Itemized Deductions

1
Chapter 7

• Itemized Deductions

2
Itemized Deductions(slide 1 of 2)

• Personal expenditures that are deductible FROM
  AGI as itemized deductions include
• Medical
• Taxes
• Interest
• Charitable Contributions
• Casualty losses
• Miscellaneous itemized deductions

3
Itemized Deductions(slide 2 of 2)

• Itemized deductions provide a tax benefit only to
  extent that in total they exceed the standard
  deduction amount for the taxpayer

4
Medical Expenses (slide 1 of 7)

• Medical expense defined
• Expenditure for the diagnosis, cure, treatment,
  prevention, or for purpose of affecting any
  structure or function of the body of the
  taxpayer, spouse, or dependents
• Includes prescription drugs and insulin
• Medical expenses do not include
• Elective cosmetic surgery
• General health items
• Hair transplant

5
Medical Expenses (slide 2 of 7)

• When medical expenditures are deductible
• In year paid ( payment by check or credit card)
• Amount of medical deduction
• Deductible to extent unreimbursed medical
  expenses in total exceed 7.5 of AGI
• Example of medical deduction limitation
• Amy has AGI of 10,000 and medical expenses of
  1,000
• Amys medical deduction 250
• 1,000 - (10,000 x 7.5)

6
Medical Expenses (slide 3 of 7)

• Nursing home expenditures
• If primary purpose of placement in home is
  medical, costs (even meals and lodging) qualify
• If primary purpose of placement in home is
  personal, only specific medical costs qualify (no
  meals or lodging)
• Special school expenditures
• If primary purpose of placement in school is
  medical, costs (including meals and lodging)
  qualify
• If primary purpose of placement in school is
  personal, only specific medical costs qualify (no
  meals or lodging)

7
Medical Expenses (slide 4 of 7)

• Capital medical expenditures
• Includes wheelchairs, medical beds, seeing eye
  dogs, etc.
• Must be medical necessity, advised by a
  physician, used primarily by patient, and expense
  is reasonable
• Full amount is medical expense in year paid
• Maintenance on capital expenditures also medical
  expenses
• Capital improvement to home
• Medical expense only to extent that cost of
  improvement exceeds increase in value to home

8
Medical Expenses (slide 5 of 7)

• Medical care of spouse and dependents
• Taxpayer may deduct cost of medical care for
  spouse and dependents
• Dependents need not meet gross income or joint
  return tests
• Children of divorced parents treated as
  dependents of both for purpose of medical
  deduction
• Medical transportation and lodging
• Transportation to and from care is deductible
• Mileage allowance of 12 cents per mile (2001)
• Lodging while away from home for medical care
• Allowable amount is 50 per person per night (for
  patient and required companion)

9
Medical Expenses (slide 6 of 7)

• Health insurance premiums
• Premiums paid for medical care insurance are
  medical expenses
• Self-employed, up to 70 of insurance premiums
  are deductible FOR AGI (increases to 80 in 2006)
• Reimbursement by medical insurance
• If reimbursed in same year as expense paid,
  reimbursement offsets medical expense and only
  excess of expenses over reimbursement allowed
• If reimbursed in the year after medical expenses
  were paid, reimbursement is income only to extent
  medical deduction was taken by taxpayer (tax
  benefit rule)

10
Medical Expenses (slide 7 of 7)

• Example of medical reimbursements
• In 2001, taxpayer paid medical expenses 1,200
• In 2001, reimbursed by insurance 800
• For 2001, deductible medical expense
• if AGI 10,000 400 - (7.5 x 10,000) 0
• Example of medical reimbursements
• In 2000, taxpayer paid medical expenses 1,200
• In 2001, reimbursed by insurance 800
• For 2000, deductible medical expense
• if AGI 10,000 1,200 - (7.5 x 10,000)450
• For 2001, reimbursement is income to extent
  taxpayer received tax benefit in 2000, so 450

11
Taxes (slide 1 of 2)

• State, local, and foreign income taxes and real
  property taxes are deductible in year paid
• State and local personal property taxes based on
  value (ad valorem) deductible in year paid
• Other taxes such as sales, excise, etc., are not
  deductible, except
• Deductible if incurred in business or production
  of income activity
• Fees are not deductible as tax (e.g. license)

12
Taxes (slide 2 of 2)

• Real estate taxes in year property sold must be
  apportioned between buyer and seller
• State and local income taxes
• Deduct amounts paid during year
• Withheld amounts
• Estimated tax payments
• Amounts paid in year for prior years liability
• Foreign income taxes deductible or claimed as
  credit

13
Investment Interest (slide 1 of 2)

• Definition interest on loans whose proceeds are
  used to purchase investment property, e.g.,
  stock, bonds, land
• Deduction of investment interest is limited to
  net investment income (Investment income less
  investment expenses)
• Investment income
• Gross income from interest, dividends, annuities,
  and royalties not derived from business
• Long-term capital gains treated as investment
  income if elected (wont qualify for LTCG rate)

14
Investment Interest (slide 2 of 2)

• Investment expenses
• All expenses (other than interest) directly
  related to portfolio income that are allowed as a
  deduction
• Application of 2 AGI floor for some investment
  expenses must be considered in computing amount
  of net investment income
• applied to non-investment expenses first
• Investment interest not used in current year due
  to limitation is carried forward indefinitely
• Deductibility subject to net investment income
  limitation in carryover years

15
Qualified Residence Interest (slide 1 of 2)

• Interest on indebtedness secured by the principal
  residence and one other residence (qualified
  residences)
• Interest must be on acquisition or home equity
  indebtedness
• Acquisition indebtedness amounts incurred to
  acquire, construct, or substantially improve the
  qualified residences
• Aggregate acquisition indebtedness for qualified
  residences cannot be greater than 1 million

16
Qualified Residence Interest (slide 2 of 2)

• Home equity indebtedness loans secured by
  qualified residences
• Aggregate home equity indebtedness for qualified
  residences is limited to 100,000
• Home equity loans cannot exceed (FMV of home
  minus acquisition indebtedness)
• Thus, maximum loans on qualified residences for
  qualified residence interest is 1.1 million
• other home mortgage interest is nondeductible
  personal interest (e.g. second vacation home)

17
Prepaid Interest

• Prepaid interest generally must be capitalized
  and amortized over the life of loan
• Exception Points (prepaid interest on a
  mortgage) paid in the acquisition or improvement
  of principal residence
• Entire amount is deductible in year paid
• Interest paid with loan proceeds
• if borrowed from third party generally deductible
• if loan is with same lender, no deduction is
  available

18
Student Loan Interest (Deduction For AGI)

• Payable on loan incurred to pay qualified higher
  education expenses
• Taken as a for AGI deduction (not itemized
  deduction)
• Maximum deductible for 2001 is 2,500
• Phased out for AGI between 40,000 to 55,000 for
  single TPs and 60,000 to 75,000 for MFJ

19
Student Loan Interest2001 Tax Act

• Repealed limit of deduction for first 60 months
  of interest payments
• Repealed restriction that voluntary payments are
  not deductible
• Increased income phase-out ranges
• 50,000-65,000 for single taxpayers
• 100,000 to 130,000 for MFJ
• Effective for 2002 and later

20
Charitable Contributions(slide 1 of 7)

• Charitable contribution defined
• Contributor must have donative intent and expect
  nothing in return
• If contributor receives tangible benefit, the FMV
  of such benefit must be deducted from the amount
  of the contribution
• Charitable contribution defined
• Contribution must be to qualified domestic
  charity or state or possession of U.S. or any
  subdivisions
• Most domestic charities are listed in IRS Pub.
  78
• No deduction for contribution of services

21
Charitable Contributions(slide 2 of 7)

• Ordinary income property
• Defined assets that would produce ordinary
  income or short-term capital gain if sold
• Contribution amount
• FMV of asset less ordinary income (or STCG)
  potential generally the lower of adjusted basis
  or FMV
• Capital gain (CG)property
• Defined assets that would produce long-term
  capital gain or Section 1231 gain if sold
• Contribution amount
• Generally FMV of asset

22
Charitable Contributions(slide 3 of 7)

• Exception to FMV deduction of CG property
• Private nonoperating foundations
• Contributions to private nonoperating foundations
  must be reduced by the amount of capital gain
  potential
• Thus, the amount is limited to the adjusted basis
• Exception to FMV deduction of CG property
• Tangible personalty
• If asset contributed is not used in charitys
  exempt function, the contributions must be
  reduced by the amount of capital gain potential,
  thus, limits the amount to the adjusted basis

23
Charitable Contributions(slide 4 of 7)

• Example of contributions of tangible personalty
• Taxpayer contributes painting to TSU
• FMV 100,000 and adjusted basis 10,000
• If TSU hangs the painting in Art Department (for
  students use), taxpayer has 100,000 contribution
• If TSU sells painting, contribution is 10,000
• Limitations on deductions 50 limit
• Includes contributions of cash, ordinary income
  property, and CG property using adjusted basis
• 50 of AGI is maximum contribution deduction

24
Charitable Contributions(slide 5 of 7)

• Limitations on deductions 30 limit
• Charity deductions for certain assets cannot
  exceed 30 of the taxpayers AGI
• CG property for which the contribution amount is
  FMV
• Certain contributions to private nonoperating
  foundations
• Can elect to treat CG property as 50 assets by
  limiting the amount of such contributions to
  their adjusted bases
• Limitations on deductions 20 limit
• Certain contributions of capital gain property to
  private nonoperating foundations

25
Charitable Contributions(slide 6 of 7)

• Interaction of limitations
• When applying the yearly overall 50 limitation,
  allowable deductions come first from the 50
  assets, then from the 30 assets
• Contribution carryover
• Contributions that cannot be taken in current
  year due to limitations may be carried forward
  for 5 years
• When using carryovers, current contributions are
  used first, then carryovers used on a FIFO basis

26
Charitable Contributions(slide 7 of 7)

• Example of the 50 and 30 limits
• Taxpayer, AGI 100,000, contributed 40,000 cash
  and long-term stocks with a FMV of 35,000 and a
  basis of 8,000 to a University
• 50 limit 50,000 30 limit
  30,000
• Amount of deduction 50,000 (40,000 cash
  10,000 stock)
• Contribution carryforward 25,000 stock (as 30
  asset)

27
Casualty and Theft Losses

• Individuals may deduct casualty and theft losses
  under Sec. 165
• Subject to two floors
• 10 AGI
• and, 100 per event
• Discussed in Chapter 8

28
Miscellaneous Itemized DeductionsSubject to 2
Floor (1 of 2)

• Certain employee expenses
• Unreimbursed travel and transportation expenses
• professional dues and subscriptions, uniforms,
  job hunting, union dues, etc.
• Sec. 212 investment expenses
• safe deposit box rental, subscriptions to
  investment journals, professional fees
• Tax preparation or consulting fees
• Hobby expenses

29
Miscellaneous Itemized DeductionsNot Subject to
2 Floor (2 of 2)

• Gambling losses (to extent of gambling income)
• Estate tax paid on income in respect of a
  decedent
• Impairment-related work expenses

30
Overall Limitation on Itemized Deductions (slide
1 of 2)

• Taxpayers with AGI in excess of the specified
  threshold will lose part of their benefits from
  certain itemized deductions
• Threshold amount in 2001 is 132,950 (66,475 if
  married, filing separately)
• Itemized deductions subject to reduction are
• Taxes, residential interest, charitable
  deductions, and miscellaneous deductions
• Medical, investment interest, and casualties
  thefts are not subject to reduction

31
Overall Limitation on Itemized Deductions (slide
2 of 2)

• Amount of reduction
• Reduction is lesser of
• (AGI - threshold) x 3, or
• 80 x total itemized deductions subject to
  reduction
• Example MFJ, AGI 300,000
• Total itemized deductions 50,000
• Mortgage interest 25,000
• Charitable contributions 5,000
• Reduction is lesser of
• 300,000 - 132,950 167,050 x 3 5,012, or
• (25,000 5,000) x 80 24,000, so 5,012
• Allowable itemized deductions 50,000 -
  501244,988

32
Limitations of Itemized Deductions and Personal
Exemptions RepealedUnder New Tax Act

• Overall limitation of itemized deductions (AGI
  over 132,950 in 2001)
• Reduced by 1/3 in 2006 and 2007
• Reduced by 2/3 in 2008 and 2009
• Eliminated in 2010 and after
• Phase out of personal exemptions (AGI over
  132,950 in 2001)
• Same reduction schedule as above