Deductions Itemized Deductions

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Deductions Itemized Deductions Powered By Docstoc
					Personal Deductions

Professor Jack Williams Georgia State University Basic Federal Income Tax

Personal Deductions
• Below the line – Introduction to Schedule A and the Backside of Form 1040. Students have copies of both the A and the 1040. • These expenses unrelated to the cost of earning income • Haig-Simons would include these expenses as part of the tax base and would not provide a tax benefit • Personal deductions fall along two lines:
– Designed to reflect differences in ability to pay, for example, the deduction for extra-ordinary medical expenses – Designed to encourage certain forms of behavior, for example, section 170 charitable deductions

• Personal deductions are subtracted from AGI to determine taxable income. • Taxpayer may take either –
– Itemized personal deductions or – A standard deduction

• Largest itemized personal deductions
– Home mortgage interest – State and local taxes

Standard Deductions
• Policy behind standard deduction:
– Consider section 63 – Certain amount of income that is shielded

• 2008 Amounts
– – – – – Married filing joint: $10,700 Surviving Spouse: $10,700 Head of Household: $7.850 Unmarried: $5,350 Married filing separately: $5,350

Itemized Deductions
• Found on Schedule A • Burden of proof on taxpayer
– Be careful of substantiation requirements

• Phase outs
– Married filing separate: $78,200 (begins) – Others: $156,400 (begins)

• AGI Thresholds
– Casualty loss: 10% – Medical deduction: 7.5% – Miscellaneous Itemized (AGI Deduction Floor): 2%

Personal Casualty and Theft Losses IRC 165
Personal casualty and theft losses are allowed as itemized deductions. As discussed in Chapter 7, business casualty and theft losses are deductible FOR AGI. The amount of loss is computed as the lesser of:
– Adjusted basis – Decline in fair market value

The loss must be reduced by insurance reimbursements received (or reasonably expected to be received)

Netting Personal-Use Casualty and Theft Gains and Losses
Each personal casualty loss must be reduced by $100 per event. Next, combine all casualty and theft gains and losses.
– If the result is a net loss, the net amount is treated as an ordinary itemized deduction and is further reduced by the 10% AGI floor. – If the result is a net gain, both gains and losses are capital gains and capital losses (discussed in Chapter 12). The losses are NOT reduced by the 10% AGI floor.


Special Disaster Election
In a Presidentially declared disaster area, taxpayers may elect to deduct the loss in the tax year immediately preceding the year in which the disaster occurred. Also, in Presidentially declared disaster areas, taxpayers will never have to recognize gain on the receipt of insurance proceeds for personal property contained in personal residences.

Medical Expenses IRC 213
• • •

Medical expenses in excess of 7.5% of AGI are allowed as an itemized deduction. The deduction is allowed only for medical expenses actually paid during the year. Medical expenses must be for medical care of the taxpayer, spouse or a dependent of the taxpayer.


A child of divorced parents is treated as the dependent of both parents for purposes of the medical expense deduction. Also, the gross income requirement for the dependency exemption is waived for the purpose of the medical expense deduction.

Types of Recognized Medical Expenses
• Acupuncture • Air conditioner necessary for relief from allergies or other respiratory problems (less any increase in the value of your home resulting from installation of air conditioning) • Alcoholism treatment, including inpatient treatment, meals, and lodging at a therapeutic center for alcohol addiction • Artificial limbs • Artificial teeth


Types cont’d
• Birth control pills prescribed by a doctor • Braille books and magazines used by a visually-impaired person • A clarinet and lessons to treat the improper alignment of a child's upper and lower teeth • Contact lenses, including equipment and materials for using contacts • Cosmetic surgery, if it's necessary to improve a deformity related to a congenital abnormality, accident, or disease

Types cont’d
• Diet, special. When prescribed by a doctor, you can deduct the extra cost of purchasing special food to alleviate a specific medical condition • Doctor or physician expenses • Drug addiction treatment, including inpatient treatment, meals, and lodging at a therapeutic center for drug addiction • Elastic hosiery to treat blood circulation problems • Exercise program if a doctor has recommended it as treatment for a specific condition

Types cont’d
• Extra rent or utilities for a larger apartment required in order to provide space for a nurse/attendant • Eye surgery, when it is not for cosmetic purposes only • Guide dog or other animal used by a visually-impaired, hearing-impaired, or otherwise physically disabled person • Hospital care • Household help for nursing care services only • Insurance premiums for medical care coverage

Types cont’d
• Laboratory fees • Lead-based paint removal, including the cost of removing lead-based paints from surfaces when a child has lead poisoning or was previously diagnosed with lead poisoning. (Does not include the cost of repainting.) • Legal fees paid to authorize treatment for mental illness • Lifetime care advance payments • Lodging expenses while away from home to receive medical care in a hospital or medical facility

Types cont’d
• Long-term care insurance and long-term care expenses (there are limitations to what you can deduct) • Mattresses and boards bought specifically to alleviate an arthritic condition • Medical aids, including wheelchairs, hearing aids and batteries, eyeglasses, contact lenses, crutches, braces, and guide dogs (and their care) • Medical conference admission costs and travel expenses for a chronically ill person or a parent of a chronically ill child to learn about new medical treatments • Medicines and drugs • Nursing care

Types cont’d
• Nursing home expenses, including the entire cost of medical care, plus meals and lodging if the main reason for being in the home is to obtain medical care • Oxygen and oxygen equipment • Reclining chair bought on a doctor's advice by a person with a cardiac condition • Special education; tuition for sending a mentally impaired or physically disabled person to a special school that has resources to relieve the disability • Smoking cessation programs (does not have to be recommended by a physician) • Swimming (the cost of therapeutic swimming prescribed by a physician)

Types cont’d
• Telephone (the cost and repair of special telephone equipment for a hearing-impaired person) • Television (the cost of equipment used to display the audio part of a TV program for hearing-impaired persons) • Transplant of an organ (but not hair transplants) • Transportation costs for obtaining medical care • Travel expenses for parents visiting their child in a special school for children with drug problems, where the visits are part of the medical treatment • Weight loss program, if it is recommended by a doctor to treat a specific medical condition or to cure any specific ailment or disease

Types cont’d
• Whirlpool baths prescribed by a doctor • Wig for the mental health of a patient who has lost his or her hair due to a disease • X-ray services


Medical Care – Capital Expenditures
Qualified expenditures for home improvements and additions may be deductible to the extent that their costs exceed any increase in the fair market value of the existing structure. Examples:
 Adding wheelchair ramps  Widening doorways to create wheelchair access  Adding a swimming pool prescribed by a physician to alleviate some ailment such as partial paralysis  Installing an elevator to provide handicap access between floors


Medical Care – Capital Expenditures
Capital expenditures may qualify for an immediate medical deduction (subject to the 7.5% floor) if prescribed by a physician to alleviate a physical or mental defect or illness. Examples:
    Seeing eye dogs Wheelchairs Eyeglasses Dentures


Medical Transportation and Lodging
Mileage - If mileage was primarily for and essential to medical care, the taxpayer may choose between
 the standard mileage allowance of 20 cents (2007) [19 cents (2008)], plus parking and tolls, or  actual expenditures.

Meals - Meals consumed during medical-related transportation are NOT deductible even if the transportation is primarily for and essential to the rendition of medical care.


Medical Transportation and Lodging
Nondiscretionary lodging during travel- A medical expense deduction is allowed for lodging (but not meals) while away from home primarily for and essential to medical care. This lodging cannot exceed $50 per night for each individual. The deduction may also be claimed for a person who must accompany the individual seeking medical care. Discretionary lodging during travel - If a doctor prescribes an operation or other medical care and the taxpayer chooses, purely for personal considerations, to travel to an out-of-town locality for medical treatment, the lodging is not deductible.

Medical Care
 The cost of in-patient hospital care, including meals and lodging, is an allowable deduction Meals consumed by patients during hospital stays are not subject to the 50% reduction.  All medicines and drugs require a prescription. Cosmetics and toiletries are not considered medicine and drugs.


Medical Insurance Premiums
 A medical expense deduction is allowed for medical insurance premiums, subject to the 7.5% limitation.  Premiums paid by the taxpayer for long term care insurance are allowed as medical expense deduction, subject to limitation. In 2007, the maximum deduction for prepaid long term care insurance premiums ranges from $290 for a taxpayer age 40 or less to $3,680 for a taxpayer over age 70.  Self-employed taxpayers are allowed to deduct 100% of medical insurance premiums “FOR” AGI

Charitable Contributions IRC 170, 501, 6115
• Charitable contributions are subject to limitations based on adjusted gross income. • Contributions are limited to 20%, 30% or 50% of AGI depending on the type of property donated and type of charity receiving the donated property. • The overall charitable contribution deduction is limited to 50% of AGI.

• Unused charitable contributions may be carried forward up to 5 years.

Charitable Organizations
Qualified charitable organizations are divided into 2 categories: public charities and private charities. Public charities include:
• • • • • Churches and hospitals Educational organizations Organizations supported by the government Private operating foundations Private non-operating foundations that distribute all of their contributions to public charities

Private charities are private non-operating foundations that do not distribute all of their contributions to public charities.

Charitable Contributions
Donations can consist of either cash or property. The type of property donated determines which percentage limitation applies. Ordinary income property includes property held by the donor primarily for sale to customers in the ordinary course of the donor’s business and works of art created by the donor. The deduction for ordinary income property is limited to the basis of the property. Capital gains property is appreciated property that, if sold at fair market value, would result in a long-term capital gain. Depreciable property and land used in a trade or business is considered capital gains property for charitable contribution purposes. The deduction for capital gains property is either the property’s basis, fair market value, or a reduced amount in the case of depreciable property.

Charitable Contributions
Category 50% public Valuation
Cash Basis

Property Donated
Cash Ordinary income property


Capital gains property reduced contributions election
Capital gains property Depreciable property

30% public



Qualified appreciated stock

30% private Cash

Ordinary income property
Capital gains property Qualified appreciated stock

20% private Basis

Property Taxes IRC 164
• State, local or foreign real property taxes and personal property taxes are allowed as an itemized deduction. • If real property is sold during the year, the tax deduction must be allocated between the buyer and seller based on the number of days each party held the property. This method is required regardless of which party actually pays the property taxes.

• Personal property taxes must be ad valorem (based on the value of the property) in order to be deductible.

Income Taxes IRC 164
• State or local income taxes are deductible as an itemized deduction. • Taxpayers may also deduct state and local income taxes withheld from their salary. • If a taxpayer receives a refund of state or local income taxes in a later year, the refund may need to be included in gross income (if a deduction was taken in an earlier year).

Interest IRC 163
• Personal interest is NOT deductible. Thus, interest on consumer debt, such as car loans and credit card debt, is not deductible. • Qualified education loan interest of up to $2,500 may be deducted FOR AGI. The deduction is phased out for single taxpayers with AGI of $55,000 ($110,000 for married taxpayers).

Qualified Residence Interest
Interest on home loans secured by a first or second home is allowed as an itemized deduction. The home must be a qualified residence. A qualified residence is
 A principal residence or  Any second residence that is for personal use

A deduction is allowed for qualified residence interest on up to $1 million of debt to acquire, construct or substantially improve a qualified residence. A taxpayer may borrow up to $100,000 in the form of a home equity loan and deduct the interest on the loan.

Home Mortgage Interest Deduction
• Introduction • Home mortgage loan interest can be deducted from your income and significantly reduce your taxes. Mortgage interest on a second home can also be deducted. • Policy
– Home mortgage interest payments are purely a personal consumption item that should not give rise to a deduction under the Haig Simons definition of taxable income? Why is the deduction provided? Why up to two homes? What policies are furthered by the deduction? Who benefits from the deduction?

Initial Assessment re Schedule A Deductions
• Add up all expenses you can itemize as deductions to make sure the total is greater than your standard deduction. The main itemized deductions are state taxes, mortgage interest, home equity loan interest, property taxes and charitable contributions. • The third section of Schedule A is for interest deductions. Check where Schedule A ties in with the Form 1040. (Both forms are on the course website!) Write on Schedule A the name of the bank, mortgage company, or any other lender to which you paid mortgage interest, and write the amount you paid during the tax year. The lending institution is required to send you a Form 1098 with this information. Write on Schedule A the name of the lending institution and the amount you paid in the tax year in points to obtain the loan, but only if the loan was to purchase your main home. Points for refinanced loans or for loans for a second home have to be deducted over the life of the loan, not at one time. The institution will send you a Form 1098 listing the points you paid.


Number of Homes
• You can deduct home mortgage interest on up to two homes (main home, vacation home, etc.)


Points to Consider
• • • • • • Keep good records if you're deducting points over the life of the loan (usually for a refinanced home or second home). When you sell the home or refinance it, you can deduct all the points you have not yet deducted. If you prepay your January mortgage payment in December, you'll get the deduction in the earlier tax year. To deduct home mortgage interest, you must own the home and you must pay the interest. If you pay the interest but don't own the home, it doesn't count. If you own the home but don't pay the interest, it doesn't count. If your home mortgage loan was obtained after October 13, 1987, you can deduct the interest on a maximum of $1 million in mortgages, or $500,000 if married filing separately. If the points were paid from the mortgage (or loan) proceeds and not out of your pocket, you have to deduct them over the life of the loan. If your mortgage loan was sold by one financial institution to another, as often occurs, the original lender may send you its Form 1098 at the time of the sale and not at the end of the year. Remember that this may be the only notification of the mortgage loan interest paid to that lender, and be sure to include this amount on your Schedule A.


Home Equity Loans Interest Deduction
• •

• •

• • • •

Introduction The interest you pay on a home equity loan may be deductible no matter what you use the money for. The deduction can save you money on your taxes. You can deduct home equity loan interest on your first or second homes only - not on any other home, even if you use the money for matters unrelated to the home. Amortizing points, which means spreading the deduction out over the life of the loan, requires good record keeping. When you pay off the loan or sell the home, you can deduct all the points you haven't taken off before. The yearly limit on the deduction for home equity loan interest is the interest on loans totaling $100,000 ($50,000 if married filing separately). If you used all or part of the loan for your business, it might be better to elect to treat the debt as unsecured by your residence. In that way, you can write off the interest as a business expense. But once you make the election, you can't reverse it without Internal Revenue Service approval. You cannot deduct interest on any amount of the home equity loan that is more than the difference between the market value of the home and your mortgage debt. These rules apply to home equity loans taken out after October 13, 1987. Downside: A home equity loan may provide a tax benefit, yet may not be worth the risk of losing your home should you need to default on the loan. Remember that a home equity loan is secured by your home. Why? What purpose is furthered by this deduction? Isn’t more tenuous than the home mortgage interest deduction?


Miscellaneous Itemized Deductions
Miscellaneous itemized deductions are generally grouped together on a tax return and are deductible to the extent that the total of all miscellaneous itemized deductions exceeds 2% of adjusted gross income. Examples:
– Unreimbursed employee expenses such as professional dues, subscriptions to professional journals, union dues and uniforms not suitable for everyday use. – Investment expenses such as safe deposit box rental, subscriptions to investment related publications, and legal and accounting fees related to investments. – Tax advice and tax return preparation.