Module 27 Nonbusiness Deductions and Exemptions

1. Module 27Nonbusiness Deductions and Exemptions

2. Menu Classification of deductible expenses Deductions for adjusted gross income Standard deduction and itemized deductions Personal and dependency exemptions Phaseout of exemptions Reduction of itemized deductions

3. Classification of Deductible Expenses Key Learning Objectives Allowable deductions of individual taxpayers • Order of deductions • Relationship of deductions • For AGI and • From AGI

4. AGI & Deductions From AGI • Itemized deductions reduced by AGI • Medical--7.5% • Miscellaneous--2% • Casualty--10% • Charitable--total deduction limited by AGI

5. §162 Trade or Business Expenses • Generally deductible • Must be • Ordinary • Necessary • Reasonable

6. §162 Trade or Business Expenses • If self-employed • Deductible for AGI • If employee • Deductible from AGI if unreimbursed • Reimbursed--non-accountable plan • Subject to 2% floor

7. §212 Expenses forProduction of Income • Generally deductible • Must be • Ordinary • Necessary • Reasonable

8. §212 Expenses forProduction of Income • For production/collection of income • For property held for production of income • Management/conservation/maintenance • Determination/collection/refund of any tax

9. §212 Expenses forProduction of Income • For AGI • Rental and royalty expenses on Sch E • From AGI • Most investment related items • Except taxes, interest expense • Miscellaneous 2%

10. §262 Personal Expenses • Generally not deductible • Exceptions for certain itemized deductions

11. Deductions for Personal Items“Otherwise Allowable” • Interest expense • Charitable contributions • Taxes • Medical expenses • Casualty losses

12. AGI Limitations • Medical--7.5% AGI offset • Misc..-- 2% - 2% AGI offset • Overall--3% AGI offset

13. AMT Add-Backs • 100% of taxes • 100% of misc.... 2% • Additional 2.5% AGI offset on medical • Equity interest expense

14. Deductions for Adjusted Gross Income Key Learning Objectives • Introduction to deductions for AGI • Moving expenses--covered in Mod 25 • Alimony payments covered in Mod 25 • Penalty on early withdrawal of savings • Health insurance costs for self-employed taxpayers • Interest on certain student loans

15. Standard & Itemized Deductions Key Learning Objectives (1) • Standard deduction • Itemized deductions • Medical expenses • Taxes

16. Standard Deduction 2000 • Married, Joint--------------- 7,350 • Married, Separate-----------3,675 • Head of Household---------6,450 • Single-------------------------4,400 • If dependent-- at least 700 increased by • earned income plus 250 • but not to exceed 4,400 • Note: several special rules for this group

17. Standard Deduction Add On • Blind and/or over 65 • Taxpayer and/or spouse only • Could be 4 add-ons per married, joint return • 2000 amounts • Married -- $850 • Single and head of household -- $1,100

18. Medical Expenses • Qualified expenses paid in tax year • For self, spouse, dependents • Also for would be dependent • Who has too much gross income

19. Qualified Medical Expenses • Only prescription medicine • Limited weight loss • Not cosmetic surgery after 1990

20. Medical ExpensesCapital Expenditures • Qualified expense for • Cost more than the increase in FMV • Meet strict requirements as to need

21. Medical ExpensesInstitutionalized Care • Nursing home only if medical care is primary purpose • Special schools--blind etc.... • If special facilities are primary purpose

22. Medical ExpensesReductions to Amount Spent • Reduce by insurance proceeds • Reduce by 7.5% of AGI • Reimbursements generally not income • Include in income if tax benefit in prior year

23. Income Taxes • All deductible • Except U.S. Federal • Optional credit treatment for foreign taxes

24. Property TaxesAd Valorem • Real estate taxes (RE) • Prorate RE tax when property sold • Other taxes if assessed on value • Not assessment for improvements

25. Standard Deductions and Itemized Deductions Key Learning Objectives (2) • Itemized deductions • Interest expense • Charitable contributions • Casualty and theft loss deductions for personal use property--on last test only • Miscellaneous itemized deductions

26. Interest Expense Categories • Active T/B • Qualified residence interest • Investment interest • Tax exempt investments--N/A • Consumer interest--N/A after 1990 • Passive T/B--follow PAL rules • To carry passive investment • To run passive T/B

27. General Limitations on Interest Deduction • Payer must be obligated on debt • Can't deduct prepaid interest

28. Interest Expense“Follow the Money” • Must track borrowing to show how money was used • Interest expense limitations based on how funds spent

29. Interest Expense Limitations • Active T/B--no limits to deductibility • Investment interest • Current deduction limited • Tonet investment income • Excess carries over indefinitely

30. Investment Income • Investment income • interest • dividends • Overpaid, refundable taxes • Interest on the refund • net capital gain • if you give up special tax rates

31. Investment Expense • Investment expenses • all related expenses • real estate taxes on investment property • management fees • safety deposit box fees • magazine subscriptions • if subject to 2% limit, only that left in excess of the limitation

32. Net Investment Income • the excess of investment income over • investment expenses

33. Example 1: Deductible investment interest expenseNo deductions relating to investments • $20,000 of interest expense on funds borrowed to buy stock • Taxable income: • $100,000 W2 wages • $ 8,500 interest income

34. Example 1: Deductible investment interest expenseNo deductions relating to investments • Investment income _______ • Related expenses _______ • Net investment income _______ • Investment interest deduction _______

35. Example 1: Deductible investment interest expenseNo deductions relating to investments • Investment income $8,500 • Related expenses 0 • Net investment income 8,500 • Investment interest Deduction 8,500 • Carryover 11,500

36. Example 2: Deductible investment interest expense • Deductions relating to investments • RE taxes of $2,000 • $20,000 of interest expense on funds borrowed to buy stock • Taxable income: • $100,000 W2 wages • $ 8,500 interest income

37. Example 2: Deductible investment interest expense • RE taxes are fully deductible on Schedule A, so • Investment income _______ • Related expenses _______ • Net investment income _______ • Investment interest deduction _______

38. Example 2: Deductible investment interest expense • Investment income $8,500 • Related expenses 2,000 • Net investment income 6,500 • Investment interest Deduction 6,500 • Carryover 13,500

39. Example 3: Deductible investment interest expense • Deductions relating to investments • Management fees of $2,000 • $20,000 of interest expense on funds borrowed to buy stock • Taxable income: • $100,000 W2 wages • $ 8,500 interest income

40. Example 3: Deductible investment interest expense • Mgt fees are deductible only if in excess of 2% of AGI • Here AGI = $108,500 • 2% = $2,170 • Since mgt fee was only $2,000 and no other misc 2% deductions, deduction = 0

41. Example 3: Deductible investment interest expense • Investment income _______ • Related expenses _______ • Net investment income _______ • Investment interest deduction _______

42. Example 3: Deductible investment interest expense • Investment income $8,500 • Related expenses 0 • Net investment income 8,500 • Investment interest Deduction 8,500 • Carryover 11,500

43. Example 4: Deductible investment interest expense • Deductions relating to investments • Management fees of $8,000 • $20,000 of interest expense on funds borrowed to buy stock • Taxable income: • $100,000 W2 wages • $ 8,500 interest income

44. Example 4: Deductible investment interest expense • Management fees are deductible only if in excess of 2% of AGI • Here AGI = $108,500 • 2% = $2,170 • Since management fee is $8,000 and no other misc 2% deductions, deduction = $5,830

45. Example 4: Deductible investment interest expense • Investment income _______ • Related expenses _______ • Net investment income _______ • Investment interest deduction _______

46. Example 4: Deductible investment interest expense • Investment income $8,500 • Related expenses 5,830 • Net investment income 2,670 • Investment interest Deduction 2,670 Carryover 17,330

47. Special Rules for Qualified Residence Interest (QRI) • Only 2 principal residences • 1 million total acquisition indebtedness • Plus 100,000 equity indebtedness

48. Acquisition Indebtedness (ACQ) • Loan secured by property • Funds used to build/improve etc.... • Limited to 1 million if after 10/16/89 • Outstanding loans at 10/17/89 • Grandfathered-in as QRI • No limit as long as secured by property

49. Equity indebtedness • Excess of FMV over ACQ debt • Funds can use for anything • Must be secured by property • Limited to 100,000 debt • AMT add back

50. Points Paid • Points on acquisition of debt deductible if • Purchase of principal personal residence • Not borrowed from lender • OK if paid by seller • Points N/D if rental or if refinancing • Amortize over life of loan