7-1 ©2008 Prentice Hall, Inc.

7-2 ©2008 Prentice Hall, Inc. ITEMIZED DEDUCTIONS (1 of 2)  Medical expenses  Taxes  Interest  Charitable contributions  Casualty and theft losses  Miscellaneous itemized deductions

7-3 ©2008 Prentice Hall, Inc. ITEMIZED DEDUCTIONS (2 of 2)  Reduction of certain itemized deductions  Tax planning considerations  Compliance and procedural considerations

7-4 ©2008 Prentice Hall, Inc. Medical Expenses  Qualified individuals  Qualified medical expenses  Amount and timing of deduction

7-5 ©2008 Prentice Hall, Inc. Qualified Individuals  Medical expenses paid for taxpayer, taxpayer’s spouse, or dependent  Dependent qualifies even if fails dependency test due to failure to meet gross income or joint return tests  Children of divorced parents  Not required to be custodial parent to take deduction for medical expenses paid on behalf of a person

7-6 ©2008 Prentice Hall, Inc. Qualified Medical Expenses (1 of 2)  Diagnosis, cure, mitigation, treatment, or prevention of disease  Transportation  $0.20/mile std. mileage rate  Includes meals & lodging if overnight  Capital expenditures  Excess of cost over amount by which value of home increases

7-7 ©2008 Prentice Hall, Inc. Qualified Medical Expenses (2 of 2)  Cost of living in institutions  Medical insurance premiums  Includes qualified long-term care insurance premiums  No cosmetic surgery unless it treats illness or promotes proper body function

7-8 ©2008 Prentice Hall, Inc. Amount and Timing of Deduction  Deductible in year paid  Amount of qualified medical expenses that exceed 7.5% of AGI  Medical insurance reimbursements  Only unreimbursed portion deductible  Self-employeds may deduct health insurance as a deduction for AGI

7-9 ©2008 Prentice Hall, Inc.Taxes  Definition of a tax  Deductible taxes  Nondeductible taxes  State and local income taxes  State and local sales taxes  Personal property taxes  Real estate taxes  Self-employment tax

7-10 ©2008 Prentice Hall, Inc. Definition of a Tax  Mandatory assessment levied under authority of a political entity for purpose of raising revenue used for public or governmental purposes

7-11 ©2008 Prentice Hall, Inc. Deductible Taxes  State, local, & foreign real property taxes  State and local personal property taxes  If based on value  Foreign, state & local income, war profits, and excess profits taxes  State and local sales taxes  If an election is made instead of deducting state and local income taxes

7-12 ©2008 Prentice Hall, Inc. Nondeductible Taxes  Federal income tax, employee’s social security tax, Federal estate & gift tax  Employer’s share of social security tax is deductible as business expense  Federal import tariffs & excise taxes  Unless for business or production of income

7-13 ©2008 Prentice Hall, Inc. State and Local Income Taxes  Cash-basis taxpayers deduct state and local income tax paid or withheld even if the taxes are attributable to another tax year

7-14 ©2008 Prentice Hall, Inc. Personal Property Taxes  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

7-15 ©2008 Prentice Hall, Inc. Real Estate Taxes  Apportionment of taxes  Necessary when real estate is sold during the year  Real property assessments only against property benefited  Capitalized costs—not deductible  E.g., Sidewalk or new sewer lines

7-16 ©2008 Prentice Hall, Inc. Self-Employment Tax  Pay tax on self-employment income in lieu of payment of Social Security tax on salary  ½ of SE tax deductible for AGI

7-17 ©2008 Prentice Hall, Inc.Interest  Definition of interest  Classification of interest expense  Timing of the interest deduction

7-18 ©2008 Prentice Hall, Inc. Definition of Interest  Compensation for use or forbearance of money  Bank service charges and certain loan acquisition costs not considered interest for tax purposes

7-19 ©2008 Prentice Hall, Inc. Classification of Interest Expense (1 of 2)  Depends on purpose of indebtedness  Active trade or business  For AGI deduction  Passive activity  Subject to passive activity loss limitation  Used to compute net passive income/loss  Investment interest  Deductible up to net investment income

7-20 ©2008 Prentice Hall, Inc. Classification of Interest Expense (2 of 2)  Qualified residence and home equity loan  Interest on up to $1M of acquisition debt  Points on acquisition indebtedness also deductible  May deduct interest on additional $100K of home equity indebtedness  Student loan interest  Up to $2,500 deductible as for AGI deduction  Phased out at higher income levels

7-21 ©2008 Prentice Hall, Inc. Timing of the Interest Deduction (1 of 2)  Prepaid interest  Capitalized and amortized over period to which interest relates  Discounted notes  Cash method taxpayer deducts in year loan received  Accrual method taxpayer amortizes over life of loan

7-22 ©2008 Prentice Hall, Inc. Timing of the Interest Deduction (2 of 2)  Interest paid on debt used to pay another creditor generally deductible  Interest owed to a related party by an accrual method taxpayer  Cannot deduct interest until interest paid  Imputed interest  Applies to below-market loans  See Chapter I11

7-23 ©2008 Prentice Hall, Inc. Charitable Contributions  Qualifying organization  Type of property contributed  Deduction limitations  Application of carryovers  Special rules for charitable contributions made by corporations

7-24 ©2008 Prentice Hall, Inc. Qualifying Organization  U.S., District of Columbia, state or possession of U.S.  Post or organization of war veterans  Domestic fraternal society, or order, or association  Public Charities  Churches, educational Institutions, hospitals, medical schools

7-25 ©2008 Prentice Hall, Inc. Type of Property Contributed (1 of 2)  Contribution of long-term capital gain property  Generally FMV  Use adjusted basis if  Contributed to private nonoperating foundation  Unrelated use by charitable organization  Certain intangibles

7-26 ©2008 Prentice Hall, Inc. Type of Property Contributed (2 of 2)  Contribution of ordinary income prop  Value generally adjusted basis  Exception for corp donation of inventory  Contribution of services  Only out-of-pocket and transportation expenses deductible

7-27 ©2008 Prentice Hall, Inc. Deduction Limitations  50% of AGI overall limitation  Applies to public charities  Sum of all contributions limited to 50%  30% of AGI limitation  Contributions of capital gain property  20% of AGI limitation  Capital gain property contributed to private nonoperating foundations

7-28 ©2008 Prentice Hall, Inc. Application of Carryovers  Carried over and deducted in subsequent five years  Apply with regard to special limitations

7-29 ©2008 Prentice Hall, Inc. Special Rules for Contributions Made by Corporations  Pledges made by accrual method corporations  Deductible in year pledged if paid by 15 th day of 3 rd month after year end  Limitation applicable to corporations  Cannot exceed 10% of corporation’s taxable income

7-30 ©2008 Prentice Hall, Inc. Casualty and Theft Losses  Individuals can deduct casualty or theft loss on personal-use property as an itemized deduction  Subject to floor of $100 plus 10 % of AGI

7-31 ©2008 Prentice Hall, Inc. Miscellaneous Itemized Deductions  Certain employee expenses  Expenses to produce income  Cost of tax advice

7-32 ©2008 Prentice Hall, Inc. Certain Employee Expenses  Unreimbursed employee business expenses  Include travel, transportation, dues to professional organizations, cost of job hunting  Generally miscellaneous itemized deductions subject to a 2% of AGI floor

7-33 ©2008 Prentice Hall, Inc. Expenses to Produce Income  Expenses to produce investment income other than rents or royalties  Miscellaneous itemized deductions subject to 2% of AGI floor

7-34 ©2008 Prentice Hall, Inc. Cost of Tax Advice  Includes  Tax return preparation fees  Appraisal fees in determining amount of casualty loss  Accountant fees for representation in a tax audit  Miscellaneous itemized deductions subject to 2% of AGI floor

7-35 ©2008 Prentice Hall, Inc. Reduction of Certain Itemized Deductions (1 of 2)  Reduction in total amount of most itemized deductions for high-income taxpayers  Only applies to individuals with AGI in excess of $156,400  Reduction is 3% of amount that individual’s AGI for year exceeds threshold amount

7-36 ©2008 Prentice Hall, Inc. Reduction of Certain Itemized Deductions (2 of 2)  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 other limitations on itemized deductions  e.g. 2% of AGI on miscellaneous deductions

7-37 ©2008 Prentice Hall, Inc. Tax Planning Considerations  Medical expense deduction  Bunch medical expenses into a single year to exceed 7.5% of AGI floor  Interest expense deduction  Deduction for charitable contributions  Election to reduce amount of contribution  Donation of appreciated long-term capital gain property  Significant substantiation requirement

7-38 ©2008 Prentice Hall, Inc. Compliance and Procedural Considerations (1 of 3)  Medical expenses  Dependent care credit vs. medical expense deduction  Compare dependent care credit rate with effective marginal tax rate for additional medical deductions

7-39 ©2008 Prentice Hall, Inc. Compliance and Procedural Considerations (2 of 3)  Charitable contributions  >$500 must file Form 8283  Property > $5000 should have appraisal  >$250 and quid pro quo > $75 require additional documentation

7-40 ©2008 Prentice Hall, Inc. Compliance and Procedural Considerations (3 of 3)  Taxes  Schedule C - related to taxpayer’s trade or business  Schedule E - related to the production of rents and/or royalties  Schedule A - if personal

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 7-41 ©2008 Prentice Hall, Inc.