% of AGI


30% Organization

Cash

30%

LTCGproperty, see rules

onprior

screen

STCG or ordinary income property, can deduct FMV less amount of gain that would’ve been recognized, then limited to 30% of AGI



Order of charitable contribution deductions:1. Deduct 50% contributions2. Deduct 30% contributions3. Deduct 20% contributions4. Any contributions not currently

deductible, can carry over for 5 years, subject to the same ceilings

Total of all 3 typesof deductions still limited to AGI x 50%




Allowed $.14/miles for mileage deduction If purchase event tickets, can only deduct amount paid in

excess of value of event Can’t deduct

If influences legislation Free use of property (for example, donate use of ski condo to

church youth group)

Non-cash contributions If more than $250 - need written acknowledgement If more than $500, complete 8283 Section A If more than $5,000, complete 8283 Section B and need appraisal


Fill out Form 4684, then

Personal or Business

Casualty and Theft

To be classified as casualty loss, needs to be “sudden” if theft, need to prove (for example, by police report)

Either business or non-business casualty loss can result in NOL

Business casualty losses are fully deductible on 4684 Section B

Personal casualty losses are subject to $100 floor per event and then only if total exceeds 10% of AGI

To Schedule A To Schedule C


Casualty and Theft (continued)Amount to deduct on 4684 is

lesser of: Difference in FMV before and after casualty, or Adjusted basis

Minus:Any reimbursement

Casualty gains can occur if reimbursed more than decrease in FMV


Miscellaneous DeductionsCategory 1: limited to total amount over 2% AGI

unreimbursed employee expenses (Form 2106) union dues tax prep fees safety deposit box journals/subscriptions investment expenses job hunting fees


Miscellaneous Deductions

Category 2: no AGI limitations Handicapped individual’s attendant care

cost Estate tax on income of decedent Gambling losses to extent of gambling

winnings Terminated annuity payments


Objective

Understand the special rules applicable to moving expenses


Moving Expenses Can use if employee or self employed To qualify for deductible moving expense

Travel from new job site to old residence must be longer by at least 50 miles than distance from old job site to old residence

Must work 39 weeks in the next 12 months; if self-employed, must work 78 weeks in the next 24 months

Must change job sites.Move can be with new or existing company

Deduct expenses of moving self and family, if related to starting work in new location Cost of moving personal goods Travel and lodging included, but not meals .13/mile for personal car


Objective

Know the factors used to determine whether an activity is a hobby, and understand the tax

treatment of hobby losses


Hobby LossesMust show business intent to be able to deduct all

losses IRS will look at the facts of each case

If a “hobby”, can only deduct hobby expenses as miscellaneous itemized deductions No expenses in excess of hobby income, i.e., cannot create a

loss Must deduct in specific order:

Expenses otherwise deductible on Schedule A (home mortgage interest, taxes, etc.)

Other expenses

Income reported on 1040 “other income”


Objective

Know the tax implications of using educational savings

accounts and qualified tuition programs


Qualified Tuition Programs (Section 529 plans)

Allow taxpayer to Buy in-kind tuition credits or certificates to cover higher education expenses Contribute to an account established to meet qualified higher education

expenses

Distributions are generally not taxed if funds used for higher education (tuition, fees, books, supplies, equipment) Reasonable amount can be used for room and board

If not used for higher education, distributions are taxable No limit on contribution amount, but contribution is not deductible

10% penalty if funds not used for qualified expenses or early withdrawal


Educational IRAs (Education Savings Accounts) An educational IRA is a trust or custodial account

created to pay qualified higher education expenses

Can contribute until beneficiary reaches 18

$2,000/year per child non-deductible contribution

Becomes tax free distribution if used for higher education

Income phase-outs begin at $190,000 for joint filers and $95,000 for single

Can roll over from one child to another


Higher Education Expense DeductionAllowed deduction for qualified tuition and related

expenses incurred during tax year. Limited to $3,000 and phased out for AGI > $65,000 (S);

$130,000 (MFJ) Must be enrolled at an institution of higher education Taken in year paid

Reduce by Interest excluded from education savings bonds Excluded distributions from state tuition plans Excluded distributions from Education Savings Accounts

(IRAs)


End of Chapter 5

©2003 South-Western College Publishing, Cincinnati, Ohio CHAPTER 5 Itemized Deductions and Other...

Documents

Transcript of ©2003 South-Western College Publishing, Cincinnati, Ohio CHAPTER 5 Itemized Deductions and Other...