The American College: HS 321 Income Taxation

1
The American College HS 321Income Taxation

• Class 6 Chapters 9 and 10
• Itemized Deductions

2
Objectives

• Explain the underlying principle regarding the
  deductibility of expenses, and describe the tax
  treatment of
• personal expenses
• medical expenses
• long-term care expenses

3
Objectives

• Explain the rules regarding the deductibility of
• tax payments
• interest payments
• charitable contributions

4
Objectives

• Explain the difference between refundable and
  nonrefundable tax credits.
• Explain the tax credit for
• children
• adoption expenses
• dependent-care expenses

5
Objectives

• Explain these three credits
• Hope scholarship
• Lifetime learning
• Phaseout

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Itemized Deductions

• Personal itemized deductions are deductible on
  Form 1040, Schedule A, only if
• They exceed the standard deduction, or
• The taxpayer is not eligible for the standard
  deduction
• Itemized deductions are taken FROM AGI

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Itemized Deductions

• Form 1040, Schedule A classifications for
  deductions
• Medical expenses
• Taxes paid
• Interest expense
• Charitable contributions
• Casualty and theft losses
• Miscellaneous deductions

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Medical Expenses
9
Medical Expenses

• Who may deduct medical expenses?
• A TP may deduct eligible medical expenses paid
  for himself/herself, spouse, and dependents.

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Medical Expenses

• Medical expenses for children of divorced parents
  are deductible by the parent who pays for them,
  regardless of who has the dependency exemption
• Eligible expenses deductible only to the extent
  they exceed 7 ½ of AGI (10 of AGI for the AMT).

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Eligible Medical Expenses

• Deductible medical expenses include any amount
  paid for
• Diagnosis, cure, mitigation, treatment or
  prevention of disease, or for the purpose of
  affecting any structure or function of the body
• Transportation for and essential to the above
• Insurance which covers the above

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Eligible Medical Expenses

• No deductions for
• Illegal operations or treatment
• Cosmetic surgery except reconstructive surgery
  for deformities, and disfigurements arising from
  trauma or disease
• Trips to improve general health
• Nonprescribed OTC medicines/drugs

13
Capital Expenditures
14
Nursing Home Expenses and Long-Term Care Health
Insurance

• Nursing home or special care facility expenses
  for the TP, spouse, and dependents are fully
  deductible only if the person is chronically ill
  or is in the facility primarily for medical care.

15
Nursing Home Expenses and Long-Term Care Health
Insurance

• Limited deductions are available for the cost for
  long-term care insurance
• Age and premium paid determine deduction
• (See textbook for limitations.)

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Medical Travel Transportation

• The cost of transportation to obtain medical care
  is deductible.
• Lodging costs (but not meals) up to 50 per day
  are deductible for the TP and one additional
  person if an overnight stay is necessary.

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Quiz Questions
18
Short Quiz 1

• Medical expense deductions cannot exceed 50 of
  the taxpayers medical care expenses for the
  year.
• True
• False

19
Short Quiz 1

• Long-term care insurance premiums are deductible
  in full as medical expenses regardless of their
  amounts.
• True
• False

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Deductible Taxes for Individuals
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Deductible Taxes for Individuals

• State, local, and foreign income taxes may be
  deducted (or claimed as a credit).
• Note Federal income taxes, including Social
  Security taxes, are not deductible by individuals.

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Deductible Taxes for Individuals

• State, local, and foreign real property taxes
• State and local personal property taxes, if based
  on the value

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Apportionment of Real EstateTaxes Between Buyer
Seller

• When real estate is sold, apportion real estate
  taxes between buyer and seller based on the
  number of days each taxpayer held ownership.
• The apportionment typically occurs at settlement.

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Interest Expense
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Deductible Interest Expense

• Types of deductible interest expenses
• Trade or business expense
• Interest from passive activities
• Interest on qualified educational loans
• Qualified residence interest
• Investment interest to the extent of net
  investment income

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Interest on Qualified Educational Loans
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Interest on QualifiedEducational Loans

• Interest on loans for qualified educational
  expenses of half-time or greater students,
  spouse, and dependents when the loan was made, is
  deductible as follows
• Maximum Deduction
• 2,500

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Investment Interest Expense

• Investment interest expense is deductible to the
  extent of net investment income.
• Net investment income means the excess of
  investment income over investment expenses.
• Investment income is typically interest,
  dividends, royalties, and short-term capital
  gains.

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Investment Interest Expense

• Investment income exceptions long-term capital
  gains may be treated as ordinary income to
  increase investment interest expense deduction
• Qualified dividend income is not
  investment income for determining the
  investment interest expense deduction. However,
  the LTCG election may be applied to qualified
  dividend income.

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Qualified Residence Interest
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Qualified Residence Interest

• Interest on qualified loans secured by a primary
  or secondary residence is deductible.

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Qualified Residence Interest

• Two types of qualified loans
• Acquisition debt debt incurred to purchase,
  construct, or substantially improve a residence
• Home equity debt debt secured by a primary or
  secondary residence that does not exceed
  FMV-acquisition debt. The loan proceeds may be
  used for any purpose.

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Qualified Residence Interest

• Residence includes vacation homes, condos,
  mobile homes, boats, or RVs if they include basic
  living accommodations.

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Limitations on Qualified Residence Interest
Deductions

• Deductible interest on aggregate acquisition debt
  is limited to 1,000,000 of debt (500,000 if
  MFS).
• Deductible interest on home equity loans is
  limited to 100,000 of debt (50,000 if MFS).

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Limitations on Qualified Residence Interest
Deductions

• Acquisition debt is increased only if capital
  improvements are made.
• Home equity debt may be increased at any time.

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Points as Interest

• Interest paid at the time of obtaining a loan is
  called points. Essentially, points are prepaid
  interest.
• One Point 1 of the mortgage amount

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Points as Interest

• Points paid by the buyer or seller of a primary
  residence are deductible if incurred to obtain
  the initial mortgage or to improve the home.
• Refinancing points are amortized over the life
  of the loan.

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Quiz Questions
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Short Quiz 2

• Any joint owner of property who actually pays a
  deductible tax on the property may take a
  deduction for the payment.
• True
• False

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Short Quiz 2

• Individual taxpayers may not deduct interest on
  credit card charges for the purchase of personal
  items.
• True
• False

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Charitable Contributions
42
Charitable Contributions Basic Questions

• Three questions must be answered before taking a
  charitable contribution deduction
• Was the contribution made to a qualifying
  charity?
• How is the contribution valued (i.e., at FMV or
  adjusted basis)?
• Is there a limitation on the amount of the
  contribution that can be claimed?

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Charitable ContributionsQualifying Organizations

• Nonprofit entities organized for the following
  purposes can apply to the IRS for qualifying
  organization status
• Religious
• Charitable
• Scientific

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Charitable ContributionsQualifying Organizations

• Literary
• Educational
• National amateur sports
• Prevention of cruelty to children and animals
• Contributions to qualifying organizations are
  deductible on Schedule A of Form 1040 (FROM AGI)

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Charitable ContributionsQualifying Organizations

• Qualifying organizations, a.k.a. public
  charities may be classified into two types. Each
  is treated differently for tax purposes
• One type is also called public charities.

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Charitable ContributionsQualifying Organizations

• A second type consists of
• Private, nonoperating foundations (ones that do
  not distribute at least 85 of their
  contributions each year)
• Organizations of war veterans, certain fraternal
  organizations, and nonprofit cemetery companies
  or associations

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Charitable ContributionsContinued
48
Charitable Contributions Limitations on
Contributions

• Two levels of limitations on amounts that
  individuals can deduct for charitable
  contributionsboth based on AGI
• Overall limitation Individuals can deduct a
  maximum of 50 of AGI for charitable
  contributions.

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Charitable Contributions Limitations on
Contributions

• Sub-limitations exist for deductible
  contributions depending on type of qualifying
  organization and type of property donated.
• These limitations are 50, 30, and 20 of AGI.

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Charitable Contributions Qualifying Organizations

• Ordinary Types of property Income contributed
  Cash Property
• GROUP 1 50 AGI 50 AGI Public Charities
• GROUP 2 30 AGI 30 AGI Private,
  Nonoperating Foundations, etc.

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Charitable Contributions Qualifying Organizations

• Sec. 1221 Types of property
  1231 contributed Property
• GROUP 1 30 AGI Public Charities
• GROUP 2 20 AGI Private, Nonoperating Foundati
  ons, etc.

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Charitable Contributions Qualifying Organizations

• Sec. 1221 or 1231 prop. Types of property not
  used according to contributed donees exempt
  purpose
• GROUP 1 50 AGI Public Charities
• GROUP 2 N/A Private, Nonoperating Foundations,
  etc.

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Charitable Contributions

• Sub-Limitations on Contributions
• Sub-limitations are applied first, then the
  overall limitation. In using the sub-limitations,
  use higher percentage category items first.

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Charitable Contributions

• Sub-Limitations on Contributions
• Any charitable contribution not deductible
  because a percentage limitation is carried
  forward for up to 5 years.
• Carryovers are applied in FIFO order in the
  carryover year.

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Quiz Questions
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Short Quiz 3

• Charitable contributions are allowed for gifts
  of property but not for gifts of services to the
  charity.
• True
• False

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Refundable and Nonrefundable Credits
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Major Individual Credits

• Refundable credits
• Earned Income Tax (EITC)
• Child Tax Credit

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Major Individual Credits

• Nonrefundable credits(may reduce regular tax
  only)
• Credit for adoption expenses
• Child and dependent care credit
• Hope Scholarship and Lifetime Learning credits

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Refundable Credits

• Child Tax Credit
• 1,000 credit per qualifying child
• Qualifying Child child or descendant under age
  17, who may be claimed as a dependent and is a
  citizen or resident of the U.S.

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Refundable Credits

• Child Tax Credit
• Credit is phased out 50 for each 1,000 or
  fraction thereof TPs AGI exceeds thresholds
• 75,000 single or head of household
• 110,000 MFJ
• 55,000 MFS

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Refundable and Nonrefundable Credits (Continued)
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Nonrefundable CreditsCredit for Adoption Expenses

• Qualified expenses include legal fees, court
  costs, and other related costs with regard to
  legal adoption

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Nonrefundable CreditsCredit for Adoption Expenses

• The limit is per child, not per year (c/o of 5
  years)
• Credit phaseout begins for TPs with AGIs
  exceeding approximately 170,000

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Nonrefundable Credits

• Child and Dependent Care Credit
• Purpose the law expands the credit to relieve
  burden of two-earner families who must pay for
  dependent care

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Nonrefundable Credits

• Child and Dependent Care Credit
• AGI reduction point is 15,000.
• When AGI exceeds 43,000, a 20 maximum credit is
  available.

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Nonrefundable Credits

• Child and Dependent Care Credit
• Amount of the Credit 35 (reduced to 20 as AGI
  increases) of employment-related expenses
• Credit limitations Lesser of
• Earned income
• 3,000 for one individual, 6,000 for two or more
  individuals

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Nonrefundable Credits

• Hope Scholarship Credit
• Available only for first 2 years of
  post-secondary education
• Must be at least a ½ time student

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Nonrefundable Credits

• Lifetime Learning Credit
• Credit is 20 of first 10,000 of expenses paid
  per year by a TP for self, spouse, and
  dependents.
• Not available if student is claimed as a
  dependent.

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Nonrefundable Credits

• Lifetime Learning Credit and Hope Scholarship
  Credit
• phased out at relatively low levels of AGI

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Quiz Questions
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Short Quiz 3

• A qualifying child for purposes of the tax
  credit for children is one who is under the age
  of 19 at the end of the tax year.
• True
• False

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Short Quiz 3

• The adoption credit must be claimed for the tax
  year following the year in which the expenses are
  paid, unless the adoption becomes final during or
  before the year the expenses are paid.
• True
• False

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Short Quiz 3

• Both the Hope and Lifetime education credits are
  subject to phaseout rules for taxpayers with
  modified adjusted gross income in excess of
  certain levels.
• True
• False