CHAPTER 5 Itemized Deductions & Other Incentives

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

2. Medical Expenses • 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

3. Health Savings Accounts (HSA) • 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

4. Taxes • 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

5. Sales Tax on New Motor Vehicle Purchases • 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

6. Overview of Interest • 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

7. Mortgage Interest • 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

8. Contributions • 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. 78 2010 Cengage Learning

9. Contributions - Substantiation • 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

10. Donation of Vehicles • 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

11. Casualty and Theft Losses • 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

12. Miscellaneous Deductions 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

13. Miscellaneous Deductions “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

14. Limitation on Itemized Deductions • Ability to deduct total itemized deductions is phased- out for high-income taxpayers • 1% x (AGI - threshold amount) • Threshold amount • $83,400 for MFSor • $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

15. Qualified Tuition Programs (QTP) • 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

16. Education Savings Accounts • 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

17. Higher Education Expense Deduction • 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