Dr. Bob’s Notes 16b-1
THE INDIVIDUAL TAX MODEL
I. Income Inclusions and Exclusions Specific to Individuals
A. Allocating Income Between Married Persons
1. Income allocation between husband and wife is dependent on state law (i.e., common
law state vs. community property state).
B. Divorce - 3 types of transfers:
a. Taxable to the recipient and deducted toward AGI by the payer if:
(1) written agreement, (2) paid in cash for spousal benefit, (3) terminates at
death of the recipient. In addition, (4) the decree doesn’t state that the
payments are NOT alimony, and (5) the parties live in separate households.
c. Disparity in tax alimony exceeding $15,000 in the first 3 years can result in
recapture (i.e. deduction for the payee and income for the payer).
2. Property Settlements:
a. Nontaxable transfers, with basis carryover.
3. Child Support
a. Nontaxable transfer
C. Major Exclusions
1. Gifts and Inheritances
2. Life Insurance Proceeds
3. Scholarships - Amounts received for tuition, fees, books, supplies, and equipment
are excluded for degree candidates.
- Additional amounts received (i.e. room and board) included in gross income.
4. Miscellaneous Items
a. Prizes & Awards: general rule is to include the FMV; exception for employee
awards for service (e.g., gold watch for 40 years)
b. Unemployment compensation: taxable in full.
c. Social Security benefits - generally excluded.
- Exception applies if modified AGI exceeds certain amounts (>$25k)
d. Compensation for Injury or Sickness
- Personal injury damages -
--Only damages received for physical injury are excluded.
--All other damages are taxable
e. Interest on Educational Savings Bonds.
- Excluded if proceeds used to pay qualified higher education expenses
- Subject to phase-out based on AGI level
Dr. Bob’s Notes 16b-2
II. Itemized Deductions
A. Medical Expenses
1. Qualified Individuals include taxpayers & dependents
2. Qualified Medical Expenses
a. Medical, dental, hospital expenses paid for the prevention or alleviation of a
physical or mental defect or illness.
b. Cosmetic surgery generally not deductible
c. Medical insurance premiums are deductible IF paid with after-tax dollars.
d. Two types of medical expenses are deducted FOR AGI
- Medical insurance premiums paid by self-employed individuals
- Contributions made to a HSA (2011 limit of $3,050 (single) $6,150 (married)).
1. Deductible Taxes
a. Choice of (1) State & Local Income Taxes or (2) State & Local General Sales Tax.
1. State and Local Income Taxes. Taxpayers deduct state and/or local income tax
paid or withheld, regardless of the tax year involved.
2. State & Local General Sales Taxes. (Note – under the current provision, this will
no longer apply after 2009. However, tax bills currently under consideration
would retroactively reinstate this provision to 2010.)
Taxpayers can deduct either:
(a) total sales taxes actually paid (substantiated by receipts); or
(b) an amount from IRS tables plus the amount of general sales taxes paid in
the purchase of a motor vehicle, boat, or other major items.
b. Personal Property Taxes
- In order to be deductible the tax must be an ad valorem tax on personal property
imposed on an annual basis. Any portion of the tax which is a flat fee (e.g.,
registration fee the same for all vehicles) is not deductible.
c. Real Estate Taxes
2. Nondeductible Taxes
a. Federal income tax, employee's social security tax (but recall that a self-employed
taxpayer may deduct 1/2 of the self-employment taxes paid for AGI), and federal
estate and gift tax.
Dr. Bob’s Notes 16b-3
1. Personal interest
a. NOT deductible
b. Examples include credit card interest, automobile loan interest.
c. Exception – Interest paid on Qualified Education Loans (up to $2,500 & subject to
phaseout) is deducted FOR AGI)
2. Investment Interest
a. Interest incurred on a loan, the proceeds of which were used to buy investment
property that is not tax-exempt (e.g., municipal bonds).
b. Deduction is limited to net investment income. Unlimited carryover allowed.
* “Net investment income” can include LTCGs & qualified dividends only if
taxpayer elects to have them taxed as ordinary income.
3. Qualified Residence Interest
a. Acquisition indebtedness: $ used to acquire, construct or improve a principal
residence and a second residence.
- Definition of "residence"
- Interest deduction is limited to $1,000,000 of PRINCIPAL (total for both)
- Acquisition debt cannot be increased with a refinance, unless the proceeds are
used to improve the house.
b. Home equity indebtedness: Proceeds of home equity loan have no restrictions - can
use the $ for any purpose.
- Interest deduction is limited to $100,000 of PRINCIPAL
c. If loan principal amounts exceed the above limits, interest deduction is scaled down.
Example: The Smiths own a home (FMV = $350,000), on which their mortgage balance
is $80,000. What happens if the Smiths refinance their mortgage and increase the loan to
What if they borrow $150,000 on a home equity loan?
4. Timing of Deduction – Points
Dr. Bob’s Notes 16b-4
D. Charitable Contributions
1. Type of Property Contributed Determines Amount of Deduction
a. Ordinary income property = Lower of basis or FMV
b. Long-term capital gain property = FMV
- EXCEPTION: Tangible personal property unrelated to the charitable function
Amount treated as ordinary income property (lower of basis or FMV)
NOTE: If FMV > $500, Form 8283 must be attached to indicate how determined. If
FMV > $5,000, property must be appraised.
c. FMV of Personal Services yield no deduction. Why?
d. Out of pocket expenses are deductible.
2. Deduction Limitations (all based on AGI)
1. 50% limitation - cash & ordinary income property to charitable organizations and to
private operating foundations (e.g., Ford Foundation)
2. 30% limitation - contributions of LTCG property & to contributions of cash and
ordinary income property to nonoperating private foundations.
3. 20% limitation - contributions of LTCG property to private nonoperating foundations.
4. Overall limitation (50%) - combination of all types cannot > 50% of AGI
Example: X, with an AGI of $100,000, made cash contributions of $40,000, and
LTCG contributions of $40,000. What is the deduction amount?
D. Summary of Property Treatment:
Type of Property Valuation of Property AGI Limit on Deduction
Dr. Bob’s Notes 16b-5
1. Charitable contributions exceeding the annual percentage limitations may be carried
over for five years, subject to the same % limitations in the carryover year as those
that caused the original carryover
F. Election to Treat LTCG property as Ordinary Income property
Example: TP contributes LTCG property (FMV = $100,000, basis = $90,000) to Red
Cross in a year when AGI = $150,000.
LTCG ORD INC
V. Miscellaneous Itemized Deductions
A. Subject to the 2% of AGI hurdle.
1. Unreimbursed employee business expenses.
2. Expenses to produce income.
3. Costs of tax advice, tax return preparation, and any related fees.
B. Not subject to the 2% of AGI hurdle.
1. Gambling losses (to the extent of reported winnings).
Dr. Bob’s Notes 16b-6
VI. Review & Overview of Credits
A. Refundable vs. Nonrefundable
B. Earned Income Credit
- Based on earned income (wages and self-employment) & number of kids
- 2011 maximum is $3,094 (1 child), $5,112 (2 children), $5,751 (3+ children), subject
C. Child Tax Credit
- $1,000 per child < age 17, subject to phase-out
D. Child and Dependent Care Credit
- Based on costs incurred for care of a child under age 13 or a disabled dependent while
the taxpayer is at work
- Credit rate ranges from 35% (AGI < $15,000) to 20% (AGI > $43,000), limited to the
lesser of: (1) $3,000 (1 child) or $6,000 (2 child), or (2) taxpayer’s earned income
E. Adoption Credit
- Based on costs incurred in the adoption of a child
- Limited to $13,360 per child, subject to phase-out.
F. Credits for Higher Education
- Consists of 2 credits
- American Opportunity scholarship credit
Based on 1st 4 years’ tuition
Maximum credit is $2,500 per child (100% of 1st $2,000, + 25% of next $2,000)
- Lifetime learning credit
Based on tuition costs of undergraduate, graduate, or professional degree programs
Maximum credit is $2,000 per year (20% of 1st $10,000)
- Both credits are subject to phase-out