Chapter 7. Deductions FROM AGI Howard Godfrey, Ph.D., CPA Professor of Accounting Howard Godfrey-2015 Chapter 7. Deductions FROM AGI Medical Expenses Taxes Home Mortgage Interest Investment interest & other interest CHARITABLE Gifts [money] CHARITABLE Gifts [Other property] Personal Casualty Losses (Bus. Pg. 9-14)
[20: 50] [22: 48] [24: 51] Medical [2: 32] Taxes [5: 36] Standard Deduction Basic Single Age/Blind $6,300
$1,550 $12,600 $1,250 Married - Separate $6,300 $1,250 Head of Household $9,250
$1,550 Exemption Amount $4,000 Married-Joint Medical Expenses-Sec. 213-1 Medical expenses paid for the taxpayer, spouse & dependents, after reduction for insurance reimbursements, are deductible only to the extent
they exceed 10% of AGI for the year. Medical Expenses-2 Qualified medical costs includes prescription drugs and insulin, costs of a hospital, clinic, doctor, dentist, eyeglasses, contract lenses, transportation for medical care and health insurance costs. Medical Expenses-3 Health insurance premiums for taxpayers and their dependents
are deductible only if paid from after-tax income Premiums paid through an employer-sponsored cafeteria plan are not deductible Medical Expenses-4 Premiums for disability insurance and for loss of life, limb or income are not deductible Premiums for long-term care insurance are deductible, subject to limits based on age Section 213. Medical Expense
(a) Allowance of deduction. There shall be allowed as a deduction the expenses paid during the taxable year, not compensated for by insurance or otherwise, for medical care of the taxpayer, his spouse, or a dependent (as defined in section 152, , to the extent that such expenses exceed 10 percent of adjusted gross income. (b) Limitation with respect to medicine and drugs An amount paid during the taxable year for medicine or a drug shall be taken into account under subsection (a) only if such medicine or drug is a prescribed drug or is insulin. (d) Definitions. For purposes of this section(1) The term medical care means amounts paid(A) for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of
affecting any structure or function of the body, (B) for transportation primarily for and essential to medical care referred to in subparagraph (A), (C) for qualified long-term care services , or (D) for insurance covering medical care referred to in subparagraphs (A) and (B) or for any qualified long-term care insurance contract (as defined in section 7702B (b)). While cosmetic surgery is generally not deductible, discretionary medical costs may be deducted where the procedure affects the structure or function of the body. Take, for example,
procedures that facilitate pregnancy by overcoming infertility. In IRS Letter Ruling 200318017, the IRS considered whether egg donor fees and expenses related to obtaining a willing donor, paid by a taxpayer who could not conceive using her own eggs, qualified as deductible medical expenses. They were deductible. They qualified as deductible medical expenses
because they were incurred in preparation of the taxpayer's medical procedure (the implantation of a donated egg). Deductible expenses included donor's fee for her time and expense in following the procedures to ensure successful egg retrieval, the agency's fee for procuring the donor and coordinating the transaction, expenses for medical and psychological testing and assistance of the donor before and after the procedure, and legal fees for preparing a contract between the taxpayer and the donor. What about the same type of expenses paid by a single male to father a child through a surrogate?
Are those expenses deductible? No, because the expenses are not related to an underlying medical condition or defect of the taxpayer nor are they affecting any structure or function of his body. See William Magdalin, TC Memo 2008-293. Medical Expense Deduction Daniel's AGI is $90,000. He incurred $14,000 of medical expenses and was reimbursed for $3,000 of these expenses. What is his allowable medical expense
deduction if he itemizes? Dan Daniels Adjusted Gross Income Med. Expenses Reimbursements Net Less: 10% of AGI Deduction 14,000 $90,000 Dan Daniels
Adjusted Gross Income Med. Expenses Paid 14,000 Reimbursements (3,000) Net 11,000 Subtract 10% of AGI
(9,000) Deduction - Med. Expenses $90,000 $2,000 Taxes Sec . 164 Deductible taxes include State, local, & foreign real property taxes State & local personal property taxes State, local, & foreign income taxes Other federal, state, local, and foreign taxes incurred in a business or other incomeproducing activity
Can elect to deduct state & local general sales taxes instead of state & local income taxes Tax Deduction from AGI? State income tax Federal income tax County real estate tax Inspection fee for car he uses only personally Homeowners association fees on personal home Gift Tax Self-employment tax Total
Paid Deduct $3,000 12,000 2,000 50 500 2,000 1,000 $20,550 Tax Deduction from AGI? State income tax Federal income tax County real estate tax Inspection fee for car
he uses only personally Homeowners association fees on personal home Gift Tax Self-employment tax Total Paid Deduct $3,000 $3,000 12,000 2,000 $2,000 50 500 2,000 1,000
$20,550 $5,000 Nondeductible Taxes Federal income taxes Employee's share of payroll taxes Federal excise taxes not incurred for business State & local sales taxes on goods for personal use Assessments on property that increase property value Tax Benefit Rule-1 Rebecca and Gregory, a married couple, filed
a joint return for 2015 with AGI of $70,000 and total allowable itemized deductions of $12,600, which included state income taxes paid of $3,100. They received a $900 refund of state income taxes in April 2016. How much of the state income tax refund must they include in income and in which year do they include it? Tax Benefit Rule-2 Zero. Their itemized deductions of $12,600 did not exceed their standard deduction of $12,600. Since there was no tax benefit
derived from deducting state income taxes, none of the refund is included in income. Tax Benefit Rule-3 If their total itemized deductions for 2015 had been $13,000, then $400 ($13,000 - $12,600 standard deduction) of the $900 refund would be included in income in 2016. If itemized deductions were 13,500 or more, the entire $900 refund would be included in income in 2016. Standard Deduction Basic
Single Age/Blind $6,300 $1,550 $12,600 $1,250 Married - Separate $6,300
$1,250 Head of Household $9,250 $1,550 Exemption Amount $4,000 Married-Joint
Home Mortgage Interest [5: 38] Investment interest Other interest  Interest Expense- Sec. 163 Deductible interest includes Home mortgage interest Investment interest No deduction for most other personal interest such as interest on auto loans, life insurance loans, credit card debt, and delinquent tax payments
(except previously mentioned student loan interest) Qualified Residence Interest- Sec. 163(h)(3) Interest paid for acquisition debt or home equity debt for up to 2 qualified residences Interest on acquisition debt of up to $1 million principal amount (combined limit for 2 homes) is deductible Acquisition debt includes mortgage to buy, construct, or improve the
residence. Qualified Residence Interest Interest on up to $100,000 principal amount of home equity loan is deductible Loan proceeds can be used for any purpose Qualified Residence Interest Points (loan origination fees) paid on initial home mortgages are deductible Points paid to refinance an exiting loan must be amortized
over life of loan. Pablo & Adriana, Interest Expense-1 Pablo & Adriana, a married couple (joint return), buy a $190,000 home by paying $38,000 cash down and giving a mortgage for the balance of the purchase price. The mortgage company charged them $3,000 in points for originating the loan that they pay at closing. They paid $7,000 in interest on the mortgage this year. They also purchased a new car this year for $28,000 by taking out a car loan from their credit union. They paid $975 in interest on the car loan this year. How much can Pablo and Adriana deduct for interest expense this year if they itemize their
deductions? Pablo & Adriana- Interest Expense-2 Facts Deduct? Pablo & Adriana file jointly Bought home at cost of $190,000 Made down payment of Gave mortgage of 38,000 152,000 Paid points at closing of
3,000 Mortage interest paid Bought new auto for 7,000 28,000 Financed auto with loan 28,000 Auto interest paid Interest expense deduction?
975 Pablo & Adriana- Interest Expense-3 Facts Deduct? Pablo & Adriana file jointly Bought home at cost of $190,000 Made down payment of Gave mortgage of 38,000 152,000 Paid points at closing of
3,000 Mortage interest paid 7,000 Bought new auto for 28,000 Financed auto with loan Auto interest paid 28,000 975
Interest expense deduction? 3,000 7,000 $10,000 Investment Int. Expense-1 Investment interest includes interest on loans to acquire or hold investment property and margin account interest paid to a broker.
Investment Interest Expense-2 Investment interest expense is only deductible to the extent of net investment income. Net investment income = excess of investment income over investment expenses. Excess is carried forward (indefinitely) subject to same limit in future years. CHARITABLE Gifts [money]
 CHARITABLE Gifts [Other prop.] [8: 42] Charitable Contributions Sec. 170 Congress allows individuals, corporations, estates and trusts to deduct contributions to certain qualified organizations. Partnerships & S corps pass the contributions through to partners and shareholders who then claim
deductions on their own tax returns. Charitable Contributions Qualified charitable organizations Government units (federal, state and local government) and entities formed and operated exclusively for religious, charitable, scientific, literary or educational purposes, including churches, nonprofit hospitals, school and universities, libraries, and social service agencies Direct contributions to needy individuals are not deductible
Charitable Contributions No deduction allowed to the extent that valuable goods or services are received in return for the contribution Exception - contributors to universities who receive preferred rights to purchase tickets for university athletic events may deduct 80% of the amount of their contribution. This important rule is not in our text. Charitable Contributions Individuals can deduct up to 50% of AGI
Excess contributions may be carried forward up to 5 years Charitable Contributions No deduction for contributions of the taxpayers services and rent-free use of the taxpayers property Out-of-pocket costs incurred for volunteer work for a qualifying charity are deductible Property other than long-term capital gain property is valued at lesser of FMV or basis
Contributions of LTCG Property LTCG property is valued at FMV (which is often greater than adjusted basis) Tangible personalty given to a charity which does not use the property in its tax-exempt activity is valued at the lower adjusted basis Contributions of LTCG Property Deduction for LTCG property valued at FMV is limited to 30% of AGI 30% limit can be avoided (and 50% AGI limit applied)
if taxpayer elects to use lower basis If made, election applies to all LTCG contributions that year Important rule, even though it is not in textbook. May be on the test. Charitable Contributions Stocks or other income producing property that have declined in value should be sold, so that the loss can be claimed with the sale proceeds donated Fees incurred for appraisals of donated property may be deducted as a misc. itemized deductions Deduction for donated vehicles sold by
charity limited to gross sales proceeds Arnold - Charitable Contributions-1 Arnold, a single individual, has adjusted gross income of $65,000 in the current year. Arnold donates the following items to his favorite qualified charities: $5,000 cash to the athletic department booster club at State University. This contribution gives him the right to purchase preferred seats to all home games. The value of this preferred right is $900. Continued on next slide Arnold - Charitable Contributions-2
Continued. Arnold gave ABC stock acquired six years ago at a cost of $6,000. FMV at date of contribution was $22,000. Personal clothing items purchased two years ago at a cost of $1,000. FMV at the date of contribution was $400. What is his charitable contribution deduction for the current year? Arnold -3 Adj. Gross Income Cash to Athletic Club Deduction limit - 80% ABC Corp. stock (L.T.)
Cost in 2009 FMV-2015 Deductible Amount Clothing Cost FMV Data $65,000 5,000 6,000 22,000 1,000
400 Return Arnold -4 Data Adj. Gross Income $65,000 Cash to Athletic Club 5,000 Deduction limit - 80% ABC Corp. stock (L.T.) Cost in 2009 6,000 FMV-2015
400 $23,900 David's AGI is $100,000. David bought investment realty several years ago for $49,000. Current value is $52,000 He gave it to the United Way to use as the site for a new local headquarters. He will retire immediately and he expects to have much less income in future years. David's maximum current year contribution deduction is: a. $30,000 b. $49,000 c. $50,000 d. $52,000 David - Gifts to Charity, etc.
Adjusted Gross Income Data $100,000 Land given to Am. Heart Assoc. Cost 49,000 Value 52,000 Amount of contribution
Limit as % of AGI Limit Alternative limit-50% if cost used. Alternative deduction 52,000 30% Return David - Gifts to Charity, etc. Adjusted Gross Income Data
Return $100,000 Land given to Am. Heart Assoc. Cost 49,000 Value 52,000 Amount of contribution Limit as % of AGI
Limit 52,000 30% $30,000 Alternative limit-50% if cost used. $50,000 Alternative deduction $49,000 Note: the test will not have
questions about contributions to foundations, including private foundations. Personal [12: 43] Casualty Losses (Business losses Pg. 9-14) Casualty Losses Family Auto. No Insurance coverage. Compute Gain or Loss before limits
Case 1 Case 2 $20,000 $20,000 $20,000 $20,000 $3,000 $24,000 Family Auto-Cost Family Auto-Basis Family Auto-Value Alternative Cases: Gain (Loss) Gain (Loss) 1. Sell for $3,000. 2. Totally destroyed by fire Casualty Losses Family Auto. No Insurance coverage.
Compute Gain or Loss before limits Case 1 Case 2 $20,000 $20,000 $20,000 $20,000 $3,000 $24,000 Family Auto-Cost Family Auto-Basis Family Auto-Value Alternative Cases: Gain (Loss) Gain (Loss) 1. Sell for $3,000. $0 $4,000 2. Totally destroyed by fire ($3,000) ($20,000)
Casualty and theft losses result from damage caused by a sudden, unexpected and/or unusual event. Fire, Storm, shipwreck, earthquake, theft, vandalism, terrorism. Often, termite damage is not sudden and does not qualify as being sudden and unexpected. Involuntary Conversions An involuntary conversion results from Theft embezzlement, larceny and robbery (but not simply losing items) Casualty requires a sudden, unexpected,
and unusual event such as a fire, flood, tornado, hurricane or vandalism Condemnation lawful taking of property for its fair market value by a government under the right of eminent domain Casualties and Thefts Gains and losses sustained on casualties and thefts are not under a taxpayers control so they receive special tax treatment Allowable losses (including personal losses) are immediately deductible Gains (receipt of insurance proceeds)
may be deferred if all insurance proceeds are used to repair the damaged property or to acquire qualifying replacement property (see later chapter) Casualty &Theft Loss Deductions Thefts are deductible in year of discovery Casualties in designated disaster areas: taxpayer can elect to deduct loss in preceding year. A net business loss is deducted from ordinary income; an investment loss is an itemized deduction. Loss from personal use assets is an itemized deduction. Individuals have additional limits on losses from personal-use property:
$100 floor per casualty (per event) 10% of AGI threshold Must itemize to deduct the loss Important Basic Amount How much is the loss before considering insurance reimbursement and limits on the deduction? Assume the home is worth $160,000 after a fire destroyed part of the home. The value was $200,000 before the casualty. This indicates a gross loss of $40,000. This requires an appraisal of the value before and after the casualty. Alternatively, the loss may be equal to the cost of repairs that return the property to its condition
before the fire. Jane's residence was totally destroyed by fire. Property had an adjusted basis of $150,000 and a FMV of $130,000 before the fire. Jane received insurance reimbursement of $120,000 for the destruction of her home. Jane's adjusted gross income was $70,000. Jane had no casualty gains. What amount of the fire loss is Jane entitled to claim as an itemized deduction on her tax return? Jane
Info. Adjusted gross income $70,000 Fair market value before casualty 130,000 Fair market value after casualty 0 Decline in value 130,000 Cost basis 150,000 Lesser of cost or decline in value 130,000 Insurance proceeds 120,000
Loss 10% of AGI $100 floor Deduction For a business casualty, loss is $150,000. Jane Adjusted gross income Fair market value before casualty Fair market value after casualty Decline in value Cost basis Lesser of cost or decline in value Insurance proceeds Loss
10% of AGI $100 floor Deduction For a business casualty, loss is $30,000. Info. $70,000 130,000 0 130,000 150,000 130,000 120,000 10,000 (7,000)
(100) $2,900 Gains on Involuntary Conversions If the insurance recovery on a casualty or theft is greater than the loss, the taxpayer has a gain Condemnations usually result in gain because proceeds received are usually fair market value Miscellaneous Itemized Deduct. [14: 29]
Employee Expenses Tax Preparation Costs Hobby, etc. [2% rule] [17: 31] Miscellaneous Deductions Only excess over 2% of AGI is deductible Unreimbursed employee business expenses Job hunting expenses (in searching for a new job in current line of business) Investment-related expenses Hobby expenses (up to hobby income) Tax preparation and planning advice
Which type of itemized deductions is included in the category of expenses that are deductible only if the aggregate of such expenses exceeds 2% of the taxpayer's AGI? a. Union dues b. Interest expense c. Moving expenses d. Medical expenses Glenn is an accountant who races stock cars as a hobby. Glenn earned a salary of $80,000 from his employer and won
$2,000 in races. Glenn had $4,200 of hobby expenses this year? What is the effect of the racing activities on Glenn's taxable income? Assume that Glenn itemizes his deductions but has no other miscellaneous itemized deductions. Glen, race car driver Salary (accountant) Gross racing income (hobby) Adjusted Gross Income Total
Racing $80,000 $2,000 $2,000 $82,000 (most of tax return omitted) Racing Expenses $4,200 Limit on hobby loss deduction
$2,000 Less 2% of AGI $1,640 Net deduction Increase in income from racing $360 $1,640 Itemized Deduction PHASE-OUT
[20: 50] Standard Deduction [22: 48] Exemption PHASE-OUT [24: 51] Phaseout of Exemptions-2015 Personal and dependency exemptions are phased out at a rate of 2% (for each $2,500 (or fraction thereof) ($1,250 for MFS)of AGI above thresholds: $258,250 if single
$284,050 if head of household $309,900 if married filing jointly or surviving spouse $154,950 if married filing separately Exemption Phaseout 1) (AGI threshold AGI)/$2,500 = Phase-out Factor (always round up to next whole number) 2) Phase-out Factor x 2 = Phase-out Percentage 3) Exemption Amount Exemption Reduction = Allowable Exemption Deduction Phaseout of Exemptions What is the total deduction for
personal and dependency exemptions for the following taxpayers? Married filing jointly with two dependents and AGI of $400,000 Exemption Phase-out Joint Return Adjusted gross income Threshold - page 7-25 Amt above threshold Layer amt($2,500 or $1,250) No. of layers
No. of Layers rounded up Disallowed % (2% per layer) 2015 $400,000 $309,900 $90,100 $2,500 Exemption Phase-out Joint Adjusted gross income Threshold Amount above threshold
Layer amount ($2,500 or $1,250) Number of layers Number of Layers rounded up Disallowed % (2% per layer) Exemption amount Number of exemptions Total exemptions before phase-out Exemption Deduction Disallowed 2015 $400,000 $309,900 $90,100 $2,500
Exemption Phase-out Joint Adjusted gross income Threshold Amount above threshold Layer amount ($2,500 or $1,250) Number of layers Number of Layers rounded up Disallowed % (2% per layer) Exemption amount Number of exemptions Total exemptions before phase-out Exemption Deduction Disallowed 2015
$400,000 $309,900 $90,100 $2,500 36.04 37.0 74.00% $4,000 3 $12,000 $8,880 Standard Deduction. Cover $6,300 single individual $12,600 married - joint return, Also S.Sp.
$6,300 married filing separately $9,250 head of household Additional standard deduction if taxpayer is elderly (age 65 or older) or blind $1,550 if single or head of household $1,250 if married or surviving spouse Standard Deduction Harry and Silvia, a married couple, are both age 67 and legally blind. What is their standard deduction for 2015? Standard Deduction
Harry & Silvia-Married Year: 2015 Basic Standard Ded. Additional Std. Ded. Amount Number Total Std. Deduction Standard Deduction Joint Harry & Silvia-Married Year: 2015 Basic Standard Ded. $12,600 Additional Std. Ded. Amount Number
$1,250 4 5,000 Total Std. Deduction $17,600 Dependents Standard Deduction-Pg 7-22 Dependents standard deduction is limited to the greater of: 1) $1,050 (in 2015) or 2) Earned income + $350 (up to otherwise allowable standard deduction) Earned income includes salary and wages Earned income does not include interest
income, dividend income, capital gains, or income as beneficiary of a trust Subject to regular limit of $6,300 (Single) Dependents Taxable Income Scott is 15 years old and qualifies as a dependent on his parents' tax return. In 2015 he earned $2,200 from a part-time job and received $1,200 of dividend income on stock given to him by his aunt. What is Scotts taxable income? Scott
2015 Wages Dividend Income Adjusted Gross Income Standard Deduction: Greater of: 1. Base deduction 2. Earned income + $350 Taxable Income $2,200 1,200 3,400
Scott 2015 Wages Dividend Income Adjusted Gross Income Standard Deduction: Greater of: 1. Base deduction 1,050 2. Earned income + $350. 2,550 Taxable Income
$2,200 1,200 3,400 2,550 $850 Itemized Deductions Itemized deductions provide tax benefit only to the extent that, in total, they exceed the taxpayers standard deduction Taxpayers can maximize use of the standard deduction and itemized deductions by timing certain
deductible payments Deduction Limits High income taxpayers deduction Standard deduction for dependent children Phase-out of Itemized Deductions Total deductions phased out by 3% of AGI in excess of $309,900 (Joint) in 2013 (single $258,250) Exception - deductions not phased out: Medical expenses Investment interest
Casualty and theft losses Total deductions are not reduced by more than 80% regardless of type Example A married couple has adjusted gross income of $325,000. They have itemized deductions of $22,000. Deductions totaling $10,000 are subject to phase-out, because the remainder are for medical expenses, which are not affected. How much of the deductions are phased out for 2015? See slides that follow.
Limit: itemized deductions Joint 2015 Adjusted gross Income $325,000 Pg-7-26 Threshold $309,900 Excess $15,100 Total itemized deductions
$22,000 Expenses Not Phased-Out (1) 12,000 Expenses Subject to Phase-Out $10,000 3% of excess 3% 80% of affected deductions 80% Lesser of two amounts above Total Itemized Deductions (1) Medical, Inv. Int., Gambling & Casualty losses. Limit: itemized deductions
Joint 2015 Adjusted gross Income $325,000 Pg-7-26 Threshold $309,900 Excess $15,100 Total itemized deductions $22,000 Expenses Not Phased-Out (1) 12,000
Expenses Subject to Phase-Out $10,000 3% of excess 453 3% 80% of affected deductions 80% 8,000 Lesser of two amounts above 453 Total Itemized Deductions 21,547 (1) Medical, Inv. Int., Gambling & Casualty losses. End
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