Itemized Deductions

Chapter 7

• 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

• Identify different types of interest deductions• Compute the amount of investment interest

deduction

Learning Objectives

• Compute the deduction for qualified residence interest

• 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

Learning Objectives

• Qualified individuals

• Qualified medical expenses

• Amount and timing of deduction

Medical Expenses

• 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 Individual

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

• Self-employed individuals may deduct 100 % of health insurance as a deduction for AGI.

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

Qualified Medical Expenses

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

• 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

Amount And Timing Of Deduction

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

Statutory Definition Of A Tax

• State, local and foreign real property taxes;

• State and local personal property taxes;

• Foreign, state, and local income taxes

• State and local sales taxes

Deductible 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

Nondeductible Taxes

• Cash-basis taxpayers deduct state and/or local income tax paid or withheld even if the taxes are attributable to another tax year

State And Local Income 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

Personal Property 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

Real Estate Taxes

• The 2004 Jobs Act allows individual to deduct state and local taxes in lieu of state and local income taxes

General Sales Tax

Self-Employment Tax

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

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

certain loan acquisition costs are not considered interest for tax purposes

Definition 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

Classification Of Interest

• Prepaid interest

• Interest paid with loan proceeds

• Discounted notes

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

• Imputed interest

Timing Of The Interest Deduction

• 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

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

•See page 7-27 for summary

• 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

Casualty And Theft Losses

• Unreimbursed employee business expenses

• Expenses to produce income

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

Miscellaneous Itemized Deductions

Reduction of certain itemized deductions

• Sec. 68 provides for a reduction in the total amount of certain itemized deductions for high-income taxpayers– Only applies to individuals with AGI in excess of

$145,950($72,975 for MFS)– Reduction is 3% of the amount that the individual’s

AGI for the year exceeds the threshold amount– Two limitations apply

• Reduction can not exceed 80% of itemized deduction other than medical, investment, casualty losses, and wagering losses

• And the 3% is applied after taking into account the other limitations on Itemized deductions (e.g. 2% of AGI on miscellaneous deductions

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

Tax Planning 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

• Charitable contributions– >$500 must file Form 8283– Property > $5000 should

have appraisal– >$250 and quid pro quo >

$75 require additional documentation

Compliance & Procedural Considerations

• 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

Taxes