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Chapter 10 Deductions and Losses: Certain Itemized Deductions Individual Income Taxes Copyright ©2009 Cengage Learning Individual Income Taxes C10-1 Itemized Deductions (slide 1 of 2) • Personal expenditures that are deductible FROM AGI as itemized deductions include: – – – – – Medical expenses Taxes Interest Charitable Contributions Miscellaneous itemized deductions Individual Income Taxes C10-2 Itemized Deductions (slide 2 of 2) • Itemized deductions provide a tax benefit only to extent that, in total, they exceed the standard deduction amount for the taxpayer Individual Income Taxes C10-3 Medical Expenses (slide 1 of 6) • Medical expenses are deductible to the extent unreimbursed medical expenses, in total, exceed 7.5% of AGI Individual Income Taxes C10-4 Medical Expenses (slide 2 of 6) • Example of medical expense deduction limitation: – Amy has AGI of $10,000 and medical expenses of $1,000 – Amy’s medical expense deduction = $250 [$1,000 – ($10,000 × 7.5%)] Individual Income Taxes C10-5 Medical Expenses (slide 3 of 6) • Example of medical expense deduction limitation: – Bob has AGI of $4,000 and medical expenses of $1,000 – Bob’s medical expense deduction = $700 [$1,000 – ($4,000 × 7.5%)] Individual Income Taxes C10-6 Medical Expenses (slide 4 of 6) • Expenditures for the diagnosis, cure, mitigation, treatment, prevention of disease, or for purpose of affecting any structure or function of the body of the taxpayer, spouse, or dependents – Includes prescription drugs and insulin Individual Income Taxes C10-7 Medical Expenses (slide 5 of 6) • Does not include the cost of items such as : – Unnecessary cosmetic surgery – General health items – Nonprescription drugs Individual Income Taxes C10-8 Medical Expenses (slide 6 of 6) • Medical expenditures are deductible in year paid – Includes payment by check or credit card Individual Income Taxes C10-9 Nursing Home Expenditures • If primary reason for being in nursing home is medical, costs (including meals and lodging) qualify • If primary purpose of placement in home is personal, only specific medical costs qualify (no meals or lodging) Individual Income Taxes C10-10 Special School Expenditures • Medical expense deduction may include the expenses of a special school for a mentally or physically handicapped individual – Deduction is allowed if a principal reason for sending the individual to the school is the school’s special resources for alleviating the infirmities – In this case, the cost of meals and lodging, in addition to the tuition, is a proper medical expense deduction Individual Income Taxes C10-11 Capital Medical Expenditures • May include a pool, air conditioners if they do not become permanent improvements, dust elimination systems, elevators, etc. • Must be medical necessity, advised by a physician, used primarily by patient, and expense is reasonable • Full amount of cost is medical expense in year paid • Maintenance on capital expenditures also medical expense Individual Income Taxes C10-12 Capital Improvement to Home • Deductible medical expense only to extent cost exceeds increase in value of home – Appraisal costs related to capital improvements are also deductible, but not as medical expenses • Exception: removal of structural barriers to home of handicapped are deemed to add no value to home – Thus, full amount is a medical expense Individual Income Taxes C10-13 Medical Care of Spouse and Dependents • Taxpayer may deduct cost of medical care for spouse and dependents – Dependents need not meet gross income or joint return tests – Medical expenses of children of divorced parents can be deducted by non-custodial parent even though child is dependent of custodial parent Individual Income Taxes C10-14 Medical Transportation and Lodging • Transportation costs to and from medical care are deductible – Mileage allowance of 19 cents per mile (in 2008) may be used instead of actual out-of-pocket automobile expenses • Lodging while away from home for medical care – Allowable amount is $50 per person per night • If parent and/or aide needs to accompany patient, their expenses are also deductible Individual Income Taxes C10-15 Health Insurance Premiums • Premiums paid for medical care insurance are deductible medical expenses • For self-employed, 100% of insurance premiums are deductible FOR AGI – Not allowed if taxpayer is eligible to participate in a subsidized health plan maintained by any employer of the taxpayer or the taxpayer’s spouse • Premiums paid for qualified long-term care insurance are deductible medical expenses – Subject to limitations based on age of the insured Individual Income Taxes C10-16 Reimbursement by Medical Insurance • If reimbursed in same year as expense paid: – Reimbursement offsets medical expense – Amount deductible is excess of expenses over reimbursement • If reimbursed in the year after medical expenses were paid: – Reimbursement is income only to extent medical deduction was taken by taxpayer (tax benefit rule) – If standard deduction was taken in year expenses were paid, none of the reimbursement is included in income Individual Income Taxes C10-17 Example of Medical Reimbursements (slide 1 of 2) • In 2008, taxpayer paid medical expenses = $1,200; In 2008, reimbursed $800 by insurance company – For 2008, deductible medical expense is $400 – (7.5% × AGI) Individual Income Taxes C10-18 Example of Medical Reimbursements (slide 2 of 2) • In 2008, taxpayer paid medical expenses of $1,200; In 2009, reimbursed $800 by insurance company – For 2008, deductible medical expense is $1,200 – (7.5% × AGI) – For 2009, reimbursement is income to extent taxpayer received a tax benefit from medical expense deduction in 2008 Individual Income Taxes C10-19 Health Savings Accounts • Used in conjunction with a high deductible medical insurance policy – Employee contributions to HSA are deductible FOR AGI and earnings on funds in account are not taxable – Deductible contributions are limited to the sum of the monthly limitations. The monthly deductible amount is limited to the lesser of one twelfth of: • The annual deductible under a high deductible plan or • $2,900 for self-only ($5,800 for family coverage) in 2008 – Withdrawals from HSA are excludible to the extent used for qualified medical expenses Individual Income Taxes C10-20 Taxes (slide 1 of 4) • State, local, and foreign income and real property taxes are deductible in the year paid – Real property taxes do not include taxes assessed for local benefits • e.g., Special assessments for streets, sidewalks, curbing, and other similar improvements • State and local personal property taxes based on value (ad valorem) are deductible in the year paid Individual Income Taxes C10-21 Taxes (slide 2 of 4) • Other taxes such as FICA, excise, etc., are not deductible – May be deductible if incurred in business or production of income activity • Fees are not deductible as tax Individual Income Taxes C10-22 Taxes (slide 3 of 4) • Real estate taxes for year property is sold must be apportioned between the buyer and the seller – Failure to correctly apportion requires offsetting adjustments to seller’s amount realized and buyer’s adjusted basis Individual Income Taxes C10-23 Taxes (slide 4 of 4) • Can elect to deduct either state & local income taxes or sales/use taxes – For state and local income taxes, deduct amounts paid during year: • Amounts withheld • Estimated tax payments • Amounts paid in current year for prior year’s liability – For sales/use taxes, deduct either: • Actual sales/use tax payments or • Amount from an IRS table • Table amount may be increased by sales tax paid on certain specific items – e.g., Purchase of motor vehicles, boats, etc. Individual Income Taxes C10-24 Interest Expense • Deduction of interest expense is limited to: – – – – Interest on qualified student loans Investment interest Qualified residence (home mortgage) interest Business interest • Personal interest expense is not deductible Individual Income Taxes C10-25 Interest on Qualified Student Loans • Deductible For AGI, subject to limits – Maximum deduction is $2,500 per year – Deduction is phased out for taxpayers with modified AGI (MAGI) between $55,000 and $70,000 ($115,000 and $145,000 on joint returns) – Not allowed for those claimed as a dependent or for married filing separate returns Individual Income Taxes C10-26 Investment Interest • Investment interest on loans whose proceeds are used to purchase investment property may be deductible – e.g., Investment property may include stock, bonds, and land held for investment • Deduction of investment interest expense is limited to net investment income Individual Income Taxes C10-27 Qualified Residence Interest (slide 1 of 4) • Interest on indebtedness secured by the principal residence and one other residence (qualified residences) • Interest must be on acquisition indebtedness or home equity loans Individual Income Taxes C10-28 Qualified Residence Interest (slide 2 of 4) • Acquisition indebtedness: amounts incurred to acquire, construct, or substantially improve the qualified residences – Interest paid on aggregate acquisition indebtedness of $1 million or less ($500,000 for married, filing separately) is deductible as qualified residence interest Individual Income Taxes C10-29 Qualified Residence Interest (slide 3 of 4) • Home equity indebtedness: loans secured by qualified residences • Interest is deductible only on portion of home equity loan that does not exceed the lesser of: – $100,000 ($50,000 for married, filing separate), or – FMV of home – acquisition indebtedness Individual Income Taxes C10-30 Qualified Residence Interest (slide 4 of 4) • Thus, maximum loans on qualified residences that will produce qualified residence interest is $1.1 million • Interest on mortgage debt exceeding $1.1 million or on mortgage debt relating to nonqualified residence (e.g., second vacation home) is nondeductible personal interest Individual Income Taxes C10-31 Interest Paid For Services (slide 1 of 2) • “Points” paid for the use or forbearance of money qualify as deductible interest – Cannot be a service charge if they are to qualify as deductible interest • Points generally must be capitalized and amortized over the life of loan Individual Income Taxes C10-32 Interest Paid For Services (slide 2 of 2) • Exception: Points paid in the acquisition or improvement of personal residence – Entire amount of such points are deductible in the year paid – Points paid to refinance an existing home mortgage must be capitalized and amortized over the life of the new loan Individual Income Taxes C10-33 Mortgage Insurance Payments • Mortgage insurance premiums are deductible as interest if they relate to a qualified residence of the taxpayer – The deduction begins to phase out for taxpayers with AGI in excess of $100,000 ($50,000 for married taxpayers filing separately) Individual Income Taxes C10-34 Classification of Interest Expense • Whether interest is deductible for AGI or as an itemized deduction (from AGI) depends on purpose of indebtedness – If related to a business or the production of rent or royalty income • Interest is deductible for AGI – If incurred for personal use, such as qualified residence interest • Deduction is reported on Schedule A, Form 1040 if taxpayer itemizes • However, interest on a student loan is a deduction for AGI – If the taxpayer incurs debt in relation to his or her employment • Interest is considered to be personal, or consumer, interest Individual Income Taxes C10-35 Charitable Contributions (slide 1 of 2) • Individuals and corporations may deduct contributions made to qualified domestic organizations • Contributor must have donative intent and expect nothing in return – If contributor receives tangible benefit, the FMV of such benefit must be deducted from the amount of the contribution Individual Income Taxes C10-36 Charitable Contributions (slide 2 of 2) • Exception to tangible benefit rule – Allows deduction of 80% of amount paid for the right to purchase athletic tickets from colleges and universities Individual Income Taxes C10-37 Contribution of Services • No deduction is allowed for the contribution of services – Unreimbursed expenses related to the services are deductible – Out-of-pocket transportation costs or a standard mileage rate of 14 cents per mile are deductible – Deductions are also permitted for transportation, reasonable expenses for lodging, and the cost of meals while away from home incurred in performing the donated services Individual Income Taxes C10-38 Nondeductible Items • The following items may not be deducted as charitable contributions: – Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups – Cost of raffle, bingo, or lottery tickets – Cost of tuition – Value of blood given to a blood bank – Donations to homeowners associations – Gifts to individuals – Rental value of property used by a qualified charity Individual Income Taxes C10-39 Qualified Organizations • To be deductible, contributions must be to a qualified domestic nonprofit organization or state or possession of U.S. or any subdivisions thereof – Many (but not all) qualified domestic charities are listed in IRS Publication #78 Individual Income Taxes C10-40 Record-Keeping Requirements • No deduction is allowed for contributions of $250 or more without written substantiation from the charitable organization • Additional information is required if value of property donated is > $500 but not over $5,000 • An appraisal is required for contributions of property valued over $5,000 Individual Income Taxes C10-41 Ordinary Income Property • Defined: assets that would produce ordinary income or short-term capital gain if sold • Contribution amount – FMV of asset less ordinary income (or STCG) potential; generally the lower of adjusted basis or FMV Individual Income Taxes C10-42 Capital Gain Property • Defined: assets that would produce longterm capital gain or Section 1231 gain if sold • Contribution amount – Generally FMV of asset Individual Income Taxes C10-43 Exceptions to FMV Deduction of Capital Gain Property (slide 1 of 3) • Private nonoperating foundations – Deduction for contributions to private nonoperating foundations must be reduced by the amount of capital gain potential – Thus, the contribution deduction is limited to the adjusted basis Individual Income Taxes C10-44 Exceptions to FMV Deduction of Capital Gain Property (slide 2 of 3) • For contributions of tangible personalty – The charitable deduction may limited to the adjusted basis if • The asset contributed is not used in charity’s exempt function, or • The property (for deductions > $5,000) is disposed of by the donee before the close of the tax year – Applies unless the donee certifies that it put the property to a related use or intended to put the property to a related use – This reduction generally does not apply if • The property is, in fact, not put to an unrelated use or • At the time of the contribution, it was reasonable to anticipate that the property would not be put to an unrelated use by the donee Individual Income Taxes C10-45 Exceptions to FMV Deduction of Capital Gain Property (slide 3 of 3) • For contributions of certain types of intellectual property – Contribution deduction is limited to the lesser of the taxpayer’s basis in the property or the property’s fair market value – Includes patents, certain copyrights, trademarks, trade names, trade secrets, know-how, and some software Individual Income Taxes C10-46 Example of Contributions of Tangible Personalty • Taxpayer contributes painting to local charity: FMV $100,000 and adjusted basis $10,000 – If charitable organization is a local museum that hangs the painting for patrons to view, taxpayer has $100,000 contribution deduction – If charitable organization is a local church that sells the painting immediately to obtain funds for its operation, taxpayer has $10,000 contribution Individual Income Taxes C10-47 Charitable Contribution Limitations (slide 1 of 4) • 50% limit – In no case can the charitable contribution deduction for a year exceed 50% of the taxpayer’s AGI – Contributions of cash, ordinary income property, and certain capital gain property (where the contribution amount is adjusted basis) are subject to the 50% limit (50% assets) Individual Income Taxes C10-48 Charitable Contribution Limitations (slide 2 of 4) • 30% limit – Charitable contribution deduction for certain assets cannot exceed 30% of the taxpayer’s AGI • Applies to 30% assets which are: – Capital gain property for which the contribution amount is FMV – Certain contributions to private nonoperating foundations Individual Income Taxes C10-49 Charitable Contribution Limitations (slide 3 of 4) • 30% limit – Taxpayer can elect to treat capital gain property as 50% assets by limiting the amount of such contributions to their adjusted bases – Referred to as the reduced deduction election • Enables the taxpayer to move from the 30% limitation to the 50% limitation Individual Income Taxes C10-50 Charitable Contribution Limitations (slide 4 of 4) • 20% limit – Certain contributions of capital gain property to private nonoperating foundations Individual Income Taxes C10-51 Charitable Contributions Carryover • Contributions that cannot be taken in current year due to limitations may be carried forward for 5 years – Contributions carried forward retain their classification • e.g., If the contribution originally involved 30% property, the carryover will continue to be classified as 30% property in the carryover year – When using carryovers, current contributions are used first, then carryovers used on a FIFO basis Individual Income Taxes C10-52 Example of Charitable Contribution AGI Limits • Taxpayer, AGI $100,000, contributed $40,000 cash and long-term stocks with a FMV of $35,000 and a basis of $8,000 to a University • 50% limit = $50,000 30% limit = $30,000 – Amount of deduction = $50,000 (40,000 cash + 10,000 stock) – Contribution carryforward = $25,000 stock (as 30% asset) Individual Income Taxes C10-53 Miscellaneous Itemized Deductions • Some expenditures are deductible only to the extent they exceed 2% of AGI • Examples include: – – – – – – – Professional dues Uniforms Tax return prep fees Job-hunting costs Certain investment expenses Hobby losses Unreimbursed employee expenses Individual Income Taxes C10-54 Misc. Itemized Deductions Not Subject to 2% of AGI Floor • Examples include: – Gambling losses to the extent of gambling winnings – Impairment-related work expenses of a handicapped person – Deduction for repayment of amounts under a claim of right if more than $3,000 – Unrecovered investment in an annuity contract when annuity ceases by reason of death Individual Income Taxes C10-55 Overall Limitation on Itemized Deductions (slide 1 of 3) • Taxpayers with AGI in excess of the specified threshold will lose part of their benefits from certain itemized deductions – Threshold amount in 2008 is $159,950 ($79,975 if married, filing separately) Individual Income Taxes C10-56 Overall Limitation on Itemized Deductions (slide 2 of 3) • Itemized deductions subject to possible reduction include: – Taxes, home mortgage interest, charitable contributions, and miscellaneous deductions • Medical, investment interest, casualty & theft losses, and gambling losses are not subject to reduction Individual Income Taxes C10-57 Overall Limitation on Itemized Deductions (slide 3 of 3) • This overall limitation is being phased out over a four-year period, beginning in 2006 • Limitation is calculated using a 2-step process • Step 1: Amount of reduction is lesser of: • (AGI – threshold) × 3%, or • 80% × total itemized deductions subject to reduction • Step 2: Multiply the amount computed in Step 1 by the fraction that applies to the tax year involved – For 2006 and 2007: phaseout equals 2/3 of the Step 1 amount – For 2008 and 2009: phaseout equals 1/3 of the Step 1 amount Individual Income Taxes C10-58 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA [email protected] SUNY Oneonta Individual Income Taxes C10-59