Chapter 7

Chapter 7Chapter 7

Itemized Deductions

Learning ObjectivesLearning Objectives

• Identify qualified medical expenses and compute the medical expense deduction

• Determine the timing of a medical expense deduction and the effect of a reimbursement

• Identify taxes that are deductible as itemized deductions

Learning ObjectivesLearning Objectives

• Identify different types of interest deductions

• Compute the amount of investment interest deduction

• Compute the deduction for qualified residence interest

Learning ObjectivesLearning Objectives• Compute the amount of a charitable

contribution deduction and identify limitations

• Identify certain miscellaneous itemized deductions subject to the 2% of AGI limitation

• Compute total itemized deductions for a taxpayer who is subject to the itemized deduction phase-out

Medical ExpensesMedical Expenses

• Qualified individuals

• Qualified medical expenses

• Amount and timing of deduction

Qualified IndividualsQualified Individuals• Medical expenses paid for the taxpayer,

taxpayer’s spouse, or dependent• For dependents: if the taxpayer could take

a dependency deduction except for the failure to meet the gross income or joint return tests

• For children of divorced parents: – the parent need not be the custodial

parent in order to take deduction for medical expenses paid on behalf of a person

Qualified Medical ExpensesQualified Medical Expenses

• Those paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, including transportation, meals & lodging, certain capital expenditures, & medical insurance premiums.

• In 2001 self-employed individuals may deduct 60 % of health insurance as a deduction for AGI. In 2002 will the percentage will increase to 70%

• No cosmetic surgery unless it treats illness or promotes proper body function.

Qualified Medical Expenses

• Transportation that is primarily for and essential to qualified medical care

• Medical insurance premiums• Qualified long-term care insurance

premiums• Capital expenditures must meet standard

Amount And Timing Of Deduction

Amount And Timing Of Deduction• Medical expense deduction is

only allowed to the extent qualified medical expenses exceed 7.5% of AGI

• During tax year - reimbursements reduce allowable deductions

• Subsequent tax years - reimbursements included in gross income under the tax benefit rule

Statutory Definition Of A TaxStatutory Definition Of A Tax

• Mandatory assessment levied under the authority of a political entity for the purpose of raising revenue to be used for public or governmental purposes

Deductible TaxesDeductible Taxes• Include state, local and

foreign real property taxes; state and local personal property taxes; foreign, state, and local income taxes

• Personal property only based on the value of the personal property

Nondeductible TaxesNondeductible Taxes• Include federal income tax, employee’s

social security tax, and federal estate & gift tax

• Employer’s share of social security tax is deductible as business expense

• Self-employed taxpayer may also deduct 1/2 of the self-employment taxes paid for AGI

State And Local Income Taxes

State And Local Income Taxes

• Cash-basis taxpayers deduct state and/or local income tax paid or withheld regardless of tax year involved

Personal Property TaxesPersonal Property Taxes

• In order to be deductible, tax must be an ad valorem tax on personal property imposed on an annual basis

• Any portion of the tax which is flat fee is not deductible

Real Estate TaxesReal Estate Taxes

• Apportionment of taxes is necessary when real estate is sold during the year

• Taxes assessed only against the property benefited are capitalize costs( i.e., Sidewalk or new sewer lines) not deduction

General Sales TaxGeneral Sales Tax

• The deduction for general sales tax was repealed by the tax reform act of 1986, effective for 1987 and later.

• Instead sales tax is treated as part of purchase price of the property.

Self-Employment Tax

• Pay tax on their self-employment income in lieu of the payment of Social Security tax on salary

Definition Of InterestDefinition Of Interest

• The charge for the use or forbearance of money– Bank service charges and

certain loan acquisition costs are not considered interest for tax purposes

Classification Of InterestClassification Of Interest

• Proper classification of interest expense is critical in determining the amount of interest expense deduction– Active trade or business– Passive activity– Investment– Personal– Qualified residence and Home equity loan– Student loan interest

Timing Of The Interest Deduction

Timing Of The Interest Deduction

• Prepaid interest

• Interest paid with loan proceeds

• Discounted notes

• Imputed interest

• Interest owed to a related party by an accrual method taxpayer

Charitable ContributionsCharitable Contributions

• Qualifying organization– The United States, The District of

Columbia, a state or possession of the United States.

– A post or organization of war veterans

– A domestic fraternal society, or order, or association

• Public Charities– Churches– Educational Institutions– Hospitals, Medical schools

Charitable Contributions

• Type of property contributed

• Deduction limitations

• 50% for public charities

• 30% for Contributions of capital gain property

•Application of carryovers

•Special rules for contributions made by corporations

Casualty And Theft LossesCasualty And Theft Losses

• Individuals can deduct casualty or theft loss on personal-use property as an itemized deduction Schedule A of Form 1040. Subject to $100 and 10 % floor

Miscellaneous Itemized Deductions

Miscellaneous Itemized Deductions

• Unreimbursed employee business expenses

• Expenses to produce income

• Costs of tax advice, tax return preparation, and any related fee

• Reduction of certain itemized deductions

Tax Planning ConsiderationsTax Planning

Considerations

• Medical expense deduction• Interest Expense Deduction• Deduction for charitable contributions

Compliance & Procedural Considerations

Compliance & Procedural Considerations

• Medical expenses– Dependent care credit

vs. Medical expense deduction

– Compare dependent care credit rate with effective marginal tax rate for additional medical deductions

Compliance & Procedural Considerations

Compliance & Procedural Considerations

• Charitable contributions– >$500 must file Form

8283– Property > $5000 should

have appraisal– >$250 and quid pro quo >

$75 require additional documentation

TaxesTaxes

• Schedule C - related to taxpayer’s trade or business

• Schedule E - related to the production of rents and/or royalties, or

• Schedule A - if personal