Itemized Business Expenses

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					Chapter 8

                           Deductions: Itemized Deductions
                                   (Revised 08/01/10)

Personal, living or family expenses are disallowed by the IRC; Section 262.
However, Congress specifically allows some deductions for expenses which are
essentially personal in nature. “Itemized Deductions” are deductible from AGI and
are reported on Schedule A, Form 1040. The discussion in this chapter does not
apply to trade and business deductions, which are usually deductible on other
schedules, without regard to limitations.

      Medical Expenses

          o Amounts paid for the diagnosis, cure, mitigation, treatment or for the
            prevention of disease for the purpose of affecting any structure or
            function of the body; for transportation primarily for and essential to
            medical care, and for insurance for medical care for the taxpayer(s)
            or dependent(s). The cost of cosmetic surgery directed solely at
            improving appearance does not qualify.

          o Capital expenditures are deductible only to the extent that the cost
            exceeds any increase in the FMV of the property, e.g. elevator.

          o Transportation and lodging expenses are deductible if primarily and
            essential to medical care, NOT including the cost of meals while
            away from home receiving medical care. The current deduction for
            medical mileage is 16.5¢ per mile. Parking fees and tolls are
            deductible. Lodging costs are limited to $50 per night per eligible

          o Only medical expenses paid by the taxpayer and not reimbursed are

          o Cost of in-patient hospital care, including cost of meals and lodging is
            deductible, as are nursing home expenses for eligible patients.

          o Cost of prescribed medicines and drugs are deductible; over-the-
            counter medications are not deductible.

          o Medical insurance premiums paid for medical care insurance is
            deductible. Long-term care insurance is deductible based on the
            policy and age of the taxpayer, as is the medical care portion of the
            cost of qualified continuing-care facilities.

       o Medical expenses are deductible only in the year paid. Subsequent
         reimbursement is reported as income in the year received, to the
         extent of the attributable deductions allowed in the prior year (Tax-
         Benefit Rule).

       o Only qualified medical expenses over 7.5% of AGI are deductible.
         This AGI “floor” usually precludes deducting medical expenses,
         except in dire circumstances or more often in elderly medical care.

            For example:

            AGI                             $40,000

            Medical expenses                  4,300
            Floor (.075 x $40,000)           (3,000)

            Net Medical Expense Deduction    $1,300 !!

   Taxes

       o Real property taxes paid to state, local, and foreign governments
           - Deductible only by the person upon whom the tax is assessed.
           - Assessments as opposed to a tax, are not deductible
           - Real estate taxes must be allocated among between the buyer
                and the seller of real property in the year of sale by using a
                daily rate.

       o Personal property (ad valorem - based on value) taxes paid to state &
         local governments.

       o Income taxes (or general sales taxes for the years 2004 through
         2009 – future? TBD) that are paid to state, local, and foreign
         governments – again, subject to the Tax-Benefit Rule.

   Interest

       o Interest is the amount which one has contracted to pay for the use of
         borrowed money. Only specified types of interest are deductible, and
         the amount deductible is often limited. The uses of loan proceeds
         must be traced to determine the deductibility of any interest on the
         loan. Loans used for personal or consumer purposes result in
         personal interest which is not deductible.

o Qualified education loan interest up to $2,500 per year is an above-
  the-line deduction, is subject to phase-out rules, and was discussed
  in Chapter 6.

o Qualified Residence Interest

      o Mortgage interest secured by the taxpayer’s principal or
        second home (a home that is not rented out for the greater of
        14 days or 10% of the number of days it is rented [vacation
        home rules]).
      o Qualified residence interest is deductible up to $1 million of
        acquisition indebtedness – the debt to purchase or improve
        any qualified residence. These rules are complex and are very
        often misunderstood by taxpayers.
      o Home Equity Indebtedness is borrowing up to $100,000
        against the equity of a qualified residence. Hence, qualified
        residence interest is limited to a total indebtedness of $1.1
        million. The proceeds of equity loans may be used for any
        purpose, but deductibility is subject to Alternative Minimum
        Tax rules, discussed in Chapter 9.
      o Qualified mortgage insurance premiums, subject to AGI
        limitations (maximum AGI: $100,000, MFS $50,000) is
        deductible as mortgage interest ( supposed to end in 2010).

o Investment Interest

      o Interest on debt incurred or continued to purchase or carry
        property held for investment, for example: stocks, bonds and
        raw land, but not for investments earning tax exempt interest.
      o Investment interest is deductible only to the extent of net
        investment income (investment income less investment
        expenses) earned by the taxpayer.

o Prepaid Interest – Points

      o Cash and accrual taxpayers must deduct prepaid interest over
        the life of a loan.
      o Points are considered additional interest charges usually
        connected with the application/approval of a loan. They are
        deducted over the life of the loan unless they are points paid in
        connection with the purchase or improvement of a loan
        secured by the taxpayer’s principal residence. Points for this
        type of loan may be deducted currently if they are common to
        the area and carry a “standard” interest rate.
      o Points paid on refinanced home loans are deductible only over
        the life of the loan. Any unamortized points are deductible

                when the loan is paid off, e.g. another refinance or if the
                property is sold.
              o Points paid by the seller may be deducted by the buyer, but
                the buyer must agree to reduce the basis of the new house by
                the seller paid points.

   Charitable Contributions

       o Contributions made to qualified domestic organizations in the year
       o Qualified organizations are defined in Code Section 501, see
         Paragraph 8301, page 8-13, and must meet specific requirements in
         order to be exempt from taxation.
       o Gifts made directly to an individual or earmarked for a specific
         individual are generally not deductible.
       o Contributions may be made in cash or property. Any contributed
         property must be valued at the Fair Market Value of the property.
       o Many restrictions exist on contributions. The amount of any
         deductible contribution must not include a personal benefit to the
       o The FMV of contributed services is not deductible.
       o Unreimbursed expenses, including automobile expenses (at 14¢ per
         mile – statutory amount) incurred in travel and transportation to
         perform charitable services are deductible.
       o Charitable contributions are limited to 50% of AGI for public charities
         with disallowed amounts carried over for up to five years. Complex
         rules exist for private charities and contributed capital gain property. It
         is important to review the Charitable Contribution Percentage Limits
         presentation and example at Paragraph 8325, pages 8-18 thru 8-20.
       o Records must be maintained for all contributions. All monetary
         contributions must be supported by a cancelled check, bank record,
         or written communication from the charity; and if $250 or more, the
         contribution must be acknowledged in writing by the charity.
         Contributions of property, at FMV, must be listed separately if over
         $500, and appraisals must be attached to the tax return if over $5,000
         for one item, or a group of similar items, excepting traded
         securities. The amount of motor vehicle, boat or airplane deductions
         is limited to the amount the charity receives for the item when it is
         sold by the charity, and if the charity keeps it for its own use, the FMV
         is the deductible amount of the contribution.

   Casualty and Theft Losses

       o Uninsured losses arising from fire, storm, shipwreck, or other sudden
         (not progressive deterioration) unexpected, identifiable and provable
         events of an unusual nature are deductible subject to incident and
         AGI limits.
       o Each personal casualty loss is subject to a $100 (it was $500 for
         2009) reduction, per event, and 10% of AGI. The effect of these limits
         for uninsured losses means that few taxpayers qualify to deduct a
         casualty loss.
       o If the damaged property is insured, a claim must be filed before
         deducting a casualty loss which is then still subject to the limitation
       o Theft losses are treated as sustained in the year discovered, and are
         subject to the same limitation rules.

   Miscellaneous Itemized Deductions

          o The following deductions are all limited to the aggregated amount
            that is in excess of 2% of AGI. As a result of this limitation, few
            taxpayers are eligible to take these deductions:

                Reimbursed and unreimbursed employee business expenses
                 were discussed in Chapter 6.
                Job-seeking expenses are deductible if the taxpayer is
                 seeking employment in the same trade or business.
                 Deductions include, travel and transportation, preparation of
                 resume, mailing expenses, employment agency fees, etc.
                Education expenses are deductible if incurred by the taxpayer
                 to maintain or improve skills that are required in the current
                 job. If the education qualifies the taxpayer for a new trade or
                 business, the expenses are not deductible (including a CPA
                 review course). If the education expenses are incurred to meet
                 the employers minimum educational requirements, the
                 expenses are not deductible. Do not confuse itemized
                 deduction education expenses with above-the-line qualified
                 education expenses. See paragraph 8665.
                Work clothes and uniforms are normally not deductible except
                 for special equipment or clothes which are required as a
                 condition of employment and not suitable for everyday use.
                Other miscellaneous itemized deductions:
                      Dues to professional societies
                      Union dues and expenses
                      Subscriptions to professional journals
                      Small tools and supplies

o Investment Expenses

        Investment expenses are deductible if incurred for the
         production or collection of, or for the management,
         conservation, or maintenance of property held for the
         production of income.
        An exception to the 2% of AGI rule is rental and royalty
         income. These types of incomes are above-the-line
         deductions and are used to reduce gross rents and gross
         royalties, and are reported on Schedule E along with all other
         expenses related to the rents or royalties.
        Miscellaneous investment expenses are deductible under
         Code Section 212, and are subject to the 2% of AGI limitation.
         These expenses include:
             Safe deposit box rental fees that is used solely to
                 safeguard investment documents and items; not
                 personal documents or other personal items.
             Investment counseling fees.
             Subscriptions to investment publications.
             Legal and accounting fees related to investments.
             Expenses related to attending investment conventions,
                 seminars, or similar meetings are not deductible.
             Office-in-Home deductions may not be taken, and do
                 not qualify as an investment deduction for a taxpayer
                 who manages their investment portfolio from their
             Depreciation on a computer used exclusively for
                 portfolio management and administration is deductible.

o Tax Counsel and Return Preparer Fees

        Expenses paid or incurred by an individual in connection with
         the determination, collection or refund of any tax are
        Fees and expenses paid for tax counsel, tax preparation fees,
         proceedings involved in the determination of, or contesting a
         tax liability, are deductible subject to the 2% of AGI limitation.
        Tax preparation fees for an individual taxpayer may be
         allocated among several schedules, e.g. Schedule A, Itemized
         Deductions; Schedule C, Sole Proprietorship; or Schedule E,
         Rents and Royalties, depending on the type and scope of tax
         preparation services. To insure some deductibility of the fees
         paid by the taxpayer, the minimum fee a good CPA should
         charge for tax preparation work should be not less than
         $3,000. 

              o Items NOT subject to the 2% of AGI Limitation

                       Wagering Losses are allowed as a miscellaneous itemized
                        deduction, not subject to the 2% limitation, but only to the
                        extent of gambling winnings. Professional gamblers may
                        deduct their losses as a business expense, but only to the
                        extent of their winnings, e.g. a zero net profit; no deductible
                        loss off-setting other income.
                       Excess deductions in the final year of an estate are passed
                        through to the beneficiary(s) of an estate.
                       If a taxpayer dies before recovering all of the after-tax
                        contributions made to an annuity, the remaining
                        unrecovered cost of the annuity can be deducted as a
                        miscellaneous itemized deduction, not subject to the 2%
                        limitation on the deceased taxpayer’s final tax return.

The following is an example of the application of the 2% of AGI rule:

AGI = $50,000, therefore, 2% of AGI is :                                $1,000

Miscellaneous Itemized Deductions :

Unreimbursed business miles (1,000 miles x 50¢ /mile                     $ 500
Unreimbursed client entertainment expenses ($320 x 50%)                     160
Tax preparation fees (EA Not CPA)                                           350
Union dues                                                                  200
Safe deposit box fees                                                        70
                    Total miscellaneous deductions                      $1,280
                    Less: 2% of AGI                                     ( 1,000)

                       Net deduction                                    $ 280

 This information is presented for your information only. This explanation and
  example of the previous rules related to the reduction of itemized deductions is
  NOT effective for 2010, but is likely to return in 2011:

The limit on total allowable itemized deductions – a reduction by 3% of the amount
of AGI over a specified amount (assume $200,000 MFJ) was introduced in Chapter
3. This limitation did not apply to medical expenses, casualty losses, investment
interest or wagering losses to the extent of wagering gains. The reduction could not
exceed 80% of the total amount of itemized deductions reported on Schedule A.


       Itemized deductions:        Deductible Taxes                      $10,000
                                   Qualified Mortgage Interest            45,000
                                   Total Itemized Deductions             $55,000

              Adjusted Gross Income                                   $ 320,000
              Less base (assumed)                                      (200,000)
              Excess                                                  $ 120,000
              Times reduction of 3%                                     x    .03
              Tentative reduction                                     $ 3,600

              Limit on reduction - lesser of:
                     80% of $55,000                                  $ 44,000
                     Tentative reduction                             $    3,600

              Actual Reduction (Disallowed)                          $    3,600

              Allowed Itemized deductions:
                    Itemized deductions                              $ 55,000
                    Reduction (Disallowed)                             ( 3,600)

              Schedule A adjusted Itemized deduction                 $ 51,400

       This decrease in otherwise qualified deductions naturally results in higher
taxable income, aimed at perceived high-income taxpayers. It is often called a
stealth tax increase, as is the same type of decrease which was applied to the total
exemption amount, because it is not readily apparent to, or understood by, normal


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