Slide 1: CHAPTER 5 Itemized Deductions & Other Incentives
Income Tax Fundamentals 2011 Gerald E. Whittenburg Martha Altus-Buller
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Slide 2: Learning Objectives
Understand
expenses Calculate itemized deduction for taxes, interest and charitable contributions Compute deduction for casualty/theft Identify miscellaneous itemized deductions Understand concepts behind deduction and exemption phase-outs for high-income taxpayers Understand tax implications of using educational savings vehicles
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nature/treatment of medical
Slide 3: Medical Expenses
First itemized deduction on Schedule A Medical expenses allowed
◦ For spouse, self and dependents ◦ For amounts spent that exceed 7.5% of AGI ◦ Must be reduced by amount of insurance reimbursement
See page 5-2 for list of health, dental, and optical expenditures that qualify
◦ Medical insurance premiums deductible ◦ Long-term care insurance premiums deductible
Specified limits that change each year based on taxpayer’s age If deducted for AGI, excluded from Schedule A calculations
Note: Health insurance for self employed is deduction for AGI
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Slide 4: Medical Expenses
Prescription medication is allowed
◦ Drugs illegally purchased abroad nondeductible ◦ Nonprescription drugs are not deductible ◦ Medical marijuana is not deductible
Special equipment purchased/installed in taxpayer’s home is deductible all in one year Transportation/lodging for medical care is allowed
◦ 2010 deduction per mile = $.165 ◦ $50 per night per person lodging deduction
Allowed for patient and one individual accompanying patient No meal deduction allowed
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Slide 5: Health Savings Accounts (HSA)
HSA
is an instrument that allows funds to be contributed to an account similar to an IRA
◦ Employee must participate in ‘high-deductible’ medical insurance plan ◦ Distributions to cover medical expenses are not taxed or penalized ◦ Earnings on HSA not taxed ◦ Employee contributions to an HSA is a deduction for AGI
Medical
Savings Accounts established in the past may be rolled into ‘new’ HSAs
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Slide 6: Medical Expenses Example
Example During the year, Frieda and José paid the following medical expenses:
Contact lenses $ 120 Face lift for cosmetic purposes 2,900 Doctor bills 1,600 Health insurance premiums 4,800 They also traveled 260 miles to see a cardiologist in July. Their gross income = $31,200 and they were reimbursed $1,000 by their insurer. What are their deductible medical/dental expenses for the current year?
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Slide 7: Solution
Example During the year, Frieda and José paid the following medical expenses: Contact lenses $ 120 Face lift for cosmetic purposes 2,900 Doctor bills 1,600 Health insurance premiums 4,800 They also traveled 260 miles to see a cardiologist in July. Their gross income = $31,200 and they were reimbursed $1,000 by their insurer. What are their deductible medical/dental expenses for the current year? Solution [120 + 1,600 + 4,800 + (.165)(260)] = $6,563 $6,563 less $1,000 reimbursement = $5,563. They may deduct these expenses in excess of (7.5% x $31,200) $5,563 – $2,340 = $3,223 medical expense as itemized deduction
Note: Face lift for cosmetic purposes is not deductible
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Slide 8: Taxes
Deductions
for certain taxes are allowed Taxes are deductible, fees are not
◦ Taxes are imposed by a government to raise revenue for general public purposes ◦ Fees are charges with a direct benefit to person paying
Examples of deductible taxes ◦ State and local income taxes (deductible in year paid) ◦ Sales/use tax
◦ Real property taxes ◦ Personal property taxes
Example
◦ May use actual sales tax or from IRS-provided tables ◦ If use actual, must keep receipts for all sales tax paid
of nondeductible taxes include estate taxes, gift taxes and excise taxes
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Slide 9: Income Tax Deduction Example
Example
What amount is the itemized deduction for taxes in the following scenario?
◦ Colleen amends her 2008 state tax return and must pay an additional $843 state income tax (SIT) in 2010
◦ She paid quarterly SIT estimates as follows
Breakdown of amount due is: $93 in penalties/interest + $750 SIT Her SIT withholding for the current year is $660 Paid $200 each on 4/15, 6/15, and 9/15 of current year and 1/15 of next year 1/15 of current year paid 4th quarter estimate from prior year - $155
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Slide 10: Solution
Example
What amount is the itemized deduction for taxes in the following scenario?
◦ Colleen amends her 2008 state tax return and must pay an additional $843 state income tax (SIT) in 2010
Breakdown of amount due is: $93 in penalties/interest + $750 SIT Her SIT withholding for the current year is $660
◦ She paid quarterly SIT estimates as follows
Paid $200 each on 4/15, 6/15, and 9/15 of current year and 1/15 of next year 1/15 of current year made 4th quarter estimate from prior year $155
Solution
Colleen may deduct the actual amounts paid in 2010 Itemized deduction for SIT = $2,165 ($750 + 660 + 200 + 200 + 200 + 155)
Note: If taxpayer receives refund of SIT that was deducted in prior year, that refund is taxable income in year it is received !
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Slide 11: Real Estate Taxes
Property taxes on real estate are deductible ◦ Even on second home ◦ Rental property real estate taxes are reported on Schedule E ◦ If paid into escrow, taxes are deductible when paid When
selling property, need to allocate real estate taxes based on number of days that each party owned Even if don’t itemize, may take deduction for portion of property taxes paid (in addition to standard deduction). Should check web site to see if this provision extends to current year.
◦ $500 (S) or $1000 (M) not to exceed actual property taxes ◦ Must file Schedule L
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Slide 12: Personal Property Taxes
Tax
on personal property
◦ Amounts paid on autos, boats, trailer, etc. are an itemized deduction ◦ Only amount that is based on the property’s value is deductible
Fees calculated on basis of weight are not deductible
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Slide 13: Tax Deduction Example
Example Selma has AGI of $31,300 for 2010. She itemizes her deductions and therefore deducts the allowable amount of tax. Her FIT withholding for the year is $2,150, SIT withholding is $1,500, Social Security taxes are $2,394, real estate taxes on her home are $3,300 and she pays auto registration of $210 (of that $180 is based on value of auto). How much may Selma show as an itemized deduction for taxes in 2010?
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Slide 14: Solution
Example Selma has AGI of $31,300 for 2010. She itemizes her deductions and therefore deducts the allowable amount of tax. Her FIT withholding for the year is $2,150, SIT withholding is $1,500, Social Security taxes are $2,394, real estate taxes on her home are $3,300 and she pays auto registration of $210 (of that $180 is based on value of auto). How much may Selma show as an itemized deduction for taxes (in addition to her other itemized deduction) in 2010? Solution Itemized deduction for taxes = $4,980 ($1,500 + 3,300 + 180)
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Slide 15: Overview of Interest
Interest
is amount paid for use of borrowed funds
◦ Borrower must be legally liable for note in order to deduct the interest
Examples
◦ ◦ ◦ ◦
of deductible interest include
Qualified mortgage interest and points Mortgage interest prepayment penalties Investment interest* Certain interest associated with passive activities
Consumer
(personal) interest is not deductible Private mortgage insurance (PMI) related to purchase of personal residence deductible (phaseouts apply)
*Investment interest nondeductible if used to generate tax-exempt income
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Slide 16: Mortgage Interest
Qualified
residence interest is mortgage interest that is deductible
◦ Used to secure/construct first or second residence - limited to loans up to $1,000,000 ◦ Home equity loans - limited to loans up to $100,000
Deductible even if proceeds used for personal purposes
o
o
Interest limited to debt at or below fair market value of home The taxpayer must be legally liable for debt to deduct mortgage interest*
Loan
origination fees
◦ Called ‘points’ because they are quoted as percentage points of principal are deductible
*Recent court case allowed relative, who essentially had ownership interest, to deduct even though not named on loan
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Slide 17: Education Loan Interest
Up
to $2,500 per year Deduction for AGI
This
deduction phases out
◦ AGI > $60,000 (S) or ◦ AGI > $120,000 (M)
Loan
must be used for qualified higher education expenses
◦ This includes tuition, room and board, and related expenses
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Slide 18: Investment Interest
Investment interest is incurred on debt to purchase investment property
◦ Can only deduct up to the amount of net investment income (such as interest)
Special rules as to including dividends and capital gains in “net investment income” because of their preferential tax treatment
◦ Carry forward any unused investment interest expense to next year
Not allowed to deduct the following
◦ Interest on loans to pay life insurance premiums ◦ Consumer interest ◦ Investment interest if funds used to generate taxexempt income
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Slide 19: Contributions
Charitable contributions are allowed as a deduction Can contribute cash or property
◦ Out of pocket expenses are deductible ◦ $.14/mile for mileage deduction ◦ Value of free use of taxpayer’s property is not deductible
To be deductible, donation must be made to a qualified recipient (see pages 5-12 and 513) IRS publishes Cumulative List of Organizations, Publication No. 78
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Slide 20: Contributions - Property
Gifts of household items/clothing subject to new requirements
◦ Must be in good condition ◦ Items with minimal value may not be deducted
If contribute property, deduction is equal to fair market value (FMV) at time of donation
◦ Exception occurs if property donated would have resulted in ordinary income or short-term capital gain (STCG)
Then, the deduction is equal to fair market value less the amount of ordinary income or STCG that would’ve resulted if property had been sold
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Slide 21: Contributions – Property
If taxpayer donates appreciated long-term capital gain (LTCG) property, such as appreciated stock, may deduct fair market value of the property, except if:
◦ Donation is made to certain private nonoperating foundation (30% organization) – then can only deduct fair market value minus potential LTCG or ◦ Donation is a contribution of tangible personal property to an organization that uses it for a purpose unrelated to the organization’s primary purpose (such as artwork contributed to Humane Society)
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Slide 22: LTCG Donation Example
Example Bea donates an antique couch to a nonprofit that provides housing items to battered women. The couch cost $2,500 and is now worth $4,000. How much may Bea deduct for contributions? Would Bea’s deduction change if she had donated the couch to an environmental organization?
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Slide 23: Solution
Example Bea donates an antique couch to a nonprofit that provides housing items to battered women. The couch cost $2,500 and is now worth $4,000. How much may Bea deduct for contributions? Would Bea’s deduction change if she had donated the couch to an environmental organization? Solution If Bea had sold the antique, her LTCG would have been $1,500 ($4,000 – $2,500); since the couch is put to a use related to the organization’s primary purposes. Deduction = $4,000. If the antique was donated to an environmental organization, the purpose is unrelated and therefore she must reduce her deduction by the amount of the LTCG that would have resulted if the item had been sold. Deduction = $2,500 ($4,000 - $1,500 LTCG).
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Slide 24: Contributions – Percentage Limitations
Generally, deduction for charitable contributions limited to 50% of taxpayer’s AGI – this applies to donations to:
◦ All public charities ◦ All private operating foundations and ◦ Private nonoperating foundations, if distribute contributions to public charities within a specified time period
Examples of “50% organizations” include churches and educational institutions and hospital/medical research organizations Contributions limited to 30% of taxpayer’s AGI if donation made to certain private nonoperating foundations, fraternal societies and veterans’ organizations
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Slide 25: Contributions to a 50% Organization
Cash
50% of AGI (see next slide)
LTCG property
STCG or ordinary income property
Can deduct FMV less amount of gain that would’ve been recognized (the basis), then limited to 50% of AGI
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Slide 26: Contributions to a 30% Organization
Cash
30% of AGI
LTCG property
Cannot exceed 20% of AGI
STCG or ordinary income property
Can deduct FMV less amount of gain that would’ve been recognized (the basis), then limited to 30% of AGI
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Slide 27: Contributions
Order of charitable contribution deductions 1. Deduct 50% contributions Total of all 3 types 2. Deduct 30% contributions of deductions still limited to AGI x 50% 3. Deduct 20% contributions
Carryforward unused amounts to subsequent years
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Slide 28: Contributions - Substantiation
Charitable contributions are allowed as a deduction Can contribute cash or property
◦ Out of pocket expenses are deductible ◦ $.14/mile for mileage deduction ◦ Value of free use of taxpayer’s property is not deductible
To be deductible, donation must be made to a qualified recipient (see pages 5-12 and 5-13) IRS publishes Cumulative List of Organizations, Publication No. 78
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Slide 29: Donation of Vehicles
Deduction for a donated vehicle limited to the amount for which the charity sells the vehicle
◦ Same rule applies to boats and planes
Charitable organization sends a Form 1098-C to taxpayer showing resale information
◦ Or certifies that no resale amount may be provided as vehicle donated to needy individual ◦ Taxpayer must attach 1098-C to tax return ◦ Taxpayer may claim estimated value if charity uses donated auto rather than selling it
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Slide 30: Contribution Example
Example During the current year, Clem donates $1,260 to his synagogue’s youth group, allows the church youth group to use his lake cabin (valued at $500), drives 1000 miles on behalf of the YWCA and donates a vehicle (valued at $950) to the United Way. United Way sells the auto for $750 and issues a 1098-C to Clem. What is Clem’s charitable contribution deduction if his AGI = $33,200?
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Slide 31: Solution
Example During the current year, Clem donate $1,260 to his synagogue’s youth group, allows the church youth group to use his lake cabin (valued at $500), drives 1000 miles on behalf of the YWCA and donates a vehicle (valued at $950) to the United Way. United Way sells the auto for $750 and issues a 1098-C to Clem. What is Clem’s charitable contribution deduction if his AGI = $33,200? Solution Clem cannot deduct the value of his lake cabin; therefore his contribution deduction = $2,150 ($1,260 + (1000 miles x .14) + 750)
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Slide 32: Casualty and Theft Losses
Deductions
are allowed for casualty and theft
losses To be classified as casualty loss, event needs to be sudden, unexpected or unusual
◦ If theft, need to prove (for example, by police report) ◦ Different calculations for deduction based on what type of property
Casualty
losses are deductible in year of occurrence
◦ Exception for federally declared disaster area losses (can amend prior year return and deduct in that year and file for refund)
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Slide 33: Casualty and Theft Losses
Two
o
rules governing casualty/theft losses:
Rule A is based on decrease of fair market value, not to exceed adjusted basis of property*
•
Used for partial/complete destruction of personal property or partial destruction of business or investment property
o
Rule B allows a deduction for the adjusted basis of the property
•
Used for complete destruction of business or investment property
*Limit to personal casualty loss calculated as follows Loss - $100 floor and only in excess of 10% of AGI
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Slide 34: Miscellaneous Deductions
There are two types of miscellaneous deductions “Those not limited to amounts over 2% of AGI”
◦ Handicapped “impairment related work expenses” ◦ Certain estate taxes ◦ Amortizable bond premiums purchased prior to 10/23/86 ◦ Gambling losses to extent of gambling winnings ◦ Terminated annuity payments
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Slide 35: Miscellaneous Deductions
“Those limited to amounts over 2% AGI”
◦ Unreimbursed employee expenses ◦ Reimbursed employee expenses made under a non-accountable plan ◦ Union dues ◦ Tax preparation fees ◦ Safety deposit box ◦ Professional journals/subscriptions ◦ Investment expenses ◦ Job-hunting fees
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Slide 36: Miscellaneous Deductions
Investment
expenses
◦ Deduction allowed if directly related to taxable income; however, no deduction for investment expenses related to tax-exempt income ◦ Fees paid to broker to acquire stocks/bonds are not deductible Instead, added to cost basis of stocks/bonds
Tax
o
Preparation Fees Job-Hunting Expenses
If seeking job in current trade, or if unemployed there is not lack of continuity since last job 2011 Cengage Learning
Slide 37: Limitation on Itemized Deductions and Exemptions
For
many years, the ability to deduct total itemized deductions has been phased-out for high-income taxpayers Also, personal and dependency exemptions have been phased-out for high income taxpayers However, this is not applicable in 2010 Phase-outs expected to return in 2011
Note: phase-out thresholds were different for itemized deductions and personal exemptions
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Slide 38: Qualified Tuition Programs (QTP)
Sometimes called §529 tuition plans Allows taxpayers to meet higher education expenses by
◦ Buying in-kind tuition credits or certificates or ◦ Contributing to an established account
Distributions are generally not taxed if funds used for higher education
◦ Tuition, fees, books, supplies, equipment plus reasonable amount for room and board ◦ Computer technology primarily used for educational purposes ◦ If not used for purposes outlined or the taxpayer withdraws early, then distributions are taxable plus 10% penalty
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Slide 39: QTP
Annual contribution amounts vary
◦ Contribution is not deductible ◦ High limits in most states
May claim American Opportunity Education Credit or Lifetime Learning Credit in same year as distribution taken from a QTP
◦ As long as distribution is not used for the same expenses for which the credit was claimed ◦ Must also reduce qualified higher education expenses exclusion by scholarships, veterans’ benefits, etc.
Note: plans vary by state – check out www.collegesavings.org or savingforcollege.com for overview
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Slide 40: Education Savings Accounts
Allows
taxpayers to meet higher education expenses by contributing to an educational savings account Annual contributions are not deductible
◦ Allowed until beneficiary reaches 18 ◦ Limited to $2,000/year per child ◦ Can’t make in same year as contribution to QTP ◦ Phase-out when AGI exceeds $190,000 (MFJ) or $95,000 (S)
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Slide 41: Education Savings Accounts
Distributions are tax free if funds used for higher education or private elementary/secondary education
◦ Tuition, fees, books, supplies, equipment ◦ Room and board if at least ½ time student
May claim educational credit in same year as distribution taken from an education savings account,
◦ As long as distribution is not used for the same expenses for which the credit was claimed
If distributions > qualified education expenses, part of distribution will be taxable income
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Slide 42: Higher Education Expense Deduction
Up to $4,000 above-the-line deduction for qualified tuition and related expenses with certain AGI limits (modified AGI < $65,000 (S) or < $130,000 (MFJ))
or
Up to $2000 deduction (modified AGI $65,000$80,000 (S) or between $130,000-$160,000 (MFJ)) Reduce deduction amount by
◦ Excludible interest from higher education savings bonds ◦ Excludible distributions from QTPs ◦ Excludible distributions from Education Savings Accounts
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Slide 43: The End
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