CHAPTER 5 Itemized Deductions & Other Incentives

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Income Tax Fundamentals 2010 edition Gerald E. Whittenburg

Martha Altus-BullerStudent’s copy

2010 Cengage Learning

First itemized deduction on Schedule A Medical expenses allowed◦ For spouse, self and dependents ◦ For amounts spend 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

Note: Health insurance for self employed is deduction for AGI

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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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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)◦ Real property taxes◦ Personal property taxes

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

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Sales tax on new vehicles purchased in certain date range is deductible◦ Even if taxpayer elects to deduct SIT instead of sales tax◦ For purchases after 2/16/09 and before 1/1/2010◦ Can be added to standard deduction if don’t itemize◦ Deduction applies to tax on first $49,500 for each vehicle

purchased◦ No limit on number of vehicles that qualify for deduction◦ Phase out after AGI > $125,000 (S) or $250,000 (M)

Note: File Schedule L to claim deduction

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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◦ Amortized points on refinanced mortgage◦ Investment interest◦ Education loan interest

Consumer (personal) interest is not deductible Investment interest nondeductible if used to generate

tax-exempt income

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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

Loan origination fees ◦ Called ‘points’ because they are quoted as percentage

points of principal are deductible◦ Refinancing points must be capitalized & amortized

Deducted over life of loan

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Charitable contributions are allowed as a deduction

Can contribute cash or property◦ Out of pocket expenses are deductible ◦ $.11/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

IRS publishes Cumulative List of Organizations, Publication No. 78

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Taxpayers should document charitable contributions◦ Cannot claim deduction of $250 or more unless taxpayer has

written acknowledgment from organization◦ Need bank record or cancelled check even if contribution is

less than $250 Even amounts put in plate at church, for example, should be in form

of a check

If property contributed exceeds $500, must attach Form 8283

If property contributed exceeds $5,000, formal appraisal must be submitted

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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 1098C to taxpayer showing resale information ◦ Or certifies that no resale amount may be provided as

vehicle donated to needy individual◦ Taxpayer must attach 1098C to tax return◦ Taxpayer may claim estimated value if charity uses donated

auto rather than selling it

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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 (see Rules A & B on page 5-16) Casualty losses are deductible in year of occurrence◦ Exception for disaster area losses (can amend prior year

return and deduction in that year and file for refund) Limit to personal casualty loss calculated as follows

Loss - $500 floor and only in excess of 10% of AGI

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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◦ Gambling losses to extent of gambling winnings◦ Terminated annuity payments

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“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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Ability to deduct total itemized deductions is phased- out for high-income taxpayers◦ 1% x (AGI - threshold amount)

Threshold amount $83,400 for MFS or $166,800 (all other filing types)

Phase-out calculation is (AGI – Threshold Amount) x 1% but limited to◦ 26-2/3% x all itemized deductions except medical,

investment interest expense, casualty losses and wagering losses

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Sometimes called Section 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 taxpayers withdraws early,

then distributions are taxable plus 10% penalty

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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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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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