ITF_IPP_Ch05_2014_IN_FINAL.ppt

8/10/2019 ITF_IPP_Ch05_2014_IN_FINAL.ppt

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CHAPTER 5

Itemized Deductions &Other Incentives

Income Tax Fundamentals 2014

Gerald E. Whittenburg

Martha Altus-BullerSteven Gill

2014 Cengage Learning 1


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Learning Objectives

Understand nature/treatment of medicalexpenses

Calculate itemized deduction for taxes, interestand charitable contributions

Compute deduction for casualty/theft

Identify miscellaneous itemized deductions andemployee business deductions

Understand tax implications of using educationalsavings vehicles

Calculate itemized deduction and exemptionphase-outs for high-income taxpayers



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Medical Expenses

First itemized deduction on Schedule A

Medical expenses allowed For spouse, self and dependents For amounts spent that exceed 10% of AGI (or 7.5% if

single and over 65 or MFJ and one spouse over 65) Must be reduced by amount of insurance reimbursementSee page 5-2 for list of health, dental, and opticalexpenditures that qualify Medical insurance premiums (including Medicare) Long-term care insurance premiums

Specified limits that change each year based on taxpayersage

If deducted for AGI, excluded from Schedule A calculations



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Medical Expenses

Prescription medication is allowedo Drugs illegally purchased abroad nondeductibleo Nonprescription drugs are not deductibleo Medical marijuana is not deductible

Special equipment purchased/installed in

taxpayers home is deductible all in one year Transportation/lodging for medical care is allowed

o 2013 deduction per mile = $.24o $50 per night per person lodging deduction

Allowed for patient and one individual accompanyingpatient

No meal deduction allowed



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Medical Expenses Example

ExampleDuring the year, Frieda (age 59) and Jos (age

66) paid the following medical expenses:Contact lenses $ 120Face lift for cosmetic purposes 2,900Doctor bills 1,600Health insurance premiums 4,800

They also traveled 260 miles to see a cardiologist inJuly. Their gross income = $31,200 and they werereimbursed $1,000 by their insurer. What are theirdeductible medical/dental expenses for the currentyear?



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Solution

2014 Cengage Learning

7.5% becauseJose is over 65

Solution[$120 + $1,600 + $4,800 + (.24)($260)] = $6,582

$6,582 - $1,000 reimbursement = $5,582.

They may deduct these expenses in excess of(7.5% x $31,200)

$5,582 $2,340 = $3,242 medical expense asitemized deduction

Note: Face l i f t for cosm etic purpo ses is not deduct ible

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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

May use actual sales tax or from IRS-provided tables If actual deduction, must keep receipts for all sales tax paid

Real property taxes Personal property taxes

Example of nondeductible taxes include estate taxes,gift taxes and excise taxes

2014 Cengage Learning7


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Income Tax Deduction Example

ExampleHow much can Colleen take for taxes as an

itemized deduction in the following scenario? Colleen amends her 2011 state tax return and

must pay an additional $843 state income tax(SIT) in 2013

Breakdown of amount due is: $93 in penalties/interest +$750 SITHer SIT withholding for the current year is $660

She paid quarterly SIT estimates as followsPaid $200 each on 4/15, 6/15, and 9/15 of currentyear and 1/15 of next year1/15 of current year paid 4th quarter estimate from prioryear - $155



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Solution


SolutionColleen may deduct the actual amounts

paid in 2013

Itemized deduction for SIT = $2,165($750 + $660 + $200 + $200 + $200 +$155)

Note : If taxp ayer receives refu nd of SIT thatw as deduc ted in pr ior year, that refund is

taxable inco m e in year i t is received!

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Real Estate Taxes

Property taxes on real estate are deductibleo Even on second homeo Rental property real estate taxes are reported on

Schedule Eo If paid into escrow, taxes are deductible when paid

When selling property, need to allocate realestate taxes based on number of days thateach party owned

Service fees, such as homeowners dues, arenot deductible



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Personal Property Taxes

Tax on personal propertyo Amounts paid on autos, boats, trailer, etc. are an

itemized deductiono Only amount that is based on the propertys value

is deductible

Fees calculated on basis of weight are no t deductible



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Tax Deduction Example

ExampleSelma has AGI of $31,300 for 2013. She

itemizes her deductions and thereforededucts the allowable amount of tax. Her

FIT withholding for the year is $2,150, SITwithholding is $1,500, Social Security taxesare $1,768, real estate taxes on her homeare $3,300, sewer fees are $867 and she

pays auto registration of $210 (of that $180is based on value of auto).

How much may Selma show as an itemizeddeduction for taxes in 2013?

2014 Cengage Learning12


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Solution


ExampleSelma has AGI of $31,300 for 2013. She itemizes

her deductions and therefore deducts theallowable amount of tax. Her FIT withholding

for the year is $2,150, SIT withholding is$1,500, Social Security taxes are $1,768, realestate taxes on her home are $3,300, sewerfees are $867 and she pays auto registration of$210 (of that $180 is based on value of auto).

Solution

Itemized deduction for taxes = $4,980

($1,500 + $3,300 + $180)13


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Overview of InterestInterest 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 (except if used to generate tax-exempt

interest) Certain interest associated with passive activities

Consumer (personal) interest is not deductible

Private mortgage insurance (PMI) related to debtacquired to purchase of personal residencedeductible if AGI is $100,000 or less



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Mortgage InterestQualified 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 purposeso

Interest limited to debt at or below fair market value ofhome

Loan origination fees Called points because they are quoted as percentage

points of principal these are deductible

Note: If taxpayer assu mes benef i t s /burd ens of own ership , maybe a llowed to deduct m ortgage insurance even i f no t d i rec t lyl iable on the mo rtgage. Not a s tandard s i tua t ion, only a llowedon c ase by case s i tua t ion.



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Education Loan Interest

Up to $2,500 per year

Deduction for AGI

This deduction phases out when AGI > $60,000 (S) or AGI > $125,000 (M)Loan must be used for qualified higher educationexpenses This includes tuition, room and board, and related

expenses



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Investment Interest

Investment interest is incurred on debt topurchase investment property Can only deduct up to the amount of net

investment income (such as interest income)*

Carry forward any unused investment interestexpense to next year

*Technical note: special rules as to including dividends andcapital gains in net investment income because of their

preferential tax treatment



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Contributions

Charitable contributions are allowed as adeductionCan contribute cash or property Out of pocket expenses are deductible $.14/mile for mileage deduction Value of free use of taxpayers property is not

deductible

To be deductible, donation must be made to aqualified recipient (see pages 5-12 and 5-13)

IRS publishes online search tool called ExemptOrganizations Select C heck



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Contributions - PropertyGifts of household items/clothing subject tonew requirements Must be in good condition Items with minimal value may not be deducted

If contribute property, deduction is equal tofair market value (FMV) at time of donation Exception occurs if property donated would have

resulted in ordinary income or short-term capitalgain (STCG)

Then, the deduction is equal to fair market value lessthe amount of ordinary income or STCG thatwouldve resulted if property had been sold



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Contributions Property

If taxpayer donates appreciated long-term capitalgain (LTCG) property, such as appreciated stock,may deduct fair market value of the property *,except if:

o Donation is made to certain private nonoperating

foundation (30% organization) then can onlydeduct fair market value minus potential LTCGor

o Donation is a contribution of tangible personalproperty to an organization that uses it for a purposeunrelated to the organizations primary purpose(such as artwork contributed to Humane Society)

*Good tax planning t ip fu l l deduct ion taken forappreciated prop er ty and tax avoided on appreciat ion



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LTCG Donation Example

ExampleBea 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 forcontributions? Would Beas deduction changeif she had donated the couch to anenvironmental organization?



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Solution


Solution

If Bea had sold the antique, her LTCG would havebeen $1,500 ($4,000 $2,500); since the couchis put to a use related to the organizationsprimary purposes. Deduction = $4,000.

If the antique was donated to an environmentalorganization, the purpose is unrelated andtherefore she must reduce her deduction by theamount of the LTCG that would have resulted ifthe item had been sold. Deduction = $2,500($4,000 - $1,500 LTCG )

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Contributions Percentage Limitations

Generally, deduction for charitable contributions limitedto 50% of taxpayers AGI this applies to donations to:

All public charities All private operating foundations and specific private

nonoperating foundationsExamples of 50% organizations include churches andeducational institutions and hospital/medical researchorganizations

Contributions limited to 30% of taxpayers AGI if

donation made to certain private nonoperatingfoundations, fraternal societies and veteransorganizations



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Contributions to a50% Organization


Cash

50% of A GI

LTCGproperty

(see next s lide)

STCG or ordinaryincome property

Can deduc t FMV lessamoun t of gain that

wouldve been

recog nized (the basis);then deduct ion l imited

to50% of A GI

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Contributions to a30% Organization

Cash

30% of A GI

LTCGproperty

Cannot exceed 30% ofAGI i f donat ion to 50%organizat ion or 20% of

AGI if to 30% org anization

STCG or ordinaryincome property

Can deduc t FMV lessamoun t of gain that

wouldve been

recog nized (thebasis ), then l im ited to

30% of A GI



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Contributions


Order of charitable contribution deductions1. Deduct 50% contributions2. Deduct 30% contributions3. Deduct 20% contributions

Carry forward unus ed amo unts to sub sequent years

Total of all3 types ofdeductions

sti l ll imited to

AGI x 50%

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Contributions - Substantiation

No deduction allowed for contributions of$250 or more unless written substantiation

Noncash contributions must be in good

condition or better to qualify for deductionIf charity knowingly provides falseacknowledgment, may be subject topenalty (generally $1,000)



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Donation of Vehicles

Deduction for a donated vehicle limited tothe amount for which the charity sells thevehicle Same rule applies to boats and planes

Charitable organization sends a Form1098-C to taxpayer showing resaleinformation 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 it2014 Cengage Learning 28


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Contribution Example

ExampleDuring the current year, Clem donates $1,260

to his synagogues youth group, allows theyouth group to use his lake cabin (valued at$500), drives 1,000 miles on behalf of theYWCA and donates a vehicle (valued at$950) to the United Way. United Way sellsthe auto for $750 and issues a 1098-C toClem. What is Clems charitablecontribution deduction if his AGI = $33,200?



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Solution


SolutionClem cannot deduct the value of his lake

cabin; therefore, his contribution

deduction = $2,150 ($1,260 + (1,000 miles x .14) + $750)

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Casualty and Theft Losses

Deductions are allowed for casualty and theftlosses

To be classified as casualty loss, event needsto 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 only deductible in year ofoccurrence Exception: for federally declared disaster area losses,

taxpayer can amend prior year return and deduct inthat year and file for refund



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Casualty and Theft Losses

Two rules governing casualty/theft losseso 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 orinvestment property

o Rule B allows a deduction for the adjusted basis ofthe property

Used for complete destruction of business orinvestment property

*Limit to p ersonal casualty loss calculated as fol lowsDeduct ible Loss = Loss in excess of ins urance proceeds - $100 f loor

(10% of A GI)2014 Cengage Learning 32


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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 (for bonds purchased

prior to 10/23/86)

Gambling losses to extent of gambling winnings Unrecovered annuity costs at death



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Miscellaneous DeductionsThose limited to amounts over 2% AGI

Unreimbursed employee expenses (use Form2106 or 2106-EZ)

Reimbursed employee expenses made under anon-accountable plan

Union dues Tax preparation fees Safety deposit box Professional journals/subscriptions

Investment expenses Job-hunting fees



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Miscellaneous Deductions

Investment Expenseso Deduction allowed if directly related to taxable

income; however, no deduction for investmentexpenses related to tax-exempt income

o Fees paid to broker to acquire stocks/bonds are notdeductible

Instead, added to cost basis of stocks/bonds

Tax Preparation Fees

Job-Hunting Expenseso If seeking job in current trade can deduct, or if

unemployed there has been no lack of continuitysince last job



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Classification of Deductions

If employee is reimbursed for expenses(such as travel) under an accountableplan, no income is reported on W-2 andno itemized deduction is taken

(effectively cancelling out)If employee is reimbursed for expensesunder a nonaccountable plan, income isreported on W-2 and itemized deduction(subject to 2%) is taken on Schedule A



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Qualified Tuition Programs (QTP)Sometimes called 529 tuition plans

Allows taxpayers to meet higher education expensesby Buying in-kind tuition credits or certificates

or Contributing to an established account

Distributions are generally not taxed if funds used forhigher 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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QTP Annual contribution amounts vary

Contribution is not deductible High limits in most states

May claim American Opportunity credit orLifetime Learning credit in same year as

distribution taken from a QTP As long as distribution is not used for the sameexpenses for which the credit was claimed

Must also reduce qualified higher educationexpenses exclusion by scholarships, veterans

benefits, etc.Note: plans vary by s tate check ou t www.col legesavings.org

o r www.savingforcol lege.com for overview

http://www.collegesavings.org/http://www.collegesavings.org/http://www.collegesavings.org/http://www.collegesavings.org/


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Education Savings Accounts

These accounts allow taxpayers tomeet higher education expenses bycontributing to an educational savingsaccount

Annual contributions are not deductible Allowed until beneficiary reaches 18 Limited to $2,000/year per child Cant make in same year as contribution

to QTP Phase-out when AGI exceeds $190,000

(MFJ) or $95,000 (S)2014 Cengage Learning 39


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Education Savings AccountsDistributions are tax free if funds used for higher

education or private elementary/secondaryeducation Tuition, fees, books, supplies, equipment

Room and board if at least time student

May claim educational credit in same year asdistribution taken from an education savingsaccount 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 income2014 Cengage Learning 40


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Phase-Out of Itemized Deductionsfor High-Income Taxpayers

If AGI exceeds following amounts, itemized deductions andexemptions are phased out

o Single $250,000

o HOH $275,000

o MFJ $300,000o MFS $150,000

Itemized deductions reduced by the less of 3% of excess oftaxpayers AGI over threshold amount

or

80% of itemized deductions other than medical expenses,investment interest, casualty/theft and wagering losses thatare in excess of wagering gains



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Phase-Out of Exemptions forHigh-Income Taxpayers

Personal and dependency exemptionsare reduced by 2% for each $2,500* (orfraction thereof) by which thetaxpayers AGI exceeds the thresholdamounts (prior slide)

*Or $1,250 for MFS



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The End


ITF_IPP_Ch05_2014_IN_FINAL.ppt

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