©2003 south-western college publishing, cincinnati, ohio chapter 5 itemized deductions and other...
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©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
© 2003 South-Western College Publishing Transparency 5-3
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
© 2003 South-Western College Publishing Transparency 5-4
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)
© 2003 South-Western College Publishing Transparency 5-5
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
© 2003 South-Western College Publishing Transparency 5-6
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)
© 2003 South-Western College Publishing Transparency 5-7
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
© 2003 South-Western College Publishing Transparency 5-8
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
© 2003 South-Western College Publishing Transparency 5-9
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
© 2003 South-Western College Publishing Transparency 5-10
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)
© 2003 South-Western College Publishing Transparency 5-11
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.
© 2003 South-Western College Publishing Transparency 5-12
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
© 2003 South-Western College Publishing Transparency 5-13
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
© 2003 South-Western College Publishing Transparency 5-14
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
© 2003 South-Western College Publishing Transparency 5-15
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
© 2003 South-Western College Publishing Transparency 5-16
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
© 2003 South-Western College Publishing Transparency 5-17
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
Charitable Contributions (continued)
© 2003 South-Western College Publishing Transparency 5-18
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%
Charitable Contributions (continued)
© 2003 South-Western College Publishing Transparency 5-19
Charitable Contributions (continued)
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
© 2003 South-Western College Publishing Transparency 5-20
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
© 2003 South-Western College Publishing Transparency 5-21
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
© 2003 South-Western College Publishing Transparency 5-22
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
© 2003 South-Western College Publishing Transparency 5-23
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
© 2003 South-Western College Publishing Transparency 5-24
Objective
Understand the special rules applicable to moving expenses
© 2003 South-Western College Publishing Transparency 5-25
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
© 2003 South-Western College Publishing Transparency 5-26
Objective
Know the factors used to determine whether an activity is a hobby, and understand the tax
treatment of hobby losses
© 2003 South-Western College Publishing Transparency 5-27
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”
© 2003 South-Western College Publishing Transparency 5-28
Objective
Know the tax implications of using educational savings
accounts and qualified tuition programs
© 2003 South-Western College Publishing Transparency 5-29
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
© 2003 South-Western College Publishing Transparency 5-30
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
© 2003 South-Western College Publishing Transparency 5-31
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)
© 2003 South-Western College Publishing Transparency 5-32
End of Chapter 5