1 CHAPTER 5 Itemized Deductions & Other Incentives Income Tax Fundamentals 2010 edition Gerald E. Whittenburg Martha Altus-Buller Student’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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

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 2010 Cengage Learning

“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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 2010 Cengage Learning